[W]e need to change our tax code so that people like me, and an awful lot of Members of Congress, pay our fair share of taxes. Tax reform should follow the Buffett rule: If you make more than $1 million a year, you should not pay less than 30 percent in taxes. [Emphasis added.]

And:

When Americans talk about folks like me paying my fair share of taxes, it’s not because they envy the rich. It’s because they understand that when I get tax breaks I don’t need and the country can’t afford, it either adds to the deficit, or somebody else has to make up the difference. . . . [Emphasis added.]

There are lots of claims there that cry out for examination. For example, what’s need got to do with it? Does Obama really favor a tax system that leaves you only what you need — as determined by someone else? And look at that term “tax breaks.” If a burglar decides not to break into your house and take your things, have you gotten a break? Or have you simply kept what is yours? Is Obama really suggesting that how much of your income you retain should depend on what “the country” can afford? What does that even mean?

Buffett Rule

All that aside, I want to home in on Obama’s notion of fairness. “If you make more than $1 million a year,” he says, “you should not pay less than 30 percent in taxes.” How does he know that constitutes fairness? Obviously 30 percent is an arbitrary figure. If he’s concerned that income and payroll taxes take a smaller percentage of Warren Buffett’s income than the percentage they take from his secretary’s income, why not reduce his secretary’s tax rate? It’s certainly not obvious that Buffett should pay more. (For an interesting discussion of the secretary’s tax rate, see this and this.) Obama (like most other politicians) regards government spending growth as inexorable and virtually untouchable, but why? (Proposed “cuts” are merely reductions in the rate of growth.)

On this matter of tax fairness, no one tops Murray Rothbard’s discussion in his classic Power and Market: Government and the Economy (online in PDF format here). Rothbard starts by noting that for many years people thought products had a “just price.”

It is clear, even to those (like the present writer) who believe in the possibility of a rational ethics, that no possible ethical philosophy or science can yield a quantitative measure or criterion of justice. . . . Economics, by tracing the ordered pattern of the voluntary exchange process, has made it clear that the only possible objective criterion for the just price is the market price. For the market price is, at every moment, determined by the voluntary, mutually agreed-upon actions of all the participants in the market.”

Rothbard of course is talking about a market unblemished by government monopoly privilege and other interventions.

He goes on next to ask: “If the search for the just price has virtually ended in the pages of economic works, why does the quest for a ‘just tax’ continue with unabated vigor? Why do economists, severely scientific in their volumes, suddenly become ad hoc ethicists when the question of taxation is raised?”

We might also ask why a president makes ethical pronouncements about levels of taxation without first laying out his moral philosophy plainly for all to judge.

Canons of Justice in Taxation

Thus the “canons of justice” in taxation must not be taken for granted. Calling something just does not make it so. Rothbard writes:

The prime objection to these “canons” is that the writers have first to establish the justice of taxation itself. If this cannot be proven, and so far it has not been, then it is clearly idle to look for the “just tax.” If taxation itself is unjust, then it is clear that no allocation of its burdens, however ingenious, can be declared just.

A few pages earlier Rothbard defined taxation, uncontroversially, I hope, as “a coerced levy that the government extracts from the populace.” Pulling no punches, he quotes his mentor Frank Chodorov, once an editor of The Freeman:

A historical study of taxation leads inevitably to loot, tribute, ransom — the economic purpose of conquest. The barons who put up toll-gates along the Rhine were tax-gatherers. So were the gangs who “protected,” for a forced fee, the caravans going to market. The Danes who regularly invited themselves into England, and remained as unwanted guests until paid off, called it Dannegeld; for a long time that remained the basis of English property taxes. The conquering Romans introduced the idea that what they collected from subject peoples was merely just payment for maintaining law and order. For a long time the Norman conquerors collected catch-as-catch-can tribute from the English, but when by natural processes an amalgam of the two peoples resulted in a nation, the collections were regularized in custom and law and were called taxes.

“Why do not economists abandon the search for the ‘just tax’ as they abandoned the quest for the ‘just price’?” Rothbard asks.

One reason is that doing so may have unwelcome implications for them. The “just price” was abandoned in favor of the market price. Can the “just tax” be abandoned in favor of the market tax? Clearly not, for on the market there is no taxation, and therefore no tax can be established that will duplicate market patterns.

So let’s hear no more about tax fairness, unless it’s to point out that fairness is approached as tax rates move toward zero.

Obviously the income tax is a tax on people’s income-generating activities. What this means is that it penalizes these activities relative to activities that do not generate income. In a market setting, income-generating activities are those that lead to the production of goods and services. So the income tax penalizes work relative to leisure, and saving and investment relative to consumption. It is the latter that tends to be least understood and therefore will be the focus of this essay.

Consume or Invest?

The broad choice facing an individual in choosing to allocate his or her income is to either spend it or save and invest it. This consumption/saving choice is distorted by the income tax in favor of consumption.

