and that's a real serious question facing america, is do we want people to be essentially disconnected from the basic costs of government? they have no sense of what government costs to them. so you get the fiscal illusion problem, which can lead to greater growth in government because these people bear none of the costs. and they're more than happy to tax millionaires to pay for it. >> actually, if you look at what has happen over the last dozen years, you say nobody has any skin in the game because we had two wars, the largest expansion in medicare in its history, and the significant expansion of federal role in education. and at the same time we were cutting income taxes. so on the margin, it probably looks like to most people we can get more government services and we'll never have to pay for it. i agree with the basic point the idea that the government is free for a significant portion of the

population is problematic. that doesn't necessarily mean we want to have burdens go up overall on low and middle income people. but we could have a tax system where for example if we had a value-added tax that was dedicated to paying for federal health care expenses, and people -- and that is the fastest growing component of spending. that's the one that is going to if we don't get it under control will bankrupt us over time, that if there were this tie-in between a broad-based tax like a vat and that component of spending, then people would see they might be more interested in doing sensible things to slow down entitlement spending. >> but in terms of a baseline discussion, we see these progressivity charts of the top 1% and their income share. but we never see a comparable chart showing the amount of income taxes, or the percentage of income taxes that that 1% pays. and that's been growing considerably over the years. and it's actually double their

share. so they earn say roughly 20% of the income taxes, but pay 40%, or they earn 20% of the income, but pay 40% of the income tax. >> but taxes is a share of their income has been going down over the last at least -- >> it's been going down for everyone. >> it's been going down more at the top. >> what is kind of interesting about some of len's charts, i mentioned this to him in jest as we were sitting down is if you take a slide 2, which shows the top income and trend in income inequality since the early part of the last century through today, and then you look at the highest income tax bracket, if you know the data, the top income bracket is going to be similar to the share of taxes paid by the top 1%. and if you were to overlay these two, you would see a high negative correlation in one conclusion some have drawn, although there is some difficulty with drawing it too

strongly is that as you have the high income taxpayers paying a much larger share, the tax rates on the high end go up, the reported incomes go down. this kind of goes to the issue that i raised earlier that the -- there is a very large behavioral response at the high end. these data are measured as reported incomes. and the incomes of high-income people are rather sensitive to the tax rates that they pay. when we had tax rates upwards of over 90% in the '50s and early '60s, those very high income taxpayers had very strong incentives not to earn an extra dollar, not to report an extra dollar. so that's, again, going back to what are the economic costs of high tax rates. you know, i think that's a very important part of the discussion. you have france, i understand, is proposing to raise its top individual tax rate to 75%.

and i just kind of wonder if we lived in an economy where we had -- just as we did in the 5ths, if we had a top tax rate of 75%, how would people behave if they only got to keep 25 cents on the dollar when they were deciding to work. would they retire earlier? would they take jobs that paid them less didn't offer much rewards? would it affect the professions that they entered into? how would that affect investment decisions or a whole range of decisions that would be affected with such high tax rates. >> i have three people waiting, and i won't forget you, i promise. but i think joe wanted to respond and you want to nonpaye. it is relevant to the debate about taxing the rich. i'm not particularly concerned about the free rider issue, because i do think that, you

know, whether or not social security taxes -- what their status is up for some debate, whether they're contributions to a program that pays you back, or whether they're just taxes. but i do think you have a good point. and i think that liberals have missed this point, that the issue of nonpayers is dangerous. because the income tax, and this is important for the politics of the subject as opposed to the economics, it's more than just a way to raise money, it's really about a connection to the government, to the polity. it has a symbolic role in american government that i think is lost there. it's silly. we all think april 15th is this big holiday. we all hate it, and we all try to rush to get our taxes in. but that's a shared experience for americans. to not be a part of that experience i think is a problem. i don't think that we need to expect the nonpayers to pay much. most of them can't afford to pay much. but i think the idea of including people in a tax that is almost -- we think of as universal, it's important.

