From Kip Hagopian:

The following is an email exchange I had with David Frum, a friend who expressed certain objections to the notion of abandoning the progressive income tax.  David is a Republican, a commentator on CNN, and the author of a blog named, “The Frum Forum”.  The email exchange started on April 6 and ran through April 11.  My comments begin just below, and continue as inserts (in red) in David’s April 6 email.  It is best to read from the bottom up.

—–Original Message—–
From: Kip Hagopian
Sent: Friday, April 08, 2011 11:26 AM
To: ‘David Frum’
Subject: RE: thoughts/trying again

Hi David,

These are very useful comments, particularly the ones that disagree with my thesis.  It is very good for me to have someone of your intellectual heft challenge me.  I have responded to most of your comments by inserting my own in red.

An overall comment I would make is that, as far as I could tell, there is very little in what you have written that challenges the intellectual foundation or merits of my basic arguments to the effect that progression is inequitable.  The thrust of your comments seems to be that: 1) when other taxes are taken into account, the system is not all that progressive; and 2) income inequality is a festering, growing sore on the body politic that is dangerous to our democracy and must be redressed.  Did I get that right?  If so, it seems that are you saying that even if our current federal tax system is, in fact, unfair (particularly to those who were born with the fewest gifts), it’s not unfair enough to run the risk of alienating the public.  Is that about right?  If so, we may have a philosophical difference of opinion on this point, which are the hardest differences to reconcile.  I believe the federal system is quite progressive and it hurts people with more lowly valued aptitudes much more than it hurts rich people.  Moreover, I believe that any system we put in place should be based on an equity principle that supports it.  In all my reading of the literature, I could not find any such principle that persuasively supports progression.  

It is true that there are other tax systems that are regressive–the most prominent of which is the sales tax (is there another one?).  It is also true that a strong argument can be made that regressive taxes are unfair.  But if such a system is unfair, that should give rise to an effort to reform that system; not to efforts to sustain another system that is unfair in the other direction.  (By the way, I have not thought deeply on this, but I am not a big advocate of consumption taxes.  I think income is a decent proxy for the value of the benefits we receive from our government.   Thus, we should pay for those benefits out of income through a proportionate tax. Just as taxing investment income is distortive, I believe taxing consumption is distortive.  I have a running dialectic going on this topic with two of my U of Chicago trained economist friends.)

 By the way, I inferred from some of your comments that you may not have read the most up-to-date version of the paper.  If that is true, I urge you to read it; it is much better than the draft you read a year ago.  If you decide to read, please read the unabridged version. (For what it is worth, the unabridged includes a section on “social justice” on pages 25-27.)

Thanks for all of your time and help.

Best,

Kip

---

From: David Frum [mailto:david.frum@mac.com]
Sent: Wednesday, April 06, 2011 8:06 AM
To: Kip Hagopian
Subject: Fwd: thoughts/trying again

Begin forwarded message:

From: David Frum <david.frum@mac.com>

Date: April 5, 2011 8:56:01 AM EDT

To: “Hagopian B. Kipling & Mary Anne” <KHagopian@appleoaks.com>

Subject: thoughts

Some thoughts that may be useful for you, then comments that maybe less useful afterward.

DAVID’S INITIAL “THOUGHTS” BECAUSE THEY WERE PERSONAL.

************************

David’s comments: Now as to my own views:

I’m in an ironic position here, since I prefer a tax code with a few simple rates. I think we got it close to right in 1986, and the falling away since then has been troubling to me. I agree with your key point that progressivity can work horizontal injustice to people who apply more work effort.  

I worry a lot about the economic costs of tax avoidance in a progressive system. They are very visible on the corporate tax side, but no less real on the individual side.

So why don’t I concur with the full conclusions of the paper?

Some of the reasons:

1) Your argument applies more forcefully the more steps there are in the progression, and especially for the intermediate brackets, where most incomes are found. In the 1970s, there were (I recall) 11 brackets, bunched closely together. Your situation exactly. But I don’t think it applies very forcefully to our world, where the top bracket hits at $373,000. The overwhelming majority of Americans earn incomes that will be taxed at either the 15% or 25% rates – the universe between $8000 of taxable income and $80,000. 

I may not understand your point here.  Having more brackets only smooths out the curve, it doesn’t change the basic fact that harder workers receive lower average, after-tax income per hour than workers who don’t work as hard.  The Class brothers are basically in the category you describe and yet, the outcome is clearly inequitable.  I have run the case for the three brothers where their respective incomes are: $25,000, $50,000 and $75,000 and Harry still comes out on the short end of the stick.  Thus, I don’t see how this impacts my argument.  Moreover, as you can see from footnote 1 of the paper, the tax brackets are only part of the equation; when you add in the various tax credits, the degree of progression is much higher. 