Using the traditional terminology, the income tax double-taxes saving relative to consumption. It should be noted that this terminology is somewhat misleading. As will be demonstrated, the tax does not explicitly double-tax saving but reduces the returns to saving twice, while reducing the returns to consumption just once.

This can be shown with a simple example. Start with an individual who has $100 of pretax income. In the absence of taxation this person has $100 for either consumption — the purchase of goods and services — or saving. If the interest rate is a simple 10 percent per year, then the person can decide whether he prefers to spend $100 or save the $100 and have $110 available for spending a year from now. The decision will be based on his preference for satisfaction now relative to satisfaction in the future. This is what economists call time preference.

Now assume that the individual faces a 10 percent income tax. His $100 is reduced to $90, cutting the amount available for consumption by that rate. Likewise, the tax implicitly reduces his returns to saving by 10 percent. In other words, by taxing the principal the government is simultaneously reducing the entire stream of returns from the investment. So if he saves the $90, because of the tax his interest income is reduced from $10 to $9.

The Returns to Waiting

In the absence of further taxation the individual’s choice is between spending $90 now or waiting a year and having the opportunity to spend $99. Returns to consumption spending and returns to saving have both been reduced equally by the tax. But under a standard income tax, the returns to saving are reduced yet again. The $9 in interest also is taxed 10 percent, leaving $8.10.

So the tax reduces the returns to savings twice: first from $10 to $9 when the initial $100 is taxed, and second from $9 to $8.10 when the interest is taxed.

Note that the return from consumption is only reduced once, from the level of satisfaction that could be obtained with $100 to the level that could be obtained with $90. The tax on interest or other returns to investment, including dividends and capital gains, biases decisions against saving, investment, entrepreneurship, and business expansion, and in favor of consumption spending.

In addition the government, at both the federal and state levels, further punishes investors with a separate corporate income tax. The corporate tax, which at the federal level is 35 percent, adds a third layer of tax on both dividends and capital gains.

Exempt Returns from Saving

The most straightforward way to remove the bias is to exempt from taxation all returns from saving. This is the approach that has been taken by those who advocate the flat tax, for example, Steve Forbes. From this perspective, saving and consumption are treated symmetrically.

An alternative way of remove this bias is by eliminating all saved income in the current time period from the tax base, taxing it only when it is withdrawn for consumption purposes. A tax that deals with the bias against saving in this way is called a “consumed income tax.” The idea would be to treat all savings and investment in the same way that IRA and 401k retirement investment plans are treated, except that there would be no penalties for withdrawing funds before any legally specified age.

In reference to our example, if the person decided to spend his $100 in pretax income, he would be subject to the 10 percent tax immediately and would have $90 available for consumption. If instead he decided to save or invest the $100 for a year, he would not be taxed on it until it was taken out of savings and used for consumption. At the end of a year, if he chose to withdraw the money from savings or to cash in his investment, the original $100 and the return of $10 would be taxed 10 percent. This would leave him with $99 for consumption, or the equivalent of a full 10 percent return on $90. The point here is that only income that is used for consumption is taxed, hence the name “consumed-income tax.” It should also be noted that this gives the same result as the flat tax, which would exempt the interest income from the tax base. The individual would save $90 ($100 minus the 10 percent tax) and earn $9 in interest.

Full Exemption of Expenses

The consumed-income tax suggests that all expenses incurred to generate future income, which is the definition of investment, should be eliminated from the tax base. This implies that all work-related expenses, including commuting expenses, educational expenses incurred to enhance future income, and day-care expenses, should be excluded from the tax base. These expenses are analytically equivalent to saved income. They represent forgone current consumption in an attempt to generate future income. This approach also implies that all business expenses (labor, plant, and equipment) should also be deducted in the year they are incurred rather than depreciated over time. This insures that the full cost of the investment, rather than a time-discounted cost, is realized in the tax deduction.

A word of warning is in order. It needs to be made clear that there is no such thing as a tax that does not damage productivity and economic growth. To invoke a term often used by economists, a “neutral tax” does not exist. At the very least, all taxation transfers the control of productive resources from the free market to government control, that is, from an institutional setting that will generate a more efficient use of resources to one that will generate a less efficient use of resources. What this means is that overall the economy, and therefore human welfare, always suffers as a result of taxation.

For over 25 years the Westport, Connecticut industrialist battled the federal withholding tax, which she refused to collect from employees’ wages.  If the government wanted her “to be their agent,” Kellems declared, they “have to pay me, and I want a badge.”

In For a New Liberty, economist Murray Rothbard discussed Kellems’s stance: “What moral principle justifies the government’s forcing employers to act as its unpaid tax collectors? The withholding principle, of course, is the linchpin of the whole federal income tax system. Without the steady and relatively painless process of deducting the tax from the worker’s paycheck, the government could never hope to raise the high levels of tax from the workers in one lump sum.”

“Temporary” Measure

The withholding tax on income had been introduced in 1943 as a temporary measure to finance World War II. Called “the Victory Tax,” it required businesses to use their own resources to withhold taxes, to maintain records, and to remit money; mistakes or noncomplaince could result in severe penalties. Thus businesses became unpaid accountants and tax collectors for the federal government.

