Fiscal Therapy

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This should come as no great surprise. For anyone born after, say, 1970, the world has been shaped by Ronald Reagan's remaking of government's relationship with private interests—a vision of lower taxes, less regulation, and maximum economic leeway for those at the top. In this view, the pursuit of wealth is the warp and weft of America; everything else will follow.

By contrast, the preamble to the Constitution tells us the nation's reason for being in 52 words that can be reduced to six principles: society, justice, peace, security, commonwealth, and freedom. Individual riches don't make the list. They are a product of American society, not its guiding purpose. Progress, then, must begin with a return to the best of the values that created this Second American Republic—one born, it's worth remembering, from the failure of the Articles of Confederation, whose principles (weak government, unfettered capitalism) found their resurrection in the economic policies of the past three decades.

Even judged by its own yardstick, the trickle-down approach has failed to deliver: Rather than getting richer, we have been slowly impoverishing ourselves. While incomes at the very top have soared to levels beyond imagining even a generation ago, the average inflation-adjusted income of the bottom 90 percent of earners was lower in 2006 than it was back in 1973. And since 2000, the median income of all Americans has actually slipped, proof that tax cuts for the rich do not create general prosperity. Today, more and more of us do not have enough money to live on without going into debt. For each dollar of equity people gained in their homes from 1980 to 2006, they borrowed two—and while a portion of that is accounted for by poor decision making, much has to do with the sheer impossibility of making ends meet.

Debt payments—individual and governmental—now consume so much income that they are suffocating economic growth. Interest on the federal government's debt this year will eat up the equivalent of all the income taxes we pay from January until at least sometime in May. (Already, the financial system bailout has added more than $3 trillion to the national debt—see "$3.4 Trillion & Counting"—for an extra $170 billion in annual interest payments.) This keeps us from making productive use of our tax dollars—launching universal health care, rebuilding our crumbling infrastructure, or funding the research we need to transform our energy system. We've been sold on tax cuts as the best way to spur growth, but what we really got was weak job growth, a sinking economy, and a slew of tax deferrals that cause increasing revenue shortfalls and force the government to borrow even more—with all of us paying the interest.

For the past 14 years, on my former beat as the tax reporter for the New York Times, and now as a columnist for the trade journal Tax Notes, I have been documenting the myriad ways in which our economy has been recalibrated to take from the poor, the middle class, and even the affluent and give to large corporations and the very richest of the rich. I discovered, for example, that in 2000, people making between $50,000 and $75,000 paid the same share of their income to the federal government as those making more than $87 million, and that those making between $100,000 and $200,000 were taxed more heavily than those making $10 million—a state of affairs the Bush administration called "progressive" when I first reported it in 2005. Thanks to Reaganite economic policies, we have encouraged once-competitive industries such as oil, car manufacturing, accounting, and news media to congeal into unchecked (and now struggling) oligopolies. We have slashed the ranks of white-collar cops—the auditors and investigators whose beats are taxes, securities, food and drugs, pollution, etc.—and hamstrung those who are left. And we have transformed the idea that bankers would self-regulate from a crackpot notion into the essence of government policy, with results as predictable as if we removed all traffic lights and stop signs on the theory that most drivers are responsible.

Over and over for the past decade, our leaders argued that the fundamentals holding up our economy were strong. Now we know that this floor of shiny statistics merely concealed the rot below. But there is an upside to this realization: The economic crisis can help us clear away the rot and build a more solid foundation—one that elevates people over capital, kick-starts commerce, and removes some of the costliest barriers to individual success and national progress.

Change will not be easy, and the cost of cleaning up the current mess will be a huge drag on the economy in the near term. But we are, at last, at a turning point; we have a chance to end the socialism for the rich that put us into this hole. How? By, in effect, reverse engineering the debacle. Rewriting tax laws and financial regulations has been the principal vehicle for turning government into a subsidy system for the deep-pocketed and well motivated. It can work in reverse as well. President-elect Obama has offered some interesting ideas to make the tax code more fair—but by and large, his proposals amount to tinkering around the edges, not the kind of serious restructuring previous presidents, most notably Reagan, undertook.

