Interview with J. D. Foster, Ph.D.

Family North Carolina Magazine—May/Jun 2008

On Air With . . .
J.D. Foster is the Norman B. Ture Senior Fellow in the Economics of Fiscal Policy at the Thomas A. Rowe Institute for Economic Policy Studies, a program of the Heritage Foundation. Dr. Foster formerly served as Associate Director for Economic Policy in the White House Office of Management and Budget. Prior to this, he was Senior Economics Advisor in the office of Tax Policy at the Department of Treasury.

The following is an edited transcript of an interview with Dr. Foster conducted by North Carolina Family Policy Council President, Bill Brooks. The interview aired in May 2007 on the NCFPC’s weekly radio program, “Family Policy Matters.” Dr. Foster talks about the amount the average American pays in taxes each year, and how high taxes impact middle class families in particular.

This interview can be heard in its entirety here: Listen (.mp3) — (Real)

Bill Brooks: I’ve heard it stated that the American family pays more in total taxes than they pay for food clothing and shelter combined. Is this accurate? How much does the average American family pay in taxes?

J.D. Foster: Well, it is accurate, and there are a lot of different ways of describing the American tax burden. I’ve found probably the easiest to understand is a calculation done by the Tax Foundation called Tax Freedom Day. The idea is if you imagine all of your income going to pay your taxes beginning January 1, when you get through the calendar, Tax Freedom Day is the day when your tax burden is paid off. This year, Tax Freedom Day came on April 30. That means that on average, all our income went to paying our taxes until April 30 this year. You asked about what the American people spend for food and shelter and clothing. Well, it takes about 105 days to accrue the income necessary to pay for food and shelter and clothing, and 120 days to pay your tax burden. So, your tax burden is definitely higher.

BB: When you say that we paid our tax burden by the Tax Freedom date, does that also include the taxes that we pay for sales tax and gasoline tax and property tax and food tax and restaurant tax and hotel tax and airport tax, and there are probably some more I’ve forgotten?

JDF: There are hundreds of taxes, especially when you get down to the state and local level. But the answer to your question is yes, that’s all in the calculation. All federal, state, and local taxes go into that.

BB: Americans are taxed by the federal, state, and local governments in a variety of ways. Give us some examples of the types of things that we pay taxes for.

JDF: Well, we pay taxes for some things that are constitutionally-mandated like national defense. We pay money for homeland security and for maintaining the Judiciary. Those are all things that are implied by the U.S. Constitution. Then, we pay taxes to support certain functions that support our economy—an example being roads and bridges and important maintenance as such. Then we pay a lot of tax for the social insurance programs like Social Security and Medicare, and then we still have more taxes to pay for such things as farm subsidies and special programs like the Corporation for Public Broadcasting and international programs for the United Nations and that’s all at the federal level. Then when you get to the state and local level, you’ve got police protection, the education system for our kids, and locally-delivered social services. Basically, if you can imagine something to be taxed,
we tax it.

BB: Middle class families bear a significant financial burden from taxes.
Why is this?

JDF: You know, a famous bank robber was once asked why he robbed a bank, and his answer was because that’s where the money is. We have a government that has a voracious appetite to spend money and most of that spending is going to be financed by taxes, so the government goes where the money is. The rich, of course, pay an enormous tax burden in this country, but as a group, middle class families earn the bulk of the income and so that’s where the taxes fall. And I should point out it’s not so much the income tax burden for the middle class families at the federal level, but it’s the payroll taxes they pay that’s a really heavy burden. Then [there is also] the state and local burden of property taxes and sales taxes and some things of that nature.

BB: Talk about the marginal tax rate a little bit and explain how it punishes success.

JDF: Well the marginal tax rate is always the tax on the last item of income or the last item of consumption that’s being taxed. One way to think about it is if you placed a flat tax of 25 percent on your wages for the first 40 hours of work in a week, and suppose I told you that the tax rate was going to be 50 percent on anything you earned after 40 hours. You would be a lot less likely to work overtime if you are going to face 50 percent tax rate instead of 25 percent. The higher tax rate discourages people from working, and that’s what a marginal tax rate does. It focuses the burden on the extra dollar of income. It’s an important principle that it’s not the tax rate on the first dollar of income that matters in terms of affecting behavior; it’s the tax rate on the last dollar of income. That’s called the marginal tax rate.

BB: Now, there’s been a lot of discussion recently about what is called the alternative minimum tax, or AMT. A lot of people who would consider themselves middle class just filed their income taxes, and have all the sudden found themselves having to pay [this tax]. What is the AMT, and what impact does it have on middle class families?

JDF: In this country, we think we have an income tax, but we don’t really have an income tax; we have two income taxes. We have the regular income tax and the alternative minimum tax, or AMT, and you pay whichever one yields the larger tax liability. The AMT was originally designed to be a catchall to make sure that upper income tax people were not able to completely avoid tax liability through the various deductions and exclusions and other types of tax preferences that they are able to take. But the AMT today is increasingly reaching down into the middle class. The AMT today primarily falls on families with incomes between $100,000 and $500,000, and if you have more than $500,000 of income, you’re very unlikely to pay the AMT. Likewise, if you have income below $100,000, you’re probably not paying AMT today, but if Congress doesn’t act, pretty soon you very well could. The AMT is reaching further and further down toward lower income tax payers. Now, there is a movement in Congress right now to reform the AMT so that it only affects upper income tax payers as was originally intended. Unfortunately, that move is really just a disguised effort to raise taxes on balance… .

