Tuesday, June 10, 2014
“You didn’t build that” and the “Benefits” Theory of Taxation
There’s a great deal to admire about Ajay Mehrotra’s terrific new book, Making the Modern American Fiscal State: Law, Politics, and the Rise of Progressive taxation, 1877-1929. In this initial post, I’ll describe the book’s central themes and a few of its many virtues, and then raise a question about the long-run consequences of the legal-intellectual transformation that Ajay describes.
At the center of Ajay’s account is a wonderfully engaging intellectual history of a group of progressive American economists, including Richard Ely, Henry Carter Adams, and Edwin Seligman. It was these scholar-activists, among others, who did the foundational intellectual work of displacing the then-prevailing “benefits” or “compensatory” theory of taxation, which imagined tax-paying as one side of a reciprocal exchange between the taxpayer and the state; and replacing it with the “ability to pay,” or “faculty” theory, premised on new model of fiscal citizenship grounded in the social democratic values of solidarity and ethical duty.
Having absorbed the historicism and empiricism of the German Historical School of Economics in which they were trained, the progressive economists eschewed the purported timelessness and universality of classical British political economy. Instead, they emphