What is, “Variations on a Theme?”

The Independent is launching a new feature this month called “Variations on a Theme.” We will occasionally choose a theme and suggest works related to it. We hope you enjoy the results.

Because we’re based in Washington and this is a presidential election year, we begin with a political theme. The books we selected address some of the issues of this electoral campaign.

Q&A – Len Burman and Joel Slemrod, authors of Taxes in America: What Everyone Needs to Know

You declare in your Foreward the need for a “clear concise” explanation of how our tax system works, but the 260+ pages that follow contain quite a lot of information — description, examples, economic analysis. Who do you see as your readers and what do you hope they’ll take away from the book? Are you pitching this at college economics majors, or maybe incoming members of Congress and their staffs who will have to wrestle with tax reform and understand economic issues driving such debates?

The books in this series break up complex, sometimes highly charged topics into digestible bits.  Our book is definitely intended to be browsable.  Readers don’t have to start at Page 1 and plow through it, and we doubt many readers will do that. We hope that readers who wish to become informed citizens will use it as a companion to follow the tax policy debate as it evolves. If Congress takes up the “Buffett Rule” or the expiration of the “Bush tax cuts” or the alternative minimum tax, a reader can look it up and understand the issues. Both presidential candidates have said that they favor tax reform. Our book covers many of the issues that will have to be addressed in turning rhetoric into policy.

The book’s primary academic audience would be tax-policy classes offered in master’s programs for public policy or public administration and in law school. It would be a useful supplemental text for undergraduate public-finance courses. And we’d be delighted if new members of Congress and their staffs, as well as reporters and editors who cover tax policy, would read the book.

A chapter on taxes and the economy tackles some of the questions involved in the contentious issue of tax cuts versus spending cuts. You note that conventional economic wisdom argues for directing tax cuts to lower-income individuals since their marginal propensity to consume (MPC) — that is, the immediate need to spend any additional income, including tax cuts — will be higher than for the wealthy. But you point out that recent evidence has called this conventional wisdom into question. So, is the evidence about MPC credible and are we looking at arguments based on economic principles, or is it all just politics?

There’s certainly a lot of politics, but economic evidence is certainly relevant. The fact is that some tax cuts intended to help get the economy out of a recession often have proven disappointing.  Policymakers hope that when they cut taxes for individuals, they will go out and spend the money, which will create new demand for products and services and induce companies to hire and invest more. The problem is that, especially in recent years, consumers often put their tax rebates in the bank or use them to pay down credit-card debt, which is good for the taxpayers but doesn’t do much to get the economy going.

The political debate sometimes mixes up the short- and long-term effects of tax policies. Even if tax cuts don’t boost the economy in the short run, they could make the economy more productive over the long run by, for example, encouraging people to work or save more or reducing the incentive to engage in unproductive tax shelters. But they could also harm the economy if they create new loopholes or increase the debt (and thus raise interest rates).

In discussing business income taxes, you explain that some mega-businesses appear to pay no income tax despite huge profits in the books to go along with tax losses. However, you point out, academic research estimates that for very large businesses, income in the books has consistently been higher than tax income (as much as 60 percent higher in 1998).

This reminded me of one experiment with book income that I wonder if we will ever have to live through again. As part of the 1986 Tax Reform Act, a new corporate alternative minimum tax (AMT) was enacted. One of its provisions was a tax on book income: If your book financial earnings exceeded your tax income, that excess went into the AMT computation, so that a corporation could (and quite a number did) pay income tax based on book income. (The Internal Revenue Code titled the concept Book Untaxed Reported Profits, which we all came to know and love as BURP — the title possibly coming from a committee staffer who had been working too many late nights on the overall tax reform bill.) The concept lasted only three or four years in the law, and was finally replaced by other provisions that were not tied into book income.

You describe how what it costs for the IRS to collect our federal taxes is tiny compared with the enormous “compliance costs” incurred by taxpayers and employers, which you estimate as $215 billion for fiscal year 2012. It is not clear whether those costs include other third parties such as return preparers (CPAs, H & R Block) or those who design and maintain tax preparation software. If they are not included, I wonder by how much the $215 billion would have to increase to take them into account. IRS estimates (as the book notes) there are between 900,000 and 1.2 million paid preparers, and that about 60% of individual returns are prepared by a paid preparer.

These estimates in principle do include these costs, because they include the out-of-pocket expenses on software, which reflect the costs of designing and maintaining tax software, marketing it, etc. However, because the use of software has exploded recently, these estimates based on studies from several years ago may not accurately reflect the cost implications of this development.

You devote two chapters to the issues of tax fairness. We all have our pet peeves on the subject, and one of the most common complaints against certain groups or industries is that they don’t pay “their fair share.” Can you define exactly what one’s “fair share” is? Does academic research offer any real definitions, or will “fair share” always be a slippery slope?

There are both subjective and objective measures of fairness. An objective concept is the idea that people in similar situations should pay similar tax (known to economists as “horizontal equity”). But even that simple standard is not so simple to implement. Do you define people at a point in time or over many years? Is the right unit of comparison individuals, families or households?

Things get murkier when we think about how burdens should be shared among people of different income levels. Surveys suggest that most Americans believe the tax system should be progressive — that is, taking a larger share of income from those with more ability to pay — but there is a lot of disagreement about the degree of progressivity. Ultimately, this is a value judgment best left to the voters and their representatives, not economists or even philosophers.

Gerald Padwe is a retired tax partner in the Deloitte accounting firm and a retired vice president of taxation at the American Institute of Certified Public Accountants. He has a longstanding interest in tax policy and tax politics.

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