BB: Give us some examples of the positive tax reforms and cuts we’ve seen at the federal level in recent years.

JDF: We’ve had, actually, a pretty good run in terms of trying to improve the tax system in recent years. Under the President’s leadership, we’ve improved the income tax system by lowering marginal tax rates. We talked about how important marginal tax rates are to economic decisions in the economy. Lower marginal rates have meant a real boom for small businesses that typically pay taxes at the individual rate. You know, most economists thought for years that taxing dividends, in particular, was a pretty foolish policy because it was double taxation, and whatever your political leanings, double taxation is usually a bad idea. Well, the President proposed eliminating the tax on dividends. Congress couldn’t quite go there, but they did cut the tax rate to 15% and cut the capital gains tax rate down to 15% as well. And we don’t think it’s really any surprise that when those tax cuts were put in place in 2003, the economy really took off and the stock market really took off almost at the same time. So, we thought that was very important and really good for the economy. At the same time, the President doubled the child tax credit to $1000. The tax system has a penalty if you’re married, through all the various complicated elements of the tax system; if you’re married you pay more tax than two individuals making the same amount of income. Well, they reduced the marriage penalty significantly. They significantly improved the savings incentive so people can save for retirement, and they phased out the debt tax. Now that’s all the good news. The bad news is all of these tax cuts expire at the end of 2010, creating the largest tax increase in history unless Congress acts to make them permanent.

BB: Do you see any likelihood of that happening and by what time would Congress need to act to keep these changes in the tax laws that have happened in recent years?

JDF: Technically, they need to act by the end of 2010, but practically they really need to be thinking of acting soon and certainly no later than 2009, and I do think they’re going to end up extending most of that tax relief, and perhaps all of it. I can’t envision a Democratic or Republican Congress allowing the child tax credit to be cut in half, or put the marriage penalty back in place. There is a lot of support for the reduction in the capital gains tax. The fight over the debt tax, of course, is a very intense one, but last year we came very, very close to having a compromise where the exemption amount under the debt tax was significantly increased and the rate was brought down from what it was previously. And so while we may, we certainly need to have debt tax repealed and keep it repealed. But if that doesn’t happen, I think a good compromise is available. So, I think there’s really no question. We’re going to have an enormous tax bill and an enormous tax debate in 2009 and 2010, and something very significant is going to happen.

BB: Dr. Foster, what further tax reforms are needed to help ease the burden on American families?

JDF: Well, there are two things. Of course, being in Washington, we always think in terms of a federal tax policy, and you really need to keep focusing on the AMT so that it doesn’t capture more and more taxpayers. We need to focus on tax policies that will encourage our economy to grow, keep the tax burden down overall, but also focus on tax policies that will get the economy to grow. You know, we have one of the highest corporate tax rates of all the industrialized countries. People don’t want to talk about corporate tax relief because it’s not very popular, but it’s hard to have a strong economy when you’re taxing your corporations more heavily than your competitors are doing. So those are a couple places you would look on the federal side, but you also shouldn’t ignore the state and local side. Now, at the federal level, the tax burden as a share of our total economy, it’s just a little bit above the historical average now. But the tax burden at the state and local level has been soaring, and we really need to focus attention at the state and local level whether the state has property taxes, property tax receipts are soaring, property tax payments are soaring. A lot of jurisdictions impose all kinds of nuisance fees and small taxes… . A great way to lower the tax burden and lower the compliance and administrative burden of a tax system at the state and local level is just to start eliminating all of these nuisance fees and small collections and small taxes. They’re expensive to collect, they’re expensive to administer, and they don’t generate a lot of revenue but they generate some. But in so doing they tend to disguise the overall tax burden because people don’t see the little nickel and dime and $1 and $2 and $10 payments that they’re making. But they all add up, and that would be a great way to simplify the tax system and get the tax burden down.

BB: As much as we may dislike paying taxes, most of us realize that taxes are necessary for our government for function, and we’ve talked a little bit about that already. How did our founding fathers understand taxes, and how far have we moved away from what they originally intended in terms of our tax policy?

JDF: I think by any measure, the role of government and taxation is vastly different today than what the founders envisioned. Of course, some of them envisioned a greater role for government, some smaller. Some envisioned stronger federal government, some weaker. But none of the founding fathers ever imagined that one in five Americans would be working for the federal government. One in five Americans today work for the government at the federal, state, or local level. They could never have imagined that government could get so huge. And of course, they never thought that government would be able to pry so deeply into our private lives. The founding fathers had a great respect for the importance of personal privacy, and we don’t tend to think of it because we’re so used to it. But the Internal Revenue Code and the form 1040 that we all file provides the government with an incredible amount of information on our personal lives—what our medical expenses are, what our investments are, where we invested, the nature of the debt we have on our housing, the kind of vacation expenses we’re incurring for our kids. We should always be debating the role of personal privacy, and the concept of homeland security and elsewhere. But somehow we ignore the tremendous invasion of our personal privacy that results from the federal tax system. So, I think both in terms of the size and the manner in which we are taxed is at great variance from anything the founding fathers would have envisioned or attempted. v