After the war there was no sign of withholding’s repeal and so Kellems, who had master’s degree in economics and a nearly completed Ph.D, ceased to comply. Her rebellion was based on far more than the lack of a badge.

In her 1952 book, Toil, Taxes and Trouble, Kellems explained that her rebellion was based on constitutional grounds. Article I Section 2, Clause 3 of the U.S. Constitution declares, “Representatives and direct taxes shall be apportioned among the several States . . . according to their respective Numbers. . . .” Section 9, Clause 4 states, “No capitation, or other direct, Tax shall be laid, unless in proportion to the Census or Enumeration. . . .”

Kellems concluded, “[O]ur forefathers bound fast the hands of Congress and secured the liberty and freedom of the American people. How? By making it utterly impossible to levy an income tax. An income tax is certainly a direct tax [which] must be paid by the person receiving the income. By specifying that direct taxes must be levied in accordance with the number of people, not upon what they produced, as in the days of ancient Egypt, an income tax was simply out of the question.”

(Contrary to Kellems’s position, however, Americans courts have long held that the income tax is a constitutional indirect tax.)

Asked for Prosecution

In February 1948 Kellems publicly invited the government to prosecute her. Instead, four IRS agents arrived and demanded $1,685.40 even though her employees had been paying the correct amount. The rebuffed agents intimidated her bank into surrending that amount from her account.

The conflict became famous nationally when television shows such as “Meet the Press” interviewed Kellems. On Eleanor Roosevelt’s 1950s talk show, “Today With Mrs. Roosevelt,” Kellems explained, “As you know, Congress can pass all of the laws it wishes to. The President may sign all of the laws that he wishes to. But no law is a valid law in our country until it has been declared constitutional by the Supreme Court. Any citizen doubting the constitutionality of a law has the right, and in my opinion the duty, to break the law in order to provide a test case. That is all I did.”

Kellems also organized a nationwide group called the Liberty Belles and Boys to seek the repeal of the withholding tax.

Sues the Government

In 1949 tax agents demanded $6,100. Despite proof that her employees had paid their own withholding, the agents once again forced her bank to turn over the money. In January 1950 Kellems sued for its return in the federal district court in New Haven. She was not permitted to argue constitutional grounds, but she secured a full refund nonetheless.

Eventually Kellems abandoned her legal pursuit of the IRS  because of its expense, but she never abandoned the fight. In 1969 she disobeyed a court order to  produce financial records on the grounds that it violated her Fifth Amendment rights. According to some reports, she also refused to file tax returns; other reports claim she filed blank forms. In a 1975 interview with the Los Angeles Times — the same year as her death — Kellums declared, “Our tax law is a 1,598-page hydra-headed monster and I’m going to attack and attack and attack until I have ironed out every fault in it.”

This little known and indomitable crusader deserves a place in individualist history, standing proudly beside contemporaries such as Rose Wilder Lane and Isabel Paterson.

Dowd offers a classical-liberal perspective on macroeconomic policy and specifically central-bank policy. Having written extensively on free banking, he concludes that a thorough decentralization of the banking business is essential to enduring macroeconomic stability. Hutchinson is a seasoned investment banker turned financial journalist. His firsthand, nuts-and-bolts knowledge of modern financial markets undergirds his broader perspective. Together, they provide an enlightening account of the long-run trends and short-sighted policy actions that culminated in the worst financial crisis since the Great Depression.

The “alchemists” in their story are the architects and practitioners of modern finance. Given the perverse regulatory environment, buying and selling derivatives can yield short-run profits to hedge funds and other traders while virtually guaranteeing that in the longer run the owners of the underlying real assets will suffer losses if not bankruptcy. The careful reader will understand that speculation, whether on a long-term or short-term basis, is an essential and healthy feature of a market economy. But, if anything, the authors’ likening of speculation to alchemy when it is based on the techniques of modern finance and carried out in the context of a regulated economy understates the perversity. On reflection we can see that turning future long-run losses (of other people) into current short-run profits (for yourself) is triply more disruptive than trying to turn lead into gold. We can note 1) that lead, unlike long-run losses, has a positive, though modest, value; 2) that it is your own lead; and 3) that given the laws of nature, you’re unable to turn the trick.

But if the laws of nature keep people from turning lead into gold, why don’t the laws of the marketplace preclude the financial alchemy that characterized most of this century’s first decade? The answer, our authors make clear, is government intervention. A toxic mix of interventions (regulatory, fiscal, and monetary) perverted the coordinating market forces by removing considerations of long-run systemic risk. The result was a systemic discoordination whose increasing severity eventually turned systemic risk into a crisis. The laws of the marketplace, if allowed to exert themselves, can preclude financial alchemy (or at least put strict limits on it). But government intervention, including loan guarantees and the too-big-to-fail doctrine, open a window in which short-run profit-taking in financial markets is pitted against long-run viability of the financial institutions.

While the Federal Reserve is recognized as an essential accommodating element in the most recent episode of boom and bust, Dowd and Hutchinson focus on the inherent perversity of modern finance theory in the context of the long-running efforts of the government to redistribute income and to encourage homeownership. Since the 1930s the government has used the tax code to redistribute incomes downward. Over the years the income tax—and over the generations the inheritance tax—has reduced the number of families that oversee their long-run business interests. The old partnerships (Dowd and Hutchinson’s term), which kept the owners’ skins in the game, have been supplanted by limited-liability corporations, which effectively separate management and ownership. This critical separation, which left-leaning authors take to be characteristic of capitalism, is shown by the authors to be a consequence of government systematically overriding the market-governed distribution of income. Whereas we once had business families that were in it for the long run, we now have financial managers and traders in derivatives markets who are in it for the short run, ultimately to the detriment of the financial system and the real economy.

Alchemists of Loss provides a multidimensional account of the nature and magnitude of our long-brewing economic woes. But the book provides us with little hope for the future. The authors’ suggestions for reform range from the radical (reinstating the gold standard and eliminating the central bank) to the not-so-radical (redrafting the Fed’s mandate to exclude concern about unemployment) to the superficial (moving the Fed’s headquarters to St. Louis). Even the casual reader will see that this extends from the virtually impossible to the not-worth-doing, with no promising midrange option. The implicit conclusion is that we should brace ourselves for more booms and busts.

Let’s put the “Tax-the-Rich Truth Squad” on the case and see how Obama’s claims hold up.  We’ll start with the claim that millionaires pay lower rates than their secretaries. This debate started when legendary investor Warren Buffett claimed that the rate he paid on his income last year — 17.4 percent — was about half what his secretary paid.

Defining “Income”

Part of the problem here is in how you define “income” and the relevant “rate.”  Buffett pays himself a very low salary, but earns a great deal of income in capital gains from his speculative activity.  Those gains are indeed taxed at a lower rate — 15 percent — than his secretary’s top rate of 30 percent or more.  The reason the capital-gains rate is so low is that those gains are taxed first at the corporate level — at  35 percent — before being taxed again as Buffett’s income at 15 percent.  In addition, it’s not clear what Buffett included in his secretary’s taxes and income.

In any case, we have aggregate data on the relationship between income and average tax rates.  According to the Tax Foundation, 2008 IRS data show that the top 1 percent of taxpayers paid an average 23.27 percent of their income, with the top 5 percent paying 20.7 percent; top 10 percent, 18.71 percent; top 25 percent, 15.68 percent, and top 50 percent, 13.65 percent.

The bottom 50 percent paid an average 2.59 percent.  So either Warren Buffett is an outlier because so much of his income is from capital gains (which appears to be the case) or he has a terrific accountant whom his secretary should hire.  We might agree that taxes should be lower for everyone, but to claim that the system is regressive, as Buffett and Obama do, is simply wrong.  The Truth Squad says:  “FALSE!”

What about paying “their fair share?”  Defining “fair” and “share” is tricky and subjective of course, but consider this from that same Tax Foundation report: In 2008 the top 1 percent earned 20 percent of all income but paid 38 percent of all total income tax receipts.  The top 10 percent earned 46 percent of all income and paid 70 percent of total taxes.  Seems like more than their fair share.

Percentage of Total Income

Suppose instead we think “fair share” means that people should pay the percentage of total tax receipts that corresponds to their income’s percentage of total income. We can sort of compute this for Warren Buffett.  He paid about $6.9 million in taxes last year, a rate of 17.4 percent. If you do the math, that means he reported about $39 million in income. Total 2010 national personal income (wages/salaries minus transfer payments) was about $6 trillion. So Buffett’s income was about 0.00065 percent of total income. Total income taxes paid by Americans in 2010 was about $900 billion.

Nine-hundred billion multiplied by 0.00065 percent is $5.85 million, hence, Buffett’s “fair share.” Except Buffet paid $6.9 million.  So by that standard, Warren Buffett is overtaxed!  Yes “fair share” is subjective, but these data are strong enough for the Truth Squad to declare: “FALSE!”

Not Enough Money

Finally, would taxing the rich help close the deficit?  The 2009 data show that the slightly more than 250,000 households making more than $1 million earned a total income of $727 billion.  A 10 percent surtax would generate at most about $73 billion, which amounts to a whole 2 percent of federal spending.  This also assumes the rich take no actions to avoid that additional tax.  Taxing millionaires will help the deficit?  The Truth Squad once again says, “FALSE!”

In the end all that’s left of the argument for taxing the rich more heavily is pure demagoguery and a desire to avoid the real solution: reducing the size and cost of government.  The danger here is that in emulating FDR’s Depression-era attacks on “economic royalists,” Obama will repeat FDR’s results: entrepreneurs and investors sitting on the sidelines, afraid to innovate, invest, and take risks lest their hard-earned income be confiscated. Engaging in fact-free class warfare is the last thing we need when private investment continues to lag, keeping the economy in the doldrums and too many people unemployed.