 2) Your argument ignores deductions, which in the real world are the real workers of horizontal inequity. If the brothers in your story all earned the same salary – all chose equally desireable dwellings – but one chose to buy his home in cash, the second to buy his home with a mortgage, and the three to rent – they would report much more dramatic differences in their tax treatment than 3 brothers earning the salaries most Americans earn. Ditto for state & local taxes. Ditto for one with a generous health plan vs one with no health plan at all.  

As you can see in footnote 1 of the essay, I don’t entirely ignore deductions.  As noted in the footnote, many of them tend to increase the degree of progressivity.  It is true that the brothers’ respective tax obligations would be different if they chose the routes you describe. (By the way I think the deduction for mortgage interest should be eliminated. Ditto for state and local taxes.  I also think that employee-provided health insurance benefits should be taxable income to the employee; either that, or  the field should be leveled so everyone who purchases his or her own insurance should get a tax deduction.) But how does the existence of deductions change anything with respect to the inequity of progression.  Are you saying that it is OK to tax progressively if mortgage interest or state taxes are deductible?  What if it is Tom and Dick that gets a mortgage and Harry doesn’t; in that event Tom and Dick would each pay even lower taxes than they do now.  As to state and local taxes, the deduction would be more or less proportional, so how does this change anything?

To do an honest analysis of this, I believe you have assume that all the brothers do the same thing (e.g., get a mortgage).  If they did, Harry might do better because he has more income to shelter.  But but he has that extra income solely because he works harder. Why should he be penalized for this?

3) Finally as I said on the phone, the American tax system as a whole is not very progressive. The federal income tax is not even half of federal revenues! Then you have to consider the state burdens… There is only one taxpayer after all.  

Excluding payroll taxes (see comments below), it is much more than half of the taxes paid by individuals.  Isn’t this what counts?

Combine the progressive federal income tax with the (at least for now) Medicare tax and the outright regressive Social Security tax – the regressive sales tax regimes of the states – and the more or less arbitrary with regard to income system of property taxes – and you get a different picture. And that’s before we consider the ease with which the very wealthy can redesignate income as capital gains … So I am left wondering at the real world relevance of your argument.
 

We may have a real philosophical difference on this point.  As I say above, I don’t think it makes any sense at all to create or sustain a tax system that you know is inequitable for the purpose of mitigating the inequities or reducing the “burdens” of some other tax system.  (As to the “burdens” of state taxes, remember that those taxes are being paid for benefits just like federal taxes are. That is the principal reason that they should not be deductible.)  If sales taxes or property taxes are unfair ways to pay for the benefits of the state, change the system.

As to “the ease with which the…wealthy can redesignate income as capital gains”:  I know this is a view held by the press and many politicians, both Democrat and Republican.  It is also commonly believed that rich people can hire lawyers and accountants that will substantially reduce or even eliminate their taxes.  If that is true, I feel stupid.  I am what some would call “rich”.  And I employ some of the best tax people on the planet. But I and my tax advisors really don’t know how to convert my earned income into capital gains income.  I also don’t have a clue as to how to reduce my taxes below the amounts indicated in the tax tables (I am in AMT, so I don’t even get deductions).  The notion that rich people can shelter substantial parts of their income is largely a myth.  The only shelters for individuals (as contrasted with corporations) that exist anymore are the ones that Congress has deliberately built into the system under pressure from special interest groups to encourage certain behavior deemed important to the economy, or “the greater good”. Incentives to invest in real estate is a prime example, but the benefits are quite small and most, if not all of them, should be abolished.  Another example are subsidies for buying “green” cars and other green things.

The “real world relevance” of my argument is that the vast majority of federal taxes paid by individuals in the lower and middle classes are the product of an inequitable system that primarily hurts people with more lowly-valued aptitudes.  That is the real world in my view.

I know you argue that the payroll tax is not a tax but a system of forced saving. I doubt you ‘ll persuade many people with this argument. The payroll tax creates no individual property rights. Benefits can be adjusted at any time by simple act of Congress, even abolished outright. (As Paul Ryan now proposes to do for much of the Medicare claims of everyone under 55.) In 1937, the Supreme Court formally adjudicated the payroll tax a tax. That’s why it’s constitutional. (And why the individual mandate in healthcare may not be … unless it’s redesignated a tax, in which case it clearly would be.) 

