Tax Day: Not Painful Enough

Chris Edwards Director of Tax Policy Studies, Cato Institute
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A lot of people hate Tax Day. Filling out tax forms is drudgery, and being forced to pay cash to the IRS is painful, especially since the taxes fund so many wasteful activities. Taxes are not the price of a civilized society as liberals claim, but the price of a government cluttered with failed and harmful programs.

Many Americans understand that. Gallup finds that most people think they pay too much in federal income taxes. And a Reason-Rupe poll finds that, on average, people think more than half the tax dollars sent to Washington are wasted.

But those views would be even more negative if people felt the full pain of funding the $4 trillion federal government. If people were hit directly with the full costs of $950 billion farm bills and $1 trillion foreign wars, they would grab their pitchforks and storm Capitol Hill. But the citizenry hasn’t resorted to pitchforks yet because politicians use “fiscal illusion” techniques to hide a lot of the costs.

Here are some of the techniques:

  • Debt. The government finances half a trillion dollars a year of its spending by borrowing. So people see the benefits of the spending, but the costs are pushed forward by deficits and debt. The government has run deficits 85 percent of the years since 1930, so this is not a transitory problem but a deliberate strategy of hiding costs.
  • Withholding. The federal government requires employers to withhold income and payroll taxes from paychecks, and that makes earnings disappear before workers get their hands on the cash. Withholding was introduced during World War II to make income taxes feel less painful, and thus to reduce taxpayer resistance.
  • Refunds. The IRS has rigged the withholding system so that more than three quarters of tax filers get refunds every April. As a result, the government appears to be Santa Claus rather than a fiscal oppressor.
  • Business Taxes. The government collects hundreds of billions of dollars a year from taxes on businesses, including the corporate income tax and the employer half of the federal payroll tax. The burden of these taxes ultimately falls on individuals, but the collection is invisible to them.
  • Real Bracket Creep. The federal income tax is indexed for inflation, but not for real economic growth. Because tax rates rise as one earns more, the system results in the government automatically and invisibly gaining a larger share of incomes over time.
  • Penalize a Minority. Higher-income households pay a much larger share of their income to federal income taxes than do lower-income households. As a result, a small minority of earners — those who have high incomes — pay the great majority of taxes. The political effect of this structure is to bias people with lower and middle incomes to favor government expansion because most of the tax bill is paid by others.
  • Complexity. Congress has spread out the federal tax burden across multiple different tax bases. It has also made the largest tax — the income tax — hugely complex. These features of tax design have reduced the ability of voters to understand the overall cost of government.
  • Regulations. When Congress wants to confer benefits on voters, an alternative to a tax-funded program is a regulation. For example, regulations require businesses to provide workers with health insurance and a range of other benefits. The costs of such mandates ultimately fall — in a hidden manner — on individuals in the form of lower wages and higher prices.
  • Smoke and Mirrors. The government uses accounting tricks to hide costs. One is the “salami strategy,” which is used by the Pentagon and other agencies on large projects. With this technique, the full costs of projects — such as weapon systems — are only revealed one slice at a time, so that by the time the full costs are evident, the project is too far along to be canceled.

All these techniques make the “price” of government seem artificially low, so that people demand too much of it. At the same time, fiscal illusions embolden politicians to spend money on activities that make no economic sense.

But fiscal illusion is fiscal dishonesty. Whether people believe in small government or big government, they should want lawmakers to trade-off the costs and benefits of programs in a transparent way. So one goal of federal tax and spending reforms should be to repeal as many of these techniques as possible.

H.L. Mencken said, “Democracy is the theory that the common people know what they want, and deserve to get it good and hard.” If the full costs of our democracy were imposed on the common people today, they would definitely know what they wanted — a much smaller federal government.

Chris Edwards is editor of www.DownsizingGovernment.org at the Cato Institute.