Can We Limit Taxes to 25 Per Cent?
Dean of the Harvard University Law School, ERWIN N. GRISWOLD,who has made an extended study of Federal Taxation, reminds ns of the increasing activity on behalf of an amendment to the Federal Constitution which would limit the power of Congress to impose income, estate, and gift taxes to a maximum rate of 25 per cent. The effort was begun thirteen years ago under very different conditions from those which prevail today, and if enough state legislatures are acquiescent, this attractive but dangerous proposition might be brought to vole.
by ERWIN N. GRISWOLD
IN recent months, there has been intensive activity on behalf of an amendment to the Federal Constitution which would limit the power of Congress to impose income, estate, and gift taxes to a maximum rate of 25 per cent. This effort began in 1939, thirteen years ago, when the state of the world and the country was very different from what it is now. Under the original proposal, the only exception to the limitation would be “in time of war,”through annual actions by Congress, Under a more recent variation, Congress would be allowed to increase the limit to 40 per cent, again by annual action, in time of “emergency.”
The proponents of this measure, knowing that Congress would never adopt such a plan, have proceeded along another channel. Ender the Constitution, Congress is required to call a Constitutional Convention whenever two thirds of the states request such a call. This procedure has never been carried through before, but the advocates of tax limitation have progressed far. The count varies, because the actions have not all been the same. But something like 27 state legislatures have already adopted, in one form or another, a resolution asking Congress to call a Constitutional Convention. In some of these states, the resolution was vetoed by the governor. In a few other states, the resolution once passed has since been rescinded. The effect of such a rescission is in doubt. At the present time, a total of 32 states makes up the constitutionally requisite two thirds requiring the call of a Convention. Whatever the technical status of some of the outstanding state actions may be, it is plain that we are close to the required total. The time has come, therefore, when the prospect should be considered very thoroughly, with all its implications, by thoughtful citizens.
I want to make it plain that I should like to see lower taxes. I should especially like to see my own taxes lower. I am wholeheartedly in favor of thoughtful action to reduce government expenditures. I believe that domestic expenditures could be reduced, along the lines of the Hoover Report and otherwise. I think it very likely that there has been waste in our military establishment, and that expenses for military purposes could be reduced materially without impairing our national defense. But I recognize that that is an extraordinarily difficult problem, on which I am not qualified to have any specific views. It is in part because I feel that we should have better leadership towards reduction of governmental expenditures that I am strongly in favor of a change of administration in the next election. But I recognize, too, that any administration will have very serious difficulties in carrying out any program for expenditure reduction.
I have no doubt that one of the motives of those who favor the tax limitation amendment is the reduction of federal expenditures. But the American people will find themselves in sorry straits if they have to try to fit themselves into this inflexible proposal.
Let us examine the inescapable consequences of the adoption of a 25 per cent limitation. Official Treasury figures show that, at present tax rates, and at the present level of economic activity, the reduction in corporate income taxes would be nearly $14,000,000,000 per year, the annual reduction in individual income taxes would be over $2,000,000,000, and the annual reduction in estate and gift taxes would be $120,000,000. The total loss of revenue comes to $16,155,000,000. These are the losses from limiting the effective over-all rate of tax to 25 per cent, and not from limiting the top bracket to 25 percent. The loss from limiting the top bracket to 25 per cent, while holding lower rates unchanged, would be considerably more in the case of individual taxes.
The problems presented by this prospect will be taken up under the following headings: —
1. What the proposal would do to the tax structure.
2. What the proposal would do to our economy.
3. The tax burden would shift from rich to poor.
4. The proposal is based on false economic premises.
What the proposal would do to the tax structure
It is obvious that $16,000,000,000 per year cannot be cut from present federal tax revenues without producing some consequences. By far the largest portion of the expenditures is directly related to national defense. It may be assumed that the proponents of tax limitation do not wish to damage our defenses. Congress, therefore, would be subjected to irresistible pressure to replace this lost revenue, or a large part of it. What would be the possible avenues open for such replacement ?