Re Social Security:  OK, let’s call it a tax.  But please explain to me why you think it’s regressive?  Despite the lack of a guaranteed contract, and despite the fact that different cohorts have been, and may in the future, be treated differently, each individual in a particular cohort will be treated the same as every other individual in the cohort with respect to the relationship between money paid in and money taken out.  The point is that the payments made into the system are directly proportional to the benefits each individual ultimately receives.  Thus, the tax is not regressive.  Moreover, when Social Security income is paid out, 85% of it is lumped in with other income (if any) and is taxed at progressive rates.  I don’t think any of this is in dispute by tax experts.   If you know such an expert who disagrees with this, I will definitely be interested in hearing his or her rationale.

Warren Buffett notes that he pays a lower rate of tax than his secretary. Because of the combined workings of the payroll tax and the capital gains tax, there are many, many wealthy people in theUnited States who can say the same.  

As I say above, it is a misnomer to equate payroll taxes to income taxes.  Social Security taxes are paid in return for very specific benefits that are proportional to the amount the individual pays into the system.  In the case of Medicare, the tax is redistributive (the tax is proportional to income, but the benefits are basically the same for everyone).  In the opinion of my tax expert, neither of the payroll taxes are regressive.

As to capital gains taxes (and all other income from savings), most economists believe (I can’t imagine who would not) that such taxes violate the principle of horizontal equity. To wit: if two people have the same lifetime earned income, tax equity requires that they each pay the same amount of taxes.  But if one person uses all of his income for consumption, and the other forgoes consumption in favor of saving, the latter will pay higher lifetime taxes simply because he saved for his future.  This is inequitable.  Moreover, all capital gains from corporations are second taxes on corporate income, which is already is taxed at 35%.  But I don’t want to debate this ( let’s save it for another paper).  It is just something to keep in mind to remind you that there are a lot of things wrong with the current tax system.

4) I’m left to wonder: if not the progressive income tax, what IS the policy response to the intensifying inequality within theUS? In the 2000s, we lived through a decade where virtually all the benefits of economic growth were claimed by the wealthiest few. (GDP/capita rose sharply, but wages stayed flat, even for college graduates.) I think that’s a problem.   

I guess you don’t agree with my analysis in the section on “Reducing Income Inequality” (pages 17- 22).  If you measure income inequality by the Gini Coefficient (which is the most commonly accepted measure), there was no change in money income inequality from 2000 to 2009.  But money income is really a poor measure of either income income inequality or standard of living.  If you used a comprehensive measure of income, the Gini declined by almost 2% during the period 1993 to 2009.  Moreover, if you look at consumption inequality (which the consensus of economists believe is the best measure of standard of living over the long term) it doesn’t not appear to have increased for 16 to 23 years.

As to flat wages, this also does not appear to accurate, at least over the last 25 years (I haven’t looked at the 2000s).  Please go to page 20 of the unabridged and you will see data from the CBO that indicates that when using a comprehensive measure of income (as defined),  during the years from 1983 to 2005, real median household income grew 35%. The economy was strong in the years 2006, 2007 and the first half of 2008, so I would think (but am not certain) that this growth would have continued.

I am not sure where you got the facts you cite above, but I am pretty sure mine are accurate.  If you have other sources that show my data are wrong, I would like to know about them.

The progressive income tax is a poor instrument to deal with this problem, but along with the even more dysfunctional estate tax, it’s the only one we’ve got. If not that, then what? Nothing? ANd what happens to our democracy if nothing is done?  

I don’t know why you are worried about income inequality. Isn’t it more important to worry about the median standard of living while ensuring that our truly needy citizens are taken care of? By the way, there was a huge study done in 2004 (?) that indicated that Americans were not really worried about income inequality.  I can get you the cite if you are interested.

The richest man in the US in 1960, J Paul Getty, could not possibly have funded a presidential election campaign himself. (Joe Kennedy’s crack about “not paying for a damn landslide” applied to a single primary, and in one of the country’s poorest states.) But George Soros or the Koch brothers or Sheldon Adelson could buy negative ads to equal the entire billion-dollar Obama campaign – and still have multiple billions left over. We’re getting into the territory here of the late Roman Republic, where as the triumvir Marcus Licinius Crassus said, no man should be considered rich unless he could field a private army.

This is another area where we may see things differently.  It would be fun to discuss it some day over a cocktail.  Suffice it to say for now that, if the cost of achieving the massive world-wide productivity gains that have been brought about by Intel, Apple, Microsoft, FedEx, Google, etc., is that Bob Noyce, Gordon Moore, Andy Grove, Steve Jobs, Bill Gates, Fred Smith and Sergey Brin and Larry Page, all end up becoming multi-billionaires, then I am really happy with income inequality.  By the way I know or knew most of these people and they are all as decent and compassionate as you and I are (or think we are).  And they give/gave much more to charity.

David