Here's another way to go. We can start by eliminating some of the most spectacular tax giveaways and move on to doable, efficient steps toward shoring up our biggest asset—not stocks, bonds, or houses, but people. Best of all, much of this won't cost a penny; in fact, it will raise billions for the big tasks ahead.

Stop the Giveaways
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Quit Cooking the Books
By law, companies must keep two sets of books, one for shareholders, the other for the irs. As a result, many corporations routinely tell investors they incur millions in corporate income taxes, while the financial records they give the irs show they owe nothing or are due refunds. They do this by using tax shelters, offsetting income with losses from years ago, and employing countless other devices that make them look like paupers to the irs but money machines to investors.

It's time to require companies to use the same accounting rules across the board—and then demand immediate payment of unpaid taxes. This would align the interests of investors with those of taxpayers while eliminating the obvious moral hazard of keeping two sets of books.

Executives are sure to complain that such a retroactive change is unfair. But recall that in 2006, when Congress voted to raise taxes on the interest from teenagers' college funds, Sen. Charles Grassley (R-Iowa) said it is proper to end abusive practices retroactively. Perhaps now's the time to prove it; the treasury could use a few hundred billion dollars.

Make the Superrich Pay Their Share
Back in 1990, people making more than $1 million in today's dollars earned less than 0.8 percent of all the wages paid in America. Last year these multimillionaires sucked up more than 5 percent, squeezing everyone else. Also during this period, the number of people getting million-dollar-plus salaries grew 12 times faster than the number of workers overall, tax data show—this in an economy where, in 2007, one in three workers earned less than $15,000, more than three-fourths made less than $50,000, and 99 percent earned less than $200,000.

We may never get back to the pre-Reagan tax rate for the top earners (70 percent), but we should at least nudge it back to the Clinton-era rate of 39.6 percent, as Obama has proposed, and for simplicity's sake round to 40 percent. To motivate executives, publicly traded companies could still be allowed to give out unlimited stock bonuses, provided that the execs pay taxes on the shares, cannot sell them for three years after leaving a company, and then must spread sales over at least five years. This would create a powerful incentive to manage companies for long-term success, which is good for jobs—and a smart ceo could still get fabulously rich.

End Legal Tax Cheating
The marginal tax rate for cops and teachers is more than 40 percent—25 percent for income taxes and another 15 percent for Social Security and Medicare taxes. The marginal rate for some hedge fund managers, five of whom earned more than $1 billion in 2007, has been zero. That's because many of these speculators have been able to avoid taxes by operating through offshore partnerships under rules that let them defer income taxes. Executives, entertainers, and athletes also have been able to amass vast untaxed fortunes: For example, Roberto C. Goizueta, the ceo of Coca-Cola in the '80s and '90s, built a nest egg of more than $1 billion, but was able to defer taxes on most of it until he died.

Tax deferrals are one of the major tools for redistributing wealth upward. While most of us must pay each time we get a paycheck, executives and corporations can defer their taxes for years, even decades. When the treasury finally gets the money, inflation has eroded its value; in the meantime, government must borrow more, pay more interest, and collect more from everyone else.

A provision in the Wall Street bailout bill addressed the hedge fund part of the problem, but a more comprehensive fix would involve stopping all deferrals beyond the modest amounts allowed for retirement savings (up to $16,500 a year for young workers, a little more for those over 50). Executives could still defer taking some of their compensation—a way of loaning money to their companies—but only after they pay taxes. Everyone would play by the same rules, and the federal government could gain $100 billion or more each year—enough to fund Obama's health care plan twice over.

