May 30, 2006

May 30, 2006 | Commentary on Taxes

Unfixed tax code

While Americans struggle to comply with one of the world's most complicated tax codes, it's worth noting that about one-dozen nations have adopted simple and fair flat-tax systems.

Hong Kong has had a flat tax for nearly 60 years, and has gone from being one of the poorest places on the planet to a first-class economic powerhouse. Even the rulers in Beijing who now control the former British colony are smart enough to realize that it would be foolish to change course and kill the proverbial goose.

Too bad American politicians aren't as economically astute as Chinese communists. Congress occasionally pays lip service to fundamental tax reform, but the House and Senate can't even agree to extend the lower tax rates on dividends and capital gains -- even though the economy has been booming ever since those supply-side provisions were enacted in 2003.

Unfortunately, there are several reasons why taxpayers shouldn't expect politicians to fix America's corrupt tax system. The first is that politicians of both parties are hopelessly addicted to big government. Democrats actually think it's a virtue to make America more like France by spending taxpayer money like drunken sailors. Republicans pretend they prefer smaller government, but the past five years show that their compulsion to spend other people's money rivals the need of a drug addict to get another fix.

Regardless of motive, it's difficult to improve the tax code when government spending is growing three times faster than inflation. The fight over dividends and capital gains is a good example. Ever since those tax-rate reductions were enacted, economic growth has been so strong that federal tax revenues have increased by about 8.7 percent annually. But Republicans and Democrats are spending the extra revenue with abandon. Government spending since 2003 has increased by an average of 7.8 percent!

Not surprisingly, the politicians who are first in line to spend other people's money are now engaged in phony hand-wringing about deficits. They piously assert that the nation cannot afford to extend the tax cuts. If they were being honest, they would admit they want to raise taxes back to 2003 levels so they can increase spending even faster (and make the deficit bigger since a tax hike will slow growth).

As bad as the situation is today, it's going to get worse. Thanks to irresponsible legislation such as the prescription-drug entitlement, long-term projections show that government, left on auto-pilot, will expand dramatically over the next 30 years. Needless to say, if America has a France-sized bloated government, we'll likely have an oppressive French-type tax system to go along with it.

The second problem is that the politics of hate-and-envy still rein supreme. Many elected officials use the tax code to exploit class warfare for political gain, and their top goal is to impose high tax rates on the so-called rich. This is a particularly destructive impulse since tax rates often are set so high that the economy suffers (thus hurting those of us without Donald Trump-sized wallets) and tax revenues go down rather than up (thus depriving politicians of money they can use to buy votes).

The fight over dividends and capital gains is a good example. The stock market has jumped since these tax cuts were enacted in 2003 and the economy is growing much faster. As a result, the government is collecting more money, especially from taxpayers with larger incomes. Yet many politicians refuse to extend these tax cuts. Bizarrely, they're willing to hurt everyone else just to penalize those who contribute most to U.S. competitiveness.

The third problem is special-interest corruption -- the biggest obstacle. Politicians can raise a lot of money by trading tax loopholes for campaign cash. Lower taxes are a great thing, but carving out special tax shelters for interest groups with richest lobbyists is not a recipe for a pro-growth tax system. Indeed, special tax breaks harm growth, since they lure people into making decisions for tax reasons rather than what makes sense from a business perspective. Not only that, every special tax break creates a risk that politicians will raise tax rates on work, saving and investment to compensate for the foregone revenue.

The internal revenue code is a giant mess, and it's getting worse every year. A flat tax would solve many problems. But there's little reason to expect politicians to move in this direction. After all, the current system works fine for them.

Daniel J. Mitchell is the McKenna senior fellow in Political Economy at The Heritage Foundation.

About the Author

Daniel J. Mitchell, Ph.D. McKenna Senior Fellow in Political Economy

First appeared in the Washington Times