Those two sentences helped focus the Progressive worldview. First, the United States needed an income tax to capture large chunks of revenue. Second, someone who had a large fortune, “by the mere fact of its size,” had to be treated differently from other wealth holders. Property rights became variable. One group would be treated one way, other groups would be treated another way. Third, the nation needed a “graduated income tax” to redistribute wealth from the haves to the have-nots. The new tax slogan would be “ability to pay.”

Author Delos Kinsman, writing while Roosevelt was president, said, “Individuals should contribute to the support of the government according to ability.” And “income is the most just measure of that ability.” Enlightened leaders like Teddy Roosevelt would redistribute wealth in the national interest.

Roosevelt’s thinking was a profound change from the views of the Founders. To them, government existed to protect property, not redistribute it. Americans had a right to pursue life, liberty, and property, not an entitlement to it. Thus the Founders never considered raising revenue through an income tax, least of all a graduated one. They wanted consumption taxes—levies on imports or on luxury goods. Why? Because, as Alexander Hamilton said in Federalist 21, “The amount to be contributed by each citizen will in a degree be at his own option, and can be regulated by an attention to his resources.”

Hamilton added, “If duties are too high, they lessen the consumption; the collection is eluded; and the product in the treasury is not so great. . . . This forms a complete barrier against any material oppression of the citizens by taxes of this class, and is itself a natural limitation of the power of imposing them.”

American law also reinforced the use of consumption taxes. “All duties, imposts and excises shall be uniform throughout the United States,” the Constitution reads. What could be more uniform than Congress’s first excise tax of seven cents a gallon on all whiskey produced in the United States?

Not Good Enough

Progressives, however, disliked consumption taxes as the major source for revenue. They were too small, too cumbersome to collect, and sometimes too regressive—wealth never properly redistributed itself through consumption taxes. Taxes on whiskey, tobacco, and imported olives from Spain shifted very little, if any, wealth from rich to poor. In 1913 the House Ways and Means Committee observed that federal revenue rested “solely on consumption. The amount each citizen contributes is governed, not by his ability to pay taxes, but by his consumption of the articles needed.” Swollen fortunes, as Roosevelt might say, went untaxed and became more swollen while some immigrants lived in poverty.

The Sixteenth Amendment was ratified in 1913, giving Congress the “power to lay and collect taxes on incomes from whatever source derived.” It did not rule out “ability to pay” as the basis for the levy. The amendment became law just as Woodrow Wilson was coming into the presidency. As a Progressive, Wilson wanted to start small, establish a precedent, and then increase rates over time. Under the new tax law, exemptions were so high that few Americans earned enough to pay any tax. Rates started at 1 percent and rose slowly to a high of 7 percent on all income over $500,000.

Progressives easily sold this tax plan to the voters. Fewer than one American family in 100 paid anything, but politicians could promise audiences that they might receive benefits from the revenue. And who would dare to suggest that billionaire John D. Rockefeller did not have the ability to pay 7 percent of his huge income to the government?

Ability to Pay

Yet that raises an interesting question. At what tax rate did Rockefeller, or other wealthy men, cease to have the ability to pay? If they could pay 7 percent, could they pay 15? Apparently so, because in 1916 Wilson and Congress raised the top rate to 15 percent. Unlike with a consumption tax, under the income tax politicians judge ability to pay and they choose the rates they think rich people can afford. If politicians choose rates too high they may lose the support of the rich, but they may gain support of those larger groups receiving subsidies from the tax revenue. If wealth really needs to be redistributed, should we trust people to do it with their own money or politicians with other people’s money?

Rockefeller, for example, was the best and cheapest oil refiner in the world. His charitable giving included the Erie Street Baptist Church, a cure for meningitis, and funding for Tuskegee Institute. That was how he redistributed his own wealth. Andrew Carnegie, the steel baron, built libraries, and banker Andrew Mellon built the National Gallery of Art in Washington, D.C. In the political realm, President Franklin Roosevelt supported high taxes and gave subsidies to silver miners, farmers, and the Tennessee Valley Authority to make cheap electric power.

Charitable givers and politicians both pursue their self-interest, but the politician’s self-interest includes winning votes. That means, if possible, channeling subsidies to voting groups to win reelection at the expense of taxpayers in general. Rockefeller’s gifts to Tuskegee did not cost anyone but him any money. FDR’s subsidy to silver miners, by contrast, cost millions of taxpayers small amounts of tax revenue. It helped FDR carry several western states each time he ran for president. His redistribution efforts were essential to his being reelected.

Thus U.S. politicians had incentives to steadily increase the income tax in the 1900s. The top rate went from 7 to 15 percent in Wilson’s first term. World War I took it over 60, then over 70 percent. It didn’t drop below 50 percent until 1924, and was about 25 percent the rest of the decade. The rate rose to 63 percent in 1932 under Herbert Hoover and then 79 percent in 1935. The World War II years pushed it over 80 percent, and in 1945, FDR’s last year in office, the top was 94 percent on all income over $200,000. Wealthy people apparently had a very high ability to pay, and politicians had a very high desire to fight wars and win elections.

The bill also contains an 18-month extension of unemployment benefits, assorted tax preferences, such as for ethanol, and “refundable tax credits,” that is, cash subsidies, for students and workers. Other goodies were thrown in to win over recalcitrant Democrats who were upset that Obama did not fight for a higher tax rate on the top 2 percent of income earners.

What prompted the compromise was the looming increase in everyone’s income tax rates. When rates were reduced in 2001 and 2003, they came with an expiration date. Unless Congress acted, the old rates would return on January 1. There was broad support for extending (or perhaps making permanent) the lower rates for most people, but the majority party was dead against letting individuals making more than $200,000 a year (or couples more than $250,000) continue under their lower rate. Obama campaigned in 2008 against the extension at the high end. Unless Congress acted, the top rate would go from 35 percent to 39.6 percent — but all other rates would rise too.

As things turned out, Obama decided that politically he could not maintain the middle-class rates while letting the top rate rise. So rather than have everyone’s taxes go up in two weeks, he opted for maintaining all current rates through 2012. This has made the members of his party’s base angry because they believe he folded too soon and could have maneuvered the Republicans into the uncomfortable position of supporting “tax cuts for millionaires and billionaires” while opposing additional unemployment payments for those whose 99 weeks of benefits were running out.

No Cut

The first thing to say is that the media and other participants in the discussion have been sloppy (at best) in calling this a debate about tax cuts. (New York Times headline: “Congress Sends $108 Billion Tax Cut Bill to Obama.”) Preventing a tax increase – even one set on automatic – is not a tax cut. Under the bill passed the tax rates in effect on December 31 will be the same as those in effect on January 1. How is that a cut?

More important, all players in the game have revealed themselves to be interventionists. (Okay, we knew this already but confirmation is nice.) Regardless of party, they see the economy as something to fix by turning a knob here, pulling a lever there, and stepping on a pedal over yonder in order to get the desired performance: higher consumer spending, lower unemployment, increased investment, and so on. It’s as though the economy were a machine in need of adjustments and a few quarts of oil. But an economy is not a machine. It’s a network of people engaged in myriad exchanges of goods and services – pursuing end-oriented activities informed by subjective values and expectations. Such information is largely unavailable to politicians, bureaucrats, and their economic advisers.

With unemployment officially at 9.8 percent, the economy indeed remains in the doldrums. None of the palliatives that George W. Bush or Obama tried has worked, but instead of realizing that government and its corporate-state policies are the obstacles to a flourishing economy, the ruling elite remains committed to the managed economy. So it’s decided not to raise taxes – for two years — and to reduce the employee payroll tax – for one year. These expiration dates are signs of political management. Understanding the necessity of a freed market would lead one to call for permanent – not temporary – government retrenchment.

Some questions were apparently overlooked. If tax rates may go up in two years, why make tax-sensitive long-term plans? If the payroll tax is to be two points lower in 2011, that implies it will most likely be two points higher in 2012. Will people spend the extra money next year or save it in anticipation of the tax increase to come? At any rate, they will need to make an unpleasant adjustment in their household economies on January 1, 2012. People do think long term, even if politicians don’t.

Something worth noting about the debate is that there was scarcely an acknowledgment that money subject to taxation belongs to someone and not the State. You’d think it magically appears in a common pot and the government’s job is to ladle it out effectively and fairly. I can recall hearing only one member of Congress say, “It’s their money,” during a television interview about why tax rates shouldn’t go up on high-income people.

The Political Means

In objecting to politicians’ taking money through taxation (and other means), I am not overlooking the fact that in America much money is made through what sociologist Franz Oppenheimer called “the political means” (as opposed to the economic means: voluntary exchange). The plutocracy is real, thanks to the centralizing effect of much government intervention. (See Benjamin Tucker on the “four monopolies.”) I second Kevin Carson’s observation: “The levels of inequality and concentration of wealth that existed even thirty years ago reflected over a century’s corporatist collusion between the state and big business…. [T]he billionaires achieved their wealth mainly through restrictions on the conditions under which they competed in the market to produce useful stuff. ”

The way to prevent accumulations of wealth via the political means, however, is not taxation but elimination of privilege — that is, all competition-stifling interventions, including barriers to self-employment. The answer to government power can never be more government power. All that gets you is bigger government

Finally, it must be noted that all the players have shown that their hand-wringing about the budget deficit is just so much meringue. Their package will require borrowing an additional $1 trillion over two years. Not only did they not cut any spending, they increased it. What did you expect?

At its start in 1966, Medicare cost $3 billion. The House Ways and Means Committee, along with President Johnson, estimated that Medicare would cost an inflation-adjusted $12 billion by 1990; however, by 1990 Medicare costs topped $107 billion. That’s nearly nine times greater than Congress’s prediction. Today’s Medicare tab comes to $420 billion with no signs of leveling off. How much confidence should we have in any cost estimates by the White House or Congress?

