10 myths about higher taxes.

• Author: Rabushka, Alvin

Tax increases will not reduce the deficit, improve fairness by making the rich pay more, or help the balance of payments.

On August 10, 1993, Pres. Clinton signed into law the largest tax increase in U.S. history for the stated purpose of reducing the Federal budget deficit. The Omnibus Budget Reconciliation Act of 1993 (OBRA93) is constructed to collect $24 1,000,000,000 in new taxes on personal income, corporations, and gasoline over the next five years. The act will fail to achieve its revenue and deficit reduction targets for a number of reasons that constitute 10 myths about higher taxes:

Myth #1. People willingly pay higher taxes for worthy goals. Proponents of tax increases point to public opinion polls to justify the claim that the public will accept higher taxes as the price of deficit reduction. Most economists, however, employ a methodology that rejects polling statements as evidence of actual behavior. This is captured in the phrase "watch what people do, not what people say." The reality of taxpaying, even with the current relatively modest 39.6% top marginal rate, is that noncompliance exceeds $100,000,000,000 a year. During the 1980s, about 70% of noncompliance took the form of underreporting income and 17% of exaggerating deductions.

Noncompliance responds to changes in marginal tax rates. High ones foster cheating. In 1983, the American Bar Association established a Commission on Taxpayer Compliance that undertook a three-year study of the sources of noncompliance and measures to improve compliance. This commission's report, issued in July, 1987, acknowledged that compliance improves when marginal tax rates decline and deteriorates when tax rates increase. It is unrealistic to expect American taxpayers to pay willingly the higher taxes embodied in the 1993 act. Rather, higher tax rates will encourage taxpayers to cheat even more.

In addition to greater cheating, higher rates will resurrect a variety of old tax shelters and generate a proliferation of new ones. Tens of thousands of lawyers, accountants, and sellers of tax shelters will fashion hundreds of ingenious ways to reduce taxable income. Tax avoidance, unlike tax evasion, is perfectly legal. Even before passage of OBRA93, the pages of the Wall Street Journal and other financial publications contained numerous advertisements and stories about the benefits of municipal bonds and other tax shelters. The popularity of tax-free bonds and other shelters goes up and down with changes in rates. Doubtless, some of the new tax shelter avoidance schemes will border on tax evasion. Since it takes the Internal Revenue Service and the courts several years to catch up with the not-quite-so-legal schemes of the purveyors of tax shelters, actual revenues will fall below estimates. When the predicted revenues fail to materialize, politicians likely will clamor for strengthening the enforcement mechanisms of the IRS.

Few people send additional voluntary contributions to the IRS despite daily political reiteration of the need for additional funds to finance vital, unmet social needs. Indeed, it is a safe bet that taxpayer compliance would fall dramatically, perhaps disappear altogether, if the IRS were dissolved and all taxpayers were placed solely on their honor without fear of penalty for noncompliance.

Myth #2. Tax increases reduce budget deficits. This statement is patently false both for tax increases in general and for deficit reduction tax increases in particular. Between 1950 and 1992, total Federal receipts rose from $39,400,000,000 to 1.09 trillion dollars. Total spending over the same period increased far more rapidly, from 42,600,000,000 to 1.38 trillion dollars. This trend, spending rising faster than revenues, holds for any starting date. Deficit-reducing tax increases, in particular, show no perceptible impact on deficit reduction; indeed, they appear to have the perverse effect of increasing future deficits.

The tax increases enacted during the Reagan-Bush years 1981-92) include the Tax Equity and Fiscal Responsibility Act of 1982 (to raise $98,000,000,000 over three years); Deficit Reduction Act of 1984 (to raise more than 20,000,000,000 a year into the indefinite future); Omnibus Budget Reconciliation Act of 1987 (to generate more than $10,000,000,000 a year); and Omnibus Budget Reconciliation Act of 1990, the...