Tax cut deal requires accord on what taxes are for

The headlines call it a “fiscal cliff” and we’re headed right for it. If Congress and the president do not come to some sort of agreement soon the federal budget and our economy will take one right in the solar plexus.

The disagreement holding up the works, and holding us hostage, is over taxation, something that is normally negotiable in Washington politics even in an election year. The reason why it is less so this year is that at bottom it is about the theory of taxation. And we don’t give up our theories easily. We find ways to justify them.

The tax code itself is an interesting example of how we do this. On a single day recently there were three separate articles on the federal income tax. One proclaimed that it was progressive; another said it was regressive; and the third declared it was proportional. Each writer had statistical proof to back up his point of view.

They cannot all be right, of course. An income tax cannot really be progressive, regressive and proportional at the same time. With a progressive tax, higher incomes pay higher rates, not just more taxes. Regressive means that lower incomes pay a higher percentage of their incomes in taxes. And proportional is simply a single tax rate, a “flat tax,” that everybody pays, no matter how high or low the income is.

Having conflicting descriptions, each supported by official statistics, isn’t good for economics. How could a science get itself stuck in this swamp of uncertainty, improvable claims and colliding facts?

British scientist Matt Ridley has written about bad theories in science, and especially about “confirmation bias,” a term coined by Peter Wason to describe the tendency for scientists to seek — and find — only the evidence and information that supports their beliefs.

This is all too common in sciences of all types and is such a pervasive element in criminal prosecutions that it has become a staple of books, movies and television. Who doesn’t immediately recognize the obstinate police lieutenant who ignores all exonerating evidence because it doesn’t fit his theory of how the crime was committed and who did it? “We already have the killer in custody” is a line that TV viewers and scriptwriters alike could recite in their sleep.

When we have a tax code as complicated as ours it isn’t very difficult to find data that will support your beliefs about it. Confirmation bias is reinforced by the ambiguous terms used in economic descriptions of individuals and households. Even a seemingly straightforward, statistically defined term like “poverty,” for example, has never achieved universal acceptance.

One underlying problem is that the basic purpose of federal taxation is unclear. Are income taxes imposed to support government expenditures of necessary services, to underwrite retirement and medical care, to finance the government’s efforts to stimulate economic growth, to redistribute income or simply to encourage some activities and discourage others?

These are just a few of the purposes that can be, have been and are used to justify federal taxes. Each, though, is being examined more closely in these unsettled times.

The current impasse in Washington, D.C., is over the so-called “Bush tax cuts,” which are set to expire at the end of the year. If the Congress fails to take action, the reinstatement of the higher tax rates next January would suck the life out of the economy at a critical time.

There is broad agreement that almost all of the earlier tax cuts should be continued. Congress only reached an impasse because of disagreements about whether the cuts should be simply restored as they are or modified to include higher taxes on income above $250,000.

Normally, this kind of difference would be negotiable, but both sides in Congress have dug in their heels. The negotiation environment is also clouded over by the “automatic spending cuts” that will begin chipping away at the federal deficit — and plunging over the fiscal cliff if Congress does not grab the steering wheel.

A net increase in taxes during a sputtering recovery is tough to justify with the same Keynesian theory that supports deficit financed stimulus programs. By depicting the issue as a matter of “fairness,” though, President Obama has introduced a totally new tax theory and this has not made negotiations any easier.

It is not at all clear how all of this will be worked out. What is clear, though, is that stress on our economy is forcing us to look at the federal income tax system as something more than a spigot for the federal government to turn when it wishes to water its favorite plants. Maybe some good will come of all this.

James McCusker is a Bothell economist, educator and consultant. He also writes a monthly column for the Herald Business Journal.

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