Another part of the Medicare lie is found in Section 1801 of the 1965 Medicare Act, which reads: “Nothing in this title shall be construed to authorize any federal officer or employee to exercise any supervision or control over the practice of medicine, or the manner in which medical services are provided, or over the selection, tenure, or compensation of any officer, or employee, or any institution, agency or person providing health care services.” Ask your doctor or hospital whether this statement contains even one iota of the truth.

Washington’s lies and deception are by no means restricted to modern times. During the legislative debate before ratification of the Sixteenth Amendment, President Howard Taft and congressional supporters said that only the rich would ever pay federal income taxes. In 1916 only one half of 1 percent of income earners were affected. Those earning $250,000 a year in today’s dollars paid 1 percent, and those earning $6 million in today’s dollars paid 7 percent. The promise that only the rich would pay was simply a lie to exploit the politics of envy and dupe Americans into ratifying the Sixteenth Amendment.

The Social Security Lie

Another big congressional lie is Social Security. Here’s what a 1936 government Social Security pamphlet said: “After the first 3 years—that is to say, beginning in 1940—you will pay, and your employer will pay, 1.5 cents for each dollar you earn, up to $3,000 a year. . . . [B]eginning in 1943, you will pay 2 cents, and so will your employer, for every dollar you earn for the next 3 years. . . . And finally, beginning in 1949, twelve years from now, you and your employer will each pay 3 cents on each dollar you earn, up to $3,000 a year”.

Here’s Congress’s lying promise: “That is the most you will ever pay.” Let’s repeat that last sentence: “That is the most you will ever pay.” That was a maximum of $90 a year. Compare that to today’s reality, which is 6.2 cents on each dollar that you earn up to nearly $107,000, which comes to $6,621. That’s $432 in inflation-adjusted 1936 dollars. And that does not include the fictional so-called employer’s share.

The Social Security pamphlet adds another lie: “Beginning November 24, 1936, the United States government will set up a Social Security account for you. . . . The checks will come to you as a right. You will get them regardless of the amount of property or income you may have.” That’s another lie. First, there’s no Social Security account for you, but more important, in Helvering v. Davis (1937) the Supreme Court held that Social Security was not an insurance program, saying, “The proceeds of both (employee and employer) taxes are to be paid into the Treasury like internal-revenue taxes generally, and are not earmarked in any way.” In a later decision, Flemming v. Nestor (1960), the Court said, “To engraft upon Social Security system a concept of ‘accrued property rights’ would deprive it of the flexibility and boldness in adjustment to ever-changing conditions which it demands. . . .” That ruling established the principle that entitlement to Social Security benefits is not a contractual right. “Flexibility and boldness” means Congress can constitutionally do anything it wishes, including cutting benefits, raising retirement age, increasing Social Security taxes, and ultimately eliminating payments for some or all Americans.

The 1936 Social Security pamphlet closes with this promise from the government: “You will always get more back from this program than you pay into it, and you will always get more with this program than you could have possibly gotten on your own by saving and investing.” That’s a lie. According to a report by Boston University Professor Laurence J. Kotlikoff (PDF), “Privatizing Social Security,” baby boomers will get a real rate of return of less than 2 percent. Generation Xers will get less than 1 percent, and today’s newborns will get a rate of return close to zero. Almost any private retirement plan yields higher returns.

Coupled with Medicare, Social Security is a disaster waiting in the wings. As the NCPA’s Pamela Villarreal writes, “The 2009 Social Security and Medicare Trustees Reports show the combined unfunded liability of these two programs has reached nearly $107 trillion in today’s dollars! That is about seven times the U.S. economy and 10 times the national debt. Unfunded liability is the difference between the benefits that have been promised to current and future retirees and what will be collected in dedicated taxes and Medicare premiums. . . . If no other reform is enacted, this funding gap can only be closed in future years by substantial tax increases, large benefit cuts,” increases in retirement age eligibility, or some combination thereof.

Why We Believe

Here’s my question: Why are so many Americans taken in by Washington’s lies? I think there are several likely answers. Man is tempted by what looks like a free lunch. He is also tempted by government’s promise to permit him to live at the expense of someone else. Some people are totally ignorant of the effects of government programs on the socioeconomic fabric of our country. There are many Americans who do understand the problem but what do they care? The primary beneficiaries of massive government spending are senior citizens. When the economic calamity arrives, they and the politicians who created all of the spending programs will be dead. Any politician who endeavors to eliminate the massive spending programs, in an effort to forestall the calamity, will be run out of office by the program’s beneficiaries. That means the status quo rules.

People might ask: What can be done to preserve American exceptionalism and greatness? My answer to such a question is a question: How do Americans systematically differ from citizens of past great nations who supported political actions that ultimately drove their nations into the ground?