and that's the real cost. so i think liberals missed the boat here. if you want to protect the income tax, you need to make it feel like it's a shared burden. and this does not make it feel that way. it's a republican plot. most of these things keeping the poor off are republican ideas originally, but now they're loved by liberals. and i think that's really short sighted for the left to just respond on the gut level, oh, these people pay lots of other taxes. i think that misses the point. >> just on bob's point about the relationship between tax rates and income inequality, i think he was deliberately overstating the point. if you look at the data, for 30 years, the share of income going to the top was at about 8, top 1% was about 8%. and during that period, the middle class was doing very well. they were getting -- basically, their incomes were growing with the economy. and something changed.

the tax rates are probably a small part of the story. but the big thing is the decline in the power of labor unions, increasing internationalization, the fact that a lot of workers now have competitors in bangalore, the financial innovations which helped sink the economy in the last decade. the financial innovations produced enormous income gains at the very, very top, increased technology. and this whole idea of a winner take all society where the earnings at the very, very top, the top performers get humongous payouts compared with people who are almost as good. i think when you look at the data on labor supply, you look at the data on savings and how it responds to taxes, the real response to taxes appear to be very, very modest. lebron james would not decide to sit out the finals if we raised his marginal tax rate. he still would want to play,

because his next best option is not going to pay him all that much. corporate ceos want to be the people earning the very top, top incomes. they're not going to decide to work a little bit less because their marginal tax rate goes up. so bob was making a valid point, but i think probably deliberately overstating it. i think the rise in inequality, the rise in inequality is really an issue. that if all of the income gains are going to a very narrow sliver of the population, i think that's politically unsustainable. and i think it's also problematic. if you need to pay for government and income gains widely shared, it's really hard to argue that people who are just struggling to get by would have to pay more in taxes. >> right. so from where i stood, i think of that as okay, you have this rising income inequality. and what should we be doing for that from a public policy perspective. if you think that's related to the bottom two or three

quintiles or lower skilled labor competing on a global labor market with people who make a lot less money in other countries, emerging market countries, then the issue really is skill level. so we should be having a continuing discussion on that issue. i think the tax code, or i should say the federal government spending and taxes are a lever. but it's certainly not the problem. it's not going to address our long-term -- the long-term issue of income inequality. i think really you have to think more fundamentally is the cause of income inequality. that's really a very important part of the discussion. >> i agree. but it's also very hard issue. >> right. >> you say invest more in education. even that's problematic. but there is much more to it. there are some people -- some people who are just not going to be able to get college degrees

or -- and people -- some of us are lucky that we're able to really take advantage of higher education and get big payoffs. and other people who aren't. it used to be there were good factory jobs that paid those people very, very well. and we have to sort of figure out a new kind of economy where people who have limited skills can still support their families with dignity. i should say the earned income tax credit, which is a significant component of that 50% of americans who don't pay income taxes on balance, i think it's a really good thing, because as opposed to raising magics substantially, which would entail an economic cost, this subsidizes the wages for people who are working and makes it possible for somebody working full-time at more than the minimum wage to be able to support their family at a level above poverty. and if you don't want to do it through the earned income tax credit, you got to think about

some other way to make sure that people who are working hard can actually survive. >> i'm with the concord coalition. so the topic of this event is taxes on the rich, right? and i want to just make the point that obviously it's -- there are economic costs associated with raising taxes on the rich. we, the panelists have talked about why base broadening would be a lower cost way of raising taxes on the rich. but there would still be economic costs. and i think that this is an issue of where the budget process and our budget constraints can really help tax policy move along. because if you give people the choice of raising tax burdens versus not raising tax burdens, they're always going to choose to not raise tax burdens. so you're not going to force tax