Invade the Caymans
In 1983 just 10 percent of America's corporate profits were funneled through places that charge little or no corporate income tax; today more than 25 percent of profits go through tax havens. The Obama administration could tell the Caymans—now fifth in the world in bank deposits—to repeal its bank secrecy laws or be invaded; since the island nation's total armed forces consists of about 300 police officers, it shouldn't be hard for technicians and auditors, accompanied by a few Marines, to fly in and seize all the records. Bermuda, which relies on the Royal Navy for its military, could be next, and so on. Long before we get to Switzerland and Luxembourg, their governments should have gotten the message.

Barring gunboat diplomacy (tempting as it is), there is no reason we cannot pass laws to block financial transactions with tax havens or even, Cuba-style, make it a crime for Americans to visit or do business with them without special permission. Congress could declare the hiding of funds a threat to national security and require that anyone with offshore assets disclose them to the irs within 30 days and pay taxes, interest, and penalties within 180 days. For the holdouts, temporary special teams in the irs and Justice Department could speedily pursue civil or criminal charges.

Wean Wal-Mart (and the Yankees)
Did you know that the sales taxes you pay at most Wal-Marts go not to your state or local government, but instead pay back the cost of building the store? Sales-tax givebacks, as well as exemptions from property taxes, can amount to an extra 9 percent profit for retailers that extract concessions from local governments. That means not only a huge advantage for new arrivals over established, often locally owned, businesses, but also a direct hit to resources for local police, schools, and parks. The chain stores claim they are creating jobs. But basic economic logic says retail can add net jobs only when a population grows or incomes rise, and when those things are happening, market forces should be enough to spur new stores.

In a similar vein, the big four commercial sports make operating profits of $1.6 billion, Forbes has calculated—but their taxpayer subsidies exceed $2 billion a year (and that's before the estimated $864 million Mayor Bloomberg and Uncle Sam just handed to the New York Yankees), according to Neil deMause, coauthor of a book on sports subsidies. In other words, taxpayers literally provide all the profits of mlb, the nfl, nba, and nhl combined.

So it is that developer Theodore Lerner and his partners purchased the Washington Nationals baseball team in 2006 for $450 million, but stand to collect more than $1 billion in subsidies over the next two decades. In effect, the public bought them the team and gave them a $600 million tip. Using the tax code to eliminate any value in stadium subsidies would take care of this problem quickly and efficiently.

Cut Off the Utility Scam
Because they are regulated monopolies, our electric, natural gas, and water utilities must collect every part of their operating costs—including their income taxes—in the price they charge customers. Except that sometimes you pay for checks they never write: Oregon's Portland General Electric collected nearly $900 million from 1997 to 2006 for federal and state taxes, but actually paid less than $1 million. Xcel Energy, which runs electric utilities in eight states, collected at least $723 million for taxes it will never pay.

When utilities charge you for taxes they don't turn over to the government, customers pony up twice: once to pad the companies' pockets, the second time in higher taxes or government borrowing to make up for the shortfalls. Some states, such as Oregon, have moved to require that utilities hand over the taxes they collect, a push that companies (including Warren Buffett's PacifiCorp electric utilities) have been fighting hard. The federal tax code could easily be adjusted to make sure taxes embedded in utility rates are either paid or refunded to ratepayers.

Ground the Private Jet Exemption
Since 1985, executives have been able to take nearly free personal trips on company jets; all they pay is income tax on the value of the travel. Under federal rules, this travel is valued so low that flying a Boeing 737 equipped with a shower and master bedroom from New York to Paris costs an exec less than $500 as long as the company claims it is unsafe for him to fly commercial. (Try getting a middle seat in coach for that.) On top of that, companies get to deduct the full cost from their taxes. So if that Paris flight costs $100,000, government loses out on about $35,000 in taxes, and shareholders shoulder the remaining $65,000 in the form of reduced profits.

Congress should make executives using corporate aircraft for personal trips pay taxes on the actual cost of the travel. (And while they're at it, lawmakers should also look at rules that give corporate jets an unfair break on air-traffic-control fees.) This will not only improve the bottom line for companies by removing a subsidy for their top employees, but help commercial airlines bring in more high-fare customers. As a side benefit, it will trim some of the corporate flights that clog an already congested air-traffic-control system—saving the rest of us some time sitting on the tarmac.

Demolish the Mansion Deduction
Much as middle-class homeowners cherish it, the mortgage deduction functions mostly as another upside-down subsidy: Less than half of homeowners can use it, and for each dollar saved by those making between $30,000 and $40,000, those making $1 million or more save $380. (Canada, by the way, does not allow mortgage interest to be deducted at all, yet its home ownership rate matches ours.) If the goal is to help people get into their own four walls, a tax credit for principal paid by home buyers in the first few years of ownership would do far more. For a home worth $100,000, for example, such a credit could reduce income taxes by $2,000 a year for the first two years and $1,000 annually for the next three, saving the buyer $7,000.

Begin the Healing
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Defang the Loan Sharks
For hundreds of years, enlightened governments have regulated interest rates to rein in loan sharks. Now Diff'rent Strokes' Gary Coleman pitches loans at 99.25 percent interest. Some "tax anticipation" loans cost the equivalent of 700 percent annual interest.

How did this happen? Back in 1978 the Supreme Court, confronted with a discrepancy between federal and state laws, threw out federal interest regulations and called on Congress to pass new ones. Instead, lawmakers milked the ruling for hundreds of millions of dollars in campaign contributions from credit companies eager to charge any rate they wanted. Thanks to interest deregulation, blue chip investment houses like Lehman Brothers got into the business of subprime mortgages while Goldman Sachs, JPMorgan Chase, Bank of America, and Wells Fargo bought or financed payday lenders that prey on the poor. In the three decades since interest-rate deregulation, credit card and other revolving debt has risen from $128 billion to $968 billion (adjusted for inflation), a 7.5-fold increase. Interest on this debt, at an average rate of about 18 percent, acts like a tax, leaving people with less to spend on the necessities of life.

But the industry wasn't satisfied with this credit boom, and so, in 2005, it prevailed on Congress (with a special assist from then-Senator Joe Biden) to pass a bankruptcy law making it much harder to restructure debt, no matter how predatory, even in case of job loss or illness. And in a little-publicized move, the Bush administration, over the protests of all 50 state attorneys general, also invoked an obscure clause in the 126-year-old National Bank Act to effectively invalidate state predatory lending laws. Repealing these anti-consumer provisions would cost the government nothing, but provide a real benefit for the economy in curbing banks' irresponsible practices, just as consumers are expected to do with theirs.

Save Our Savings
Compared with any other developed economy, Americans save far too little. In 2006, 55 percent of tax returns showed zero interest income from savings accounts. If we were to eliminate taxes on the first $500 of interest earned, people could set aside almost $17,000 with tax-free interest (assuming 3 percent interest) to cushion the shock of a layoff, accident, or illness. Congress could even match savings for low-income people dollar for dollar up to $500 per year, with the government share locked up for 10 years.

Protect Pensions
A pension is simply wages deferred to old age, which is why federal law requires that corporate pension plans be run "exclusively" for the benefit of the members. But in the past two decades Congress has turned that promise into a cruel joke; thanks to a little-known provision inserted by lobbyists in 2006, for example, workers could conceivably lose up to 85 percent of their pension when a new buyer takes over a company, as my one-time coworkers at the Philadelphia Inquirer recently discovered.

The core problem is that Congress lets companies postpone setting aside pension funds year after year. It also allows them to record as investment gains what they expect to earn in the market—even when they make less or actually lose money. Three years ago these phantom pension gains at General Motors accounted for the carmaker's entire net worth, a telling example of how accounting rules can create economic mirages.

Employee stock ownership plans, devised as a way to help workers build wealth, have also been turned into credit lines for speculators. Government rules allowed buyers of companies to use esop money as part of their financing, putting workers' shares at risk. United Airlines employees lost most of their shares' value in the company's 2002 bankruptcy—while ceo Glenn Tilton got a $40 million compensation package. Employees of the media conglomerate Tribune Co. may see their esop go bust, too, but ceo Sam Zell's stake is not at risk—because he made sure his equity is guaranteed even if Tribune collapses. Congress should restore protections so that workers get 100 percent of what they were promised, even if taxpayers have to make up the shortfall. It could also hold hearings to shame executives who got rich by shortchanging retirement plans, and make it easier to seize the bonuses of those who looted pensions.