Roosevelt’s quest for “a real democracy” and for centralizing power was a clear break with the American founders. James Madison, for example, distrusted both democracy and human nature; he believed that separating power was essential to good government. He urged in Federalist No. 51 that “those who administer each department” of government be given “the necessary constitutional means and personal motives to resist the encroachments of others. . . . Ambition must be made to check ambition.” If power was dispersed, Madison concluded, liberty might prevail and the republic might endure.

Roosevelt argued in this speech that the recent rise of corporations gave businessmen too much economic control. Madison’s constitutional restraints, therefore, allowed too much wealth to be concentrated in too few hands. Redistribution of wealth by government, Roosevelt thought, would achieve “a more substantial equality of opportunity.”

The economic power of railroads triggered Roosevelt’s ire during his presidency. He was frustrated that railroads gave rebates to large customers. In effect, the railroads charged varying rates for carrying the same products the same distance. Roosevelt thought rates should be roughly similar for large shippers and small shippers, especially if the small shippers were far from major cities.

He posed the problem this way: “Combinations in industry are the result of an imperative economic law which cannot be repealed by political legislation. The effort at prohibiting all combination has substantially failed. The way out lies, not in attempting to prevent such combinations, but in completely controlling them in the interest of the public welfare.”

In practical terms, “completely controlling” railroads in the public interest meant that the Interstate Commerce Commission (ICC) would have power to set rates so that larger shippers would not get such big discounts on their high volume of business. James J. Hill, president of the Great Northern Railroad, argued that large shippers received higher rebates because their massive business created “economies of scale” for the railroads—that is, railroads could reduce their costs best when shipping large amounts of goods over the rails. The bigger shippers contributed more to the reduced costs of shipping, so they got larger rebates.

To Roosevelt and to the smaller shippers, rebates for the bigger shippers were “unfair money-getting” and have “tended to create a small class of enormously wealthy and economically powerful men, whose chief object is to hold and increase their power.” The founders may have provided a “right to life, liberty, and the pursuit of happiness,” but Roosevelt believed that the pursuit of happiness and private property were not absolute. “We grudge no man a fortune which represents his own power and sagacity,” Roosevelt said—but then added, “when exercised with entire regard to the welfare of his fellows.” If railroads were enriching themselves and larger shippers disproportionately to the smaller shippers, then Roosevelt believed such power to set rates needed to be limited: “The Hepburn Act, and the amendment [Mann-Elkins Act] to the act in the shape in which it finally passed Congress at the last session [1910], represent a long step in advance, and we must go further.”

The Hepburn Act gave the ICC the power to reduce railroad rates and placed the burden on railroads to show their rates were reasonable. One intervention led to another. The railroads now had to prove that the rates they set were fair, so Congress created a Bureau of Valuation, which was empowered with a huge staff to value railroad property. According to historian Ari Hoogenboom, the bureau’s “final report, issued after a twenty-year study costing the public and the railroads hundreds of millions of dollars, disproved assumptions by Progressives that railroads were . . . making fabulous returns on their true investment.”

The lesson that Roosevelt learned from passing the Hepburn Act was that federal power was needed to break up those businesses that engaged in price discrimination. “The citizens of the United States,” Roosevelt said, “must effectively control the mighty commercial forces which they have called into being.”

Once Roosevelt established that the federal government should regulate the prices railroads charged for shipping, the next step was to intervene in other industries as well. “In particular,” Roosevelt argued in his speech, “there are strong reasons why . . . the United States Department of Agriculture and the agricultural colleges and experiment stations should extend their work to cover all phases of farm life. . . .” He added, “The man who wrongly holds that every human right is secondary to his profit must now give way to the advocate of human welfare, who rightly maintains that every man holds his property subject to the general right of the community to regulate its use to whatever degree the public welfare may require it.”

The shift from the individual rights of the founders to the community rights of the Progressives was a watershed transition in American thought in the early 1900s. But Roosevelt needed a federal income tax to help him redistribute wealth in the national interest. The title “New Nationalism” reflected his view that he and other leaders could determine the national interest and redistribute wealth and power accordingly.

Of the income tax Roosevelt said, “The really big fortune, the swollen fortune, by the mere fact of its size, acquires qualities which differentiate it in kind as well as in degree from what is possessed by men of relatively small means, Therefore, I believe in a graduated income tax on big fortunes, and in another tax which is far more easily collected and far more effective—a graduated inheritance tax on big fortunes, properly safeguarded against evasion, and increasing rapidly in amount with the size of the estate.”

Three years after Roosevelt’s speech, the Sixteenth Amendment, authorizing a federal income tax without regard to source, became law. Roosevelt had his wish—the 1913 tax was progressive: Most people paid no income tax, and the top rate was 7 percent. Roosevelt probably envisioned rates not much higher than that, but once Congress established the principle that some people could be taxed more than others, there was no way to calculate or determine what the national interest was.

Within one-third of a century after Roosevelt’s speech, the United States had a top marginal income tax rate of more than 90 percent.

When the individual liberty of the founders was transformed into the national interest of Teddy Roosevelt and the Progressives, we were only one generation away from a major threat to all our personal liberties. That threat still exists today.