In the first place, it would be virtually inevitable that the 25 per cent tax rate would become not merely the maximum but also the minimum rate, If this amendment were adopted, it is safe to predict that, almost immediately, we would be confronted with a flat tax of 25 per cent, no more, no less. No more than 25 per cent would be constitutional, and no less than 25 per cent would be feasible. But such a change alone would not be enough, It is also clear that Congress would be forced to reduce deductions and exemptions sharply. The federal income tax would quickly be converted into a flat tax of 25 per cent on gross income. There is nothing in the proposed amendment about net income, and it would be extraordinarily difficult and unwise to try to define net income in constitutional terms. It has long since been established by the Supreme Court that deductions are a matter of legislative grace. It is wholly clear that this grace would have to be very thin if Congress had to try to meet the present problems of this country within a 25 per cent tax limitation.
What other alternatives are there? A sales tax is one possibility. When we talk of a sales tax, though, we usually think in terms of the sales taxes at the rate of 2 per cent or 3 per cent which are in force in many of the states. But, to produce the revenue lost by this tax limitation proposal would require a federal sales tax of 10 per cent on all retail sales — including food. If food were excluded from the tax, the rate would have to be 15 per cent to produce approximately the same amount of revenue. It seems obvious that the voters of this country would not consciously adopt such a tax.
We cannot, moreover, confine our consideration to the effect of the proposal on federal taxes. If federal revenues were reduced, there would be great pressure on the states to take up functions now performed by the federal government. The natural consequence Would be a great increase in the rate of state income taxes. It is not hard to visualize a state income tax which used the present rates of federal taxation, and then allowed a credit against the state tax for taxes paid to the federal government at the 25 per cent rate allowed under the proposed amendment. If this should happen, the tax limitation amendment would not limit taxes at all but would simply transfer the tax money from the federal government to the states.
Some might feel that such a change was desirable, even if the over-all tax burden were not affected, because of its tendency to enhance the functions and responsibilities of the state. But would not such a “Balkanization of the United States” be a clear turning back of the clock? We have become a great nation not as forty-eight separate units, but because we are a single economic entity. If income taxation should become basically the province of the states, the problems which would arise in the way of conflicts between the states, in determining the proper allocation of interstate income among the states, and so on, would be staggering, and would benefit no one except the lawyers who would have to unravel them.
What the proposal would do to our economy
Let us look at some other consequences. What about the credit of the United States? What happens to the value of government bonds when the power of Congress to impose taxes is seriously restricted? It takes no prophet to see that government bonds would decline sharply in value and there would be a rush to cash in savings bonds. What happens to savings banks, commercial banks, insurance companies in such a case? The seeds of catastrophe here are shockingly evident.
But let us go beyond this. Many of us have felt that in this post-war period the budget should be balanced. We should provide by taxation at least the amount of our expenditures. That has been the position of conservative people generally, including most businessmen. But what possibility is there for a balanced budget when Congress is constitutionally prevented from levying taxes? Let it be remembered that the proposed tax limitation is on the power to tax only, and provides no limit on the amount that may be spent or on the amount that may be borrowed. What happens to the economy when Congress is put into a situation where it is virtually compelled to finance the country through borrowing, with no very satisfactory prospect that the borrowed money can ever be repaid? Could there be a surer recipe for disastrous inflation? A 25 per cent tax limitation in such an event would be a sad and fateful mockery.
The tax burden would shift from rich to poor
Up to this point we have been considering the tax limitation proposal simply in terms of money and public finance and without giving any consideration to the place where the money comes from — as if that were not important. But it is important, and worthy of very thoughtful consideration. Examination of this aspect of the question discloses much of the motivation which lies behind the tax limitation proposal. For it is very clear that the benefits of such a change would redound to the relatively rich, and the burdens would have to be borne by the relatively poor. Not only would the change in effect eliminate progressive income and estate taxation, as has already been pointed out, but it, would confer the financial benefits almost exclusively on persons of very large incomes. The facts on this are striking — indeed startling. At present, the overall rate of 25 per cent — not the 25 per cent bracket — does not take effect, in the case of a married couple with two dependents, until the income of husband and wife amounts to at least $20,000. In other words, no married couple with an income of less than $20,000 would receive any benefit from this proposal. But a married couple, with two dependents, who were fortunate enough to have an income before taxes of $1,000,000, would save $621,000 under the proposed limitation.
For more than half a century, we have imposed taxes in this country in accordance with ability to pay. Progressive taxation has not merely been accepted, but has been widely hailed as a sound and constructive economic policy. During this period, the economic position of the lower income groups has been enormously improved, thus building up the purchasing power of many millions of people, and stimulating business activity generally to the great benefit and advantage of all segments of the economy. For many years, we have not had a country in which the rich got richer and the poor got poorer. We have had a country in which the poor have become progressively belter off, without any real evidence of material hardship to the rich.
What happens under the proposed limitalionl Out of 42,000.000 individual taxpayers, a total of 450,000 persons, or about one per cent, would benefit from the amendment. Those 450,000 persons would save over $2,000,000,000. But that is not the whole story. Corporate taxes, from present rates, would be reduced nearly $14,000,000,000. Some of this reduction would undoubtedly result in lower prices to consumers. It is probable, too, that some would be taken away in higher wages, although the inflationary effect of that development is obvious, and the distribution of the benefits would be far from general. But a large part of the benefits would be received by shareholders in the corporations; and a large proportion of them are among the 450,000 persons to whom we have already referred. Is it conceivable that the American people should knowingly tie themselves into a fiscal strait jacket for the purpose of conferring an enormous, and annually recurring, benefit upon three tenths of one per cent of the total population?
A reduction of exemptions, with a probable drastic elimination of deductions, would result in greatly increased taxes on persons of small income. The alternative of a sales tax at the rate of 10 per cent on all purchases, or at the rate of 15 per cent on all purchases except food, would obviously bear most heavily on persons of small income.
The proposal is based on false economic premises
The proponents of tax limitation say that it is necessary to encourage enterprise and to make it possible to have adequate capital formation. They say that this will provide jobs, that it will stimulate and promote the economy, and that it will make us all better off. If one seriously believes that making the rich richer will stimulate and encourage the economy, he will accept this argument. Actually, though, there is no evidence that the economy is stagnant. The recent years of high taxes have been years when national income was at a maximum. Capital formation has never been higher. We have never had such a great increase in our productive capacity. This increase has not come through the investments of a few persons: there has been vast private investment. The savings of millions of people, through savings banks and insurance companies, have provided enormous amounts of capital. Even greater amounts have come through the undistributed earnings of corporations, which are, after all, the properly of their shareholders.
The proponents of the tax limitation proposal talk as if the country were stagnant economically. They then conclude that this is the consequence of high taxes, and their answer is the tax limitation amendment. But the fact is that we have never been stronger economically, never more productive, never had such facilities and capacity for production. Nor is there any other nation of the world, with or without high taxes, that closely approaches us.
It is time to stop taking a dim view of America. It is true that our country and our people now carry heavy burdens. But this is not the first time that Americans have faced problems or carried burdens. The pioneers of various periods did not seek to escape the difficulties of their times. They fought the Indians, struggled against nature, worked on the roads with their own hands, and taught their children to read. We are better organized. We meet many of our problems by concerted public action. The necessary consequence is taxes, and it should not be surprising that they seem very high. Will we really do ourselves any good by seeking to escape the problems of our time by taking to the supposed shelter of a constitutional tax limitation?
This is a bad proposal. Through its appeal to tax reduction, it has a specious attraction. Its inherent dangers should be obvious to thoughtful persons. It is time to wake up to what is going on and to fight hard against this foolhardy plan.