End the Burglar-Alarm Subsidy
Each time police respond to a burglar alarm, it costs taxpayers $50 or more, for a total of $1.8 billion in 2002. More than $800 million of this hidden subsidy goes to adt Security, a subsidiary of Tyco, which was at the center of the Wall Street scandals eight years ago; in the '90s, Tyco started buying so many mom-and-pop alarm companies that it now controls nearly half of the market. Government data show that at least 94 percent of alarms are false, and a 2000 study in Seattle found that officers responding to alarms make one-ninth as many arrests as those just driving around in patrol cars.

In Los Angeles and elsewhere, the rise of gangs in the 1980s tracked a sharp decline in funding for parks and programs for young people. Ending the burglar-alarm subsidy and shifting the spending to youth programs would reduce crime (saving even more money) and help more kids grow up to become taxpayers instead of tax eaters. Washington could threaten to cut federal funding for any city that fails to charge the alarm companies the full cost of each response, thus encouraging companies to build more reliable systems.

Stop Indenturing Students
Over the past 40 years, the cost of public colleges has doubled, and financing tuition is an $85 billion a year business for credit companies. Sallie Mae, the biggest of the private student loan companies, earns an average 48 percent annual return, three times the return of commercial banks. Students who sign up for loans with what appear to be low fixed rates may discover upon graduating that they face an 18 percent rate; if they make a single late payment, late fees will be tacked on every month until the debt is paid off. And the law makes no allowance for students who can't find a job in a bad economy, or can't work because of illness, or choose to serve their communities by, say, joining Teach for America. Albert Lord, Sallie Mae's chief executive, has become so rich from student lending that he built his own private golf course just outside the nation's capital.

Profiteering off students is not just an obscenity; it ultimately weakens the economy. The abuses at Sallie Mae and other student lenders deserve exposure via congressional hearings. Then perhaps lawmakers will find the spine to make the rules fairer. Indenturing the brightest young minds in an information society is the equivalent of eating your seed corn in an agrarian one. In the long run, you're doomed.

Drag the irs Into the 21st Century
When the 16th Amendment establishing the federal income tax was being debated, advocates argued it would return some portion of "surplus incomes" to the commonwealth. The goal was to make those enriched by the new phenomenon of industrialization pay back the society that made their fortunes possible. Consequently the middle class paid very little; incomes of $3,000 (the equivalent of $66,000 today) were exempt from income tax, and in the lowest tax bracket you paid just 1 percent. Today a single person is taxed at 10 percent once she makes more than $8,950 (twice that for married couples). Social Security taxes start with the first dollar of wages and end at just more than $100,000.

Given the vast sums they have transferred to the superrich in the past 30 years, the 88 percent of taxpayers who make less than $100,000 a year deserve a break. Congress should lower their taxes with an eye toward restoring their capacity to save (thus, as a side benefit, generating fresh capital for investment), while at the same time studying how to create a high-wage economy that can generate more revenue.

At a deeper level, it's time for a national debate about how we can go from our existing federal tax system, which was well designed for the 20th century but now throws sand into the economy's gears, toward an efficient, effective system for sustaining a 21st-century democracy. Congress should begin by holding hearings and giving Treasury a budget for research into alternative revenue sources such as a value-added tax and taxes on greenhouse emissions.

Our nation was founded on the idea that we would shape our own destiny. Structuring our taxes is a critical part of how we do that; and no matter what Sarah Palin told us during the campaign, paying taxes that are fair and just is the duty of a patriot. Time and hard evidence revealed that Reaganism was a disastrous mistake. Now we must get through the terrible night and on to a real morning in America.