Red Ink Read online

  Why such a declining share? In part, because Congress has offered corporations all sorts of tax breaks. And, in part, because businesses have exploited loopholes or shifted profits overseas or legally organized themselves into entities that aren’t subject to the corporate tax. (That last factor is a big one: in 1980, 22 percent of all U.S. business profits were booked by outfits organized so they didn’t pay corporate taxes, though their owners—like partners in a law firm—paid individual income taxes on the profits. In 2008, 73 percent of all business profits were in entities that didn’t pay corporate taxes.)

  With competition from abroad to attract businesses increasingly stiff, most economists and many politicians challenge the wisdom of relying more heavily on corporate taxes. Both the White House and congressional Republicans were flirting with corporate tax reform in early 2012, but both were talking about rearranging the burden among businesses, not raising more money from corporations.

  The federal government’s only explicit tax on wealth—the estate tax levied on the money that the wealthy leave when they die—was an important source of revenue in the 1930s but has been on the wane ever since. Last year, it accounted for much less than 1 percent of revenues. Unlike most other developed countries, the United States at the federal level doesn’t rely on broad sales taxes on consumer spending, such as the value-added tax common abroad.

  This book focuses on the federal government, but Americans pay state and local taxes, too. For every $1 the federal government raised in 2011, state and local governments collected another 58 cents from sales, property, income, and other taxes. That measure recently has been distorted by the federal government’s ability to cut taxes and run deficits during a recession; most states can’t do that. But even before the recession, the weight of state and local taxes rose from 44 cents for every $1 of federal taxes in 2001 to 49 cents in 2007. Of course, the burden varies widely by state. State and local governments in New York take about 15 percent of personal income, while in Missouri they take about 9 percent.

  WHO MAKES THESE DAMN TAX LAWS ANYHOW?

  Details of tax laws—more than almost anything else Congress does—are largely the province of congressional and Treasury staff tax experts and battalions of well-paid lobbyists. Particularly the lobbyists. At last count, more than 12,500 people were registered as lobbyists in Washington, all trying to influence the government, many of them toiling over an obscure piece of the tax code that matters to a handful of companies.

  Among them is Jon Talisman. He is a balding tax lawyer and accountant who would never be cast as a flashy lobbyist in a Hollywood drama about money and politics. But he is both typical and highly successful, regularly named one of the two or three dozen most influential lobbyists in Washington. Talisman spent eight years as a tax lawyer in private practice, six as a congressional staffer, and another four years as a top tax official in the Treasury during the Clinton administration, much of that time waging war against tax shelters. In 2000, he turned to lobbying because, he says, “Gore lost and I got fired.”

  He formed Capitol Tax Partners, a firm that, like most others, deliberately mixes tax experts who once worked for Democrats with others who had worked for Republicans. The firm’s client list includes brand-name companies like Delta Airlines, Federal Express, JPMorgan Chase, Time Warner, and 3M that pay retainers of between $10,000 and $20,000 a month. Talisman’s office in a modern building at 101 Constitution Avenue is triangular in shape. The placement of the conference table in front of a large window tells clients they’ve come to the right place: Talisman sits with his back to the window. The client sits on the other side. Over Talisman’s shoulder, perfectly framed in the window, is the U.S. Capitol building.

  The job of getting or protecting tax breaks for companies is harder than it used to be, Talisman says. One reason is the overwhelming size of looming federal budget deficits. “Everybody understands that deficits make everything in the tax arena harder,” he says. “Tax reform”—the always popular, always politically treacherous goal of making the tax code simpler and smarter—“is really difficult when you can’t throw money at it. Losers always squeak louder than winners cheer,” he says. Another reason is the passing of the day when there was bipartisan cooperation to fix glaring problems in the tax code—outdated provisions, conflicting requirements, abused loopholes, sections that had been challenged by the courts. “You didn’t worry about whether it raised revenue or lost revenue,” he recalled. “Today, if it raises revenue, it’s a tax increase. And if it loses revenue, it’s a special-interest provision.” And either one makes it controversial.

  RESISTING TAXES: FROM LADY GODIVA TO GROVER NORQUIST

  Taxes are never popular, and resistance is perennial, sometimes successful. According to eleventh-century legend, Lady Godiva repeatedly begged her husband, Leofric, to lift heavy taxes he had imposed on the people of Coventry. He relented on one condition: that she ride naked on horseback through the streets. After demanding that everyone stay inside behind closed windows and doors, Godiva took her famous ride, and Leofric kept his promise. (A fellow named Tom, the story goes, cut a hole in his shutters to watch her—the original “Peeping Tom.”) The Boston Tea Party of 1773 was a reaction to the British tax on imported tea. The American Revolution was fought, in part, over colonists’ anger at “taxation without representation.” In 1794, in what was known as the Whiskey Rebellion, Pennsylvania farmers attacked federal agents trying to collect a tax on whiskey. The insurrection was forcibly quashed by George Washington, but populist anger at taxes has been a recurring theme in American politics ever since.

  In today’s Washington, one cannot talk about taxes without mentioning Grover Norquist, a round-faced Harvard MBA with a closely cropped beard who has been a Republican activist since he volunteered for Nixon’s 1968 campaign at age twelve. Norquist, fifty-five, has had a single mission since Ronald Reagan recruited him from the staff of the U.S. Chamber of Commerce in 1985 to build an organization to push for tax reform—i.e., to fight increases in tax rates. Nearly thirty years ago, Norquist’s Americans for Tax Reform asked members of Congress to sign “the pledge” that they’ll oppose any tax increases. “It’s very difficult to lie when you write it down,” Norquist says.

  Norquist has helped brand the Republican Party as the antitax party. Republicans who violate his pledge, he says, are as damaging to the image as reports of rat heads in Coke bottles would be to the Coca-Cola brand, he says. His organization raised more than $13 million in 2010, according to its latest available IRS filings.

  Norquist is not subtle. He keeps a miniature bathtub on his desk, a reference to a 2001 NPR interview in which he famously declared: “I don’t want to abolish government. I simply want to reduce it to the size where I can drag it into the bathroom and drown it in the bathtub.” He is funny, though, the runner‑up in a Washington’s funniest celebrity contest. (A sample: “I’m drinking bourbon neat. No water. I never drink water. Dick Cheney tortures with it.” Another, coming from the father of two: “The person who came up with the phrase ‘sleeps like a baby’ was an eighth-century eunuch who had never seen a baby, and had certainly never seen one try to sleep.”)

  Norquist insists the no-tax-increases pledge is made to voters, not to him, but he has become the arbiter of what policies would or wouldn’t violate the promise. That has made him a huge obstacle for those of both parties who see no way to bring the deficit under control except by raising taxes and cutting spending. Among them is Tom Coburn, a fiercely independent, conservative Republican senator from Oklahoma who began as a manager in the family manufacturing business, then went to medical school and became a family doctor and obstetrician. After six years in the House, Coburn left in 2001, keeping a vow to serve no more than three terms. But he came back to Congress as a senator four years later and lately has been among a bipartisan band—dubbed the Gang of Six—trying to fashion a package of tax increases and spending cuts to reduce the deficit. When he successfully pushed to eliminate a tax
break for ethanol, Norquist accused him of having “lied his way into office” because the resulting increase in revenues wasn’t used to reduce other taxes. “Which pledge is most important,” Coburn asked on Meet the Press, “the pledge to uphold your oath to the Constitution of the United States or a pledge from a special interest group who claims to speak for all of American conservatives when in fact they really don’t?”

  WHO PAYS? HOW MUCH?

  In the high-volume debate over taxes, facts about basic issues—who pays? how much? who doesn’t?—often get lost, twisted, or distorted. Perhaps the most salient and overlooked fact is this one: for most Americans, federal taxes have not risen over the past couple of decades.

