By Michael J. Graetz
Thirty years ago, Dan Throop Smith, a renowned Harvard economist who had served as the Treasury Department's top tax adviser during the Eisenhower administration, accepted the invitation of his daughter, a teacher, to visit her one-room school in Montana. To get a better handle on tax equity, Smith asked three children what would be a fair tax on a family with an income of $5,000 if a family with an income of $2,000 paid a tax of $200.
The first child said, "Five hundred dollars," thereby showing a predisposition for proportional burdens and perhaps a desire to make use of a newly acquired familiarity with percentages. A second child immediately disagreed, adding the comment that the payment should be more than $500 because "each dollar isn't so important" to the family with the larger income. A third child agreed, but with the reservation that the additional tax over $500 shouldn't be "too much more or they won't work so hard."
Smith subsequently relayed this story in a scholarly article, adding: "Elaborate theoretical structures concerning diminishing utility and incentives and disincentives are all really refinements of the quasi-intuitive opinions of those children and may not lead to any greater certainty."
Shortly after my recent book, "The Decline (and Fall?) of the Income Tax," which retells Smith's story, was published, my daughter's fifth-grade teacher asked me to visit her classroom to talk about it. While there, I repeated Dan Throop Smith's experiment. I asked the identical question, and remarkably, the first three students to speak gave the identical answers in exactly the same order. The intuitions about progressive taxation of the children of the 1990s in a large New Haven, Conn., school mirrored precisely those of the Montana children of the 1960s. After I told them that they had given exactly the same answers in exactly the same order as did children three decades earlier in a one-room Montana schoolhouse, a number of them wrote to me remarking how "cool," "neat," "amazing" and "weird" that was. One concluded, "I guess that must be fair, if both of the schools got the same answers."
These two experiments should serve as a caution to congressional Republicans like Armey and Tauzin, who believe that the American public will view as fair replacing a progressive tax on income with a flat rate tax on consumption. That sentiment will last only until the second child answers.
The current income tax is a horrible mess and should indeed be scrapped. But in the course of radically restructuring our tax system, we should not enact a massive tax reduction for the country's most wealthy people, those who least need such relief. In discovering how we should move forward, we can usefully take a look backward. We should return the income tax to its pre-World War II status a relatively low-rate tax on a thin slice of the wealthiest Americans. Enacting a value-added tax (VAT) of 10 or 15 percent would finance an income tax exemption of up to $100,000 and would allow a vastly simpler income tax at a 20 to 25 percent rate to be applied to incomes over $100,000. The VAT, which is commonly used throughout the world, would operate much like a national sales tax, but would be much easier to administer and far more difficult to evade. Such a change would eliminate 100 million of the 115 million income tax returns that currently are filed each year and would allow considerable simplification to the sliver of an income tax that remained. As Billy Tauzin is fond of saying, for the 100 million people from whom no income tax would be required, April 15 would be just another spring day.
The writer, a professor of law at Yale Law School, served at the Treasury Department from 1990 to 1992.
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