reform or any action on tax policy unless you have a binding budget constraint and it's something different from the budget constraint we've been following. so i think we have an opportunity in that there is a need for deficit reduction, there is a need for a lot of deficit reduction, and the budget process can help inform the tax reform debate by setting a budget constraint, not necessarily simply on the revenue side versus the spending side, but set an overall budget constraint of how much budget deficit reduction has to happen and forces us as policymakers to weigh costs against benefits on different types of tax policies or spending policies. so one thing i have repeatedly pointed out is that the current law baseline is a really good baseline in terms of achieving economically sustainable budget deficits. if we were to stick to the current law baseline, that doesn't mean going over the

fiscal cliff or running into the fiscal cliff or however you want to use that metaphor. it can mean sticking to pay as you go on the expiring tax cuts over a ten year budget window. and i think a lot of people have the tendency to look at the fiscal cliff and look at the expiration, the tax cuts as it's an all or nothing deal. okay. we got to either run into the cliff or run off of the cliff or stop short of it and don't do anything about it. and i think that's the mistake. so i'm hoping, i'm still hopeful, i'm naively hopeful that the budget constraint, the fiscal outlook, the budget constraint, the fiscal cliff coming up, that it's all an opportunity to actually let budget, the budget outlook and budget process help make better tax policy. >> do me a favor for the tv audience and explain what you mean by the current baseline. >> the current law baseline assumes that current tax law actually happens. currently --

>> so it's silly. >> so currently the bush tax cuts are scheduled to expire at the end of this calendar year. they were previously scheduled to expire at the end of 2010, but were extended. so we are nearing the end, at the end of this year they're all supposed to go away. alternative minimum tax relief is another tax provision that is going to expire. and the payroll tax cut is going to expire. so those are just the tax portions of the fiscal cliff which when you throw in some sequestration possibility on the spending side make for -- make for a rather steep cliff in terms of the one-year timing. current law is literally that the tax cuts would expire at the end of the year, but sticking to pay/go on the current baseline just requires that that revenue be made up over ten years. and that's what the difference is between current law and a current law baseline. >> thank you over here?

>> good morning. victor teroni. many good ideas here. let me add one more. so is let's suppose a decision is made in tax reform to lower rates, broaden the base, probably lower the corporate tax rate. i am skeptical that this is going to satisfy the current law baseline, come up with the revenues we need, or do an up on the distribution. so about a year ago, i wrote an article in "tax notes" describing the progressive expenditure tax. this would be a supplemental expenditure tax. it's a little different from what is suggested in bob carroll's book, which i haven't read yet, but look forward to. and i think it would be great if we -- we can't do it here, but in a subsequent event to look into these alternatives and to see, you know, how can we actually do it if we decided that we wanted to. thank you. >> okay.

did i see somebody raise their hand in the back, by the way? okay, two. and then joe, i'll get around to you. >> i'm rebecca wilkins. i'm with citizens for tax justice. i think we need to embrace taxmaggedon, or as bruce calls it, tax-majinon. it's almost an opportunity to reset the button and let the bush tax cuts expire, and then do some sensible reforms, come back in january, and decide what targeted tax cuts really need to be made. and everybody, like len said is going to have to pay higher tax rates to address the budget problems. but i find it really frustrating for us to focus, as scott did, on just the federal income tax. when you look at the chart that len so kindly copied up from our report in april, the taxes that people pay, people at the low

income range pay huge amounts of state and local taxes. now all of news this room, the federal income tax is the biggest tax we pay, so that's what we tend to focus on. but there is a washington on the other coast where the bottom 20% pay 17% of their income in state and local taxes. and the top 1% pays less than 3% of their income in state and local taxes. now when you go to the store to buy your kids school supplies in august, and you have a $20 bill in your pocket, if you're in the low income range, you know you can't put $20 worth of stuff in your basket. you can only put 17 or $18 worth of stuff in your basket, because when you get to the checkout counter, they're going to add another 10% or 12% of the sales taxes. so we do, as robert said, need to look at the tax system as a whole and where people pay taxes. and that's including the corporate income tax. in november we updated our

corporate taxpayer and corporate tax report. we looked at the fortune 500. we included only the companies that had been profitable over the three-year period we looked at. we found an average corporate tax rate of only 18.5%, which is almost half the statutory rate of 35%. there were 78 companies in our study who pay zero income tax in at least one year. and there were 30 companies that had a zero or lower tax rate in all three years. so to say that that corporate income is taxed and then taxed again at the investor level is just really not what reality is. and also looking at the tax system as a whole, you got to look at the problem that the capital gains lower rate causes. not only all those smart people wasting their time figuring out ways to convert your income to capital gains. i think it contributed in a great way to all of the financial innovations that

happened that almost brought down the world economy. and look at how much it contributes to inequality. if you have two people making, let's say a nice salary, $250,000. and one of them all their income is from salaries and wages, and the other all their income is from capital gains and ordinary income. well, the guy who works for a living is going to pay about $57,000 in federal income tax. but the person living off his wealth is only going to pay $38,000 in federal income tax. a $20,000 difference. so at the end of the year, he's got $20,000 more to invest. here is somebody who already has substantial assets, and we have just given him $20,000 more so at the end of the year he is going to continue to increase the amount of assets that he has. so i think we really have to look at the system as a whole and see what makes sense.

and the tax -- the wealthy can pay more tax, and the threshold should be a lot lower than $250,000. and also i wanted to give joe a shout out. i've never heard april 15th talked about as a holiday before. >> an anti-holiday. i misspoke. >> i have two in the back i'm going to go to in a second and over here and over here. david wanted to jump in for a second. >> respond to one thing that rebecca said. she mentioned the state of washington having a very regressive tax system. but i wanted to remind her that the citizens of washington, i think it was two years ago, rejected adoption of an income tax, overwhelmingly. and it was an income tax that was going to fall on the top 1% of the population or something. it was only incomes over $400,000, like nobody was going to pay it. and it was rejected 70-o30.

>> we can't explain why people keep voting against their self-interest. >> interesting point. when you include state tax levels, the 50 states and d.c., the citizens are making choices in terms of what they want their state systems to look like. i saw your chart when i was looking through len's handout. and it's really a very interesting chart. but then it kind of leads you down a road of whether the folks in washington should attempt to undo the distributional effects of state level policies through the federal tax code. and i think that's kind of a very problematic path to go down in my own view. >> but actually, it's harder for states to have very progressive tax systems because it's actually easier for high income people to avoid state taxes. they can move from oregon to washington if they don't want to pay income taxes, where if we decide collectively that we're going to provide as we want to

provide support for lower income people, it's much easier to do it at the lower level. >> eduardo saverin. >> right here. le less snyder. i would like to challenge the emerging convention, the conventional wisdom that the way to reform tax laws is by reducing tax expenditures and lowering the top rates. i think people have selective memory loss because we tried that in 1986. we lowered the rate to 28%. and most people don't realize it, but when you look at the distribution tables, that tax law change was a tax increase, not a tax cut. and the greatest increase according to the distribution tables were to incomes at the top. but i would say within three months after the enactment of that statute, more liberal politicians already were screaming that the rate on wealthy people were too low, and they wanted to increase it. i think if you buy off on this myth that you'll trade tax

expenditures for a lower rate, you're going to end up with no tax expenditures and a higher rate in the end. now maybe that's what people want. but i think on one side of the aisle that's not what they want, but that's what they're going to end up with, in the long run. >> you have a response? >> most of the base broadening in '86 was actually on the corporate side. and actually a lot of those changes survived. it is true that rates went up. also, right after tax reform is enacted, there was a -- i'll call it a lower capital gains tax rate, and to restore the tax investment credit, one of which eventually happened. i mean it certainly for people who are thinking about tax reform, i think the biggest challenge is figuring out how to make it stick. it's certainly -- and the other thing is we talk glibly about $1.1 trillion of tax expenditures. most of those would be extremely difficult politically to get rid of. when you're talking about raising -- one of the things happened in '86 was corporate ceos came to washington and said we kind of like this thing, even though we're really raising taxes on corporations, they liked the idea that their own

personal tax rates were going down to 28%. talking about trimming the mortgage interest deduction, limiting the tax break for health insurance and things like that is -- both of those i think would be a good idea as a matter of policy, but politically if they're not impossible, extremely difficult. >> and to your point, there is another incentive in the tax code that we haven't talked about yet, and that's the incentive of the politicians to keep it so they can keep picking winners and losers. and that's the one i worry about. do we have somebody else in the back? no? dave? >> dave carter from the tax center at american university. and i'd like to narrow the discussion maybe a little bit for a minute or two. one of the issues it seems to me that muddies the debate on how much the rich should pay or what the rate should be is something that bob mentioned, which is a large percentage of business income flows through and is taxed at individual rates.

and whenever there is a discussion about raising the individual rates, then it's described as a tax on job creation. i wonder if the panelists have any thoughts about separating the taxation of business income from individual income. in other words, on the existing form 1040, you have two schedules, one where you have a number for sole proprietorship income, one with s corporation and private corporate income. what if the system were to take those two numbers off the rest of the individual returns, subject them to a business rate schedule, the same rate as a corporate rate schedule, and then deal with individual -- i understand that doesn't deal with integration issues for corporate. but tax business income under one system and individual income under another system. >> you both addressed that. so one, two. >> so the idea of taxing

flow-through business income at a different rate, actually i haven't heard that suggested before. i think it would be problematic. and the reason is that -- first, there is a question about whether you would actually want to do it. and i would say that the progressive tax system actually is good for most businesses. most businesses are owned by people that actually don't have -- they're not in the top brackets. now it is true that most of the income is earned by people in the top brackets. they're the ones with the large businesses with many, many employees. basically, business investment is risky, and effectively progressive taxation provides a kind of safety nate, that if you don't do very well you're taxed at a much lower rate than if you turn out to be very, very successful. the issue of trying to separate s corporations, partnerships,

other sole pro priprietorships d be hard to draw the line. according to income tax returns, i'm a small business. i file a schedule c. i didn't get an hon haorarium f this, but i sometimes get paid. >> you get our love and respect. >> yes. but a lot of the people who look like businesses on tax returns, they're really just -- they're people who do a little bit of consulting on the side. they're fairly wealthy people who are on corporate boards and get paid for their activities doing that on schedule c. the treasury department has a very nice study. susie nelson and several other people looked very, very closely at business income reported on individual income tax returns. and a very large percentage of that was people you wouldn't actually -- you wouldn't

actually think of as small business people, people who are hiring other people, creating jobs. the more fundamental problem is if you said that business income was taxed at a lower rate than other income, a lot of people would be looking for ways to make their business income -- to make their wages and salaries actually look like business income. and that would be economically inefficient. and also it would raise fairness issues. >> just a couple points. the first time i heard of this idea was actually 1993 where i was a staff economist at the treasury department shortly after president clinton was elected. his interest in raising the top tax rates, the millionaire sur tax morphed into the 39.6% rate, kicking in at $250,000 at the time. and in any case, that was a hotly contested debate on the congress. and one of the things, an idea that was broached was having a

separate rate schedule for certain type of flow-through or business income. and it was considered and then not -- it was considered on the hill. it was considered internally for a very short while before it was rejected. you know, i think one of the problems with this issue is the corporate income tax is really a tax on investment returns, on equity finance investment returns primarily. and corporations tend to pay everyone who works for the corporation wages, and those wages are subject to the individual income tax. with flow-throughs, it works a couple different ways. s corporations are required to pay the owners some reasonable compensation. partnerships are not. so proprietors, there is no distinction between wage income and the return to capital from the investment in the enterprise. so