  Over the last thirty years, the U.S. tax collector has sliced for itself a share of the national economic pie of about 18 percent of the GDP, which is the broadest way to measure the tax burden. The government’s take hit 19.6 percent in 1981 as Ronald Reagan was arriving in Washington, fell in subsequent years due to tax-cutting and recessions, and peaked at 20.6 percent in 2006 as George W. Bush was running for president, which was one of the forces that drove his tax-cut proposals. Before the Great Recession arrived in 2007, taxes as a share of GDP were hovering around 18.5 percent. Lately, the tax take has been unusually low—15.4 percent of GDP last year. That’s the consequence of the very weak economy and tax cuts enacted in response. The CBO projects that if current policies persist—that is, even if all the Bush tax cuts are renewed beyond December 31, 2012—revenues will rise gradually, returning to the 18 percent of GDP average in 2017.

  For ordinary Americans, the tax take as a percentage of GDP is hard to comprehend. Their question is simpler: how much of my paycheck does the government take? That answer depends on how much money they make and whether their income derives from wages or more lightly taxed profits from trading stocks or other capital gains.

  Although many taxpaying Americans suspect otherwise, the share of the income that most of them have been paying to Washington has been coming down over the past few decades.

  Consider taxpayers on the middle rungs of the ladder: the 60 percent of households whose incomes put them neither in the top fifth nor the bottom fifth—the ones with incomes these days between $16,800 and $103,500 a year. Their federal income taxes fell, on average, from about 8 percent of their income in 1979 to around 4 percent in 2007, according to the latest CBO estimates.

  Then add the payroll tax, generally split between employer and employee, which has been taking a bigger and bigger bite. The payroll tax is a big deal. In 2011, about 40 percent of all households paid more in the employee share of the payroll tax than they paid in federal income taxes. Combining the employee and employer shares of taxes (because the employer share comes out of the wages they would otherwise pay and because the self-employed pay both halves themselves), over 60 percent of households paid more in payroll than income taxes.

  The payroll tax rate has more than doubled over the past fifty years, and the ceiling on the wages to which it applies has risen with inflation. But because wages for the best-paid workers have been rising faster than those of other workers, the tax hit a shrinking fraction of all wages paid in the economy. The current tax rate is 15.3 percent—12.4 percent for Social Security (on wages up to $110,100 in 2012) and another 2.9 percent for Medicare (without any wage ceiling). At Obama’s urging, Congress has for the past couple of years declared a temporary 2-percentage-point tax holiday for workers. That is likely to disappear as the economy recovers. Beginning in 2013, Obama’s health reform law, the Affordable Care Act, imposes an additional 0.9% Medicare payroll tax on wages over $200,000 for individuals and over $250,000 for couples, and adds a new 3.8 percent tax on their investment income.

  A full tax accounting has to include not only income and payroll taxes, but taxes imposed on corporations that eventually are passed along to consumers, workers, and shareholders. Add them in and, by the CBO’s reckoning, that middle 60 percent of taxpayers paid about 19 percent of their income in federal taxes of all kinds, direct and indirect, in 1979. In 2007, it was down to 15 percent. In 2011, according to separate estimates by the Tax Policy Center, it was down to 13 percent.

  No one enjoys paying taxes, but public opinion polls suggest the attitude toward taxes is more complex than the rhetoric of antitax politicians sometimes suggests. In fact, recent surveys find fewer Americans complaining about the size of their federal tax bill. In December 2011, for instance, the Pew Research Center asked: “Considering what you get from the federal government, do you think you pay more than your fair share of taxes, less than your fair share or about the right amount?” Some 52 percent answered “the right amount,” significantly more than the 41 percent who gave the same answer in March 2003 shortly after Bush cut taxes significantly. Pew’s polls are no fluke. Gallup’s shows a similar trend.

  For a lot of Americans, the issue isn’t the size of their tax bill, but whether the tax code is—in their minds—“fair.” As Pew puts it, “The focus of the public’s frustration is not how much they themselves pay, but rather the impression that wealthy people are not paying their fair share.” In the December 2011 Pew poll, 55 percent said the U.S. tax system isn’t fair.

  TAX RETURNS: FROM NIXON TO ROMNEY

  This off-again, on-again “fairness” issue surfaced early in the 2012 Republican presidential primaries when Mitt Romney, reluctantly, released his 104-page tax return. “Tax returns of the rich and famous have a way of highlighting important policy issues that often get ignored in public debate,” tax columnist Joseph J. Thorndike said at the time. Indeed.

  Romney’s return revealed that he and his wife had income of $20.9 million in 2011 and paid $3.2 million in federal income and payroll taxes. In other words, they paid about 15 percent of their gross take (that is, before deductions) in federal income and payroll taxes, much less than the typical upper-income taxpayer. Romney’s income was largely from capital gains (taxed at a lower rate than wages), and his taxes were reduced by big deductible charitable contributions, mainly to the Mormon Church.

  The controversy over Romney’s taxes was nothing compared to the one that erupted over Richard Nixon’s during the Watergate scandal. On November 17, 1973, four hundred newspaper editors gathered at Walt Disney World for a televised question-and-answer session with the president. Nixon was tense. He had been reelected, but his presidency was on the rocks. He joked that if Air Force One went down, Congress “wouldn’t have to impeach.” The joke drew laughs, but the editors pressed him about the Watergate break-in and subsequent cover‑up as well as a less-remembered scandal: his taxes.

  The Wall Street Journal had reported that the president’s handwritten tax returns (fewer than twenty pages each) revealed that he had paid just $5,100 in combined federal income taxes for 1970, 1971, and 1972 on income that totaled $795,000. His 1970 tax bill was only $792. It would have been zero if not for the alternative minimum tax enacted in 1969 over Nixon’s objections, to make sure no one got so many deductions and credits that he or she came close to avoiding taxes altogether. The new tax followed testimony by the Treasury secretary that 155 households with incomes above $200,000 in 1967 (about $1.4 million in today’s dollars) hadn’t paid any income taxes. Tax historians speculate that Nixon’s $792 bill in 1970 may have been made him the first AMT taxpayer.

  It was during questioning about all this that Nixon uttered the famous words: “I’m not a crook. I’ve earned everything I’ve got.” That was true, but he had cheated on his taxes. He took a questionable $576,000 deduction for donating his vice presidential papers to the government, though the transfer documents were later found to have been backdated. He overdid the home-office deductions for his San Clemente, California, house, claiming it was his primary residence even though he was living in the White House, and then, to top matters off, he didn’t pay state taxes in California despite alleging that he was living there. After audits by the IRS and, because the Nixon White House had so undermined the credibility of
the IRS, audits by the staff of the congressional Joint Committee on Taxation, Nixon ultimately agreed to pay $465,000 in back taxes for those years. No surprise, every president since Nixon has released his tax returns voluntarily. Nixon’s successor, Gerald Ford, reported paying more than $95,000 in federal income taxes in 1975 on gross income of $252,000, a 38 percent tax rate.

  The flap over Nixon’s taxes, largely forgotten today, focused public attention at the time on the “fairness” of the tax code—who should be asked to pay how much—and the capacity of the best off to find ways to reduce their taxes. That debate has been revived lately for reasons beyond Romney’s tax returns: the gap between winners and losers in the U.S. economy has been widening substantially. Underlying the debate over how much to tax the rich is a fundamental disagreement about how hard the government should use the tax code to resist that tendency. Obama would raise taxes on those with incomes above $250,000: “Those who have done well, including me, should pay our fair share in taxes to contribute to the nation that made our success possible,” he argued. Romney objected. His counterargument: “You know, there was a time in this country that we didn’t celebrate attacking people based on their success and when we didn’t go after people because they were successful.”

  It is important to understand the starting point. Today’s tax code does take more from the rich than from the middle class and the poor. The political issues are whether the rich, whose share of national income has been growing, should pay even more and whether making them do so would have undesirable side effects on the economy. Here’s where things stand today, based on estimates covering all federal taxes—income, payroll, and corporate—produced by the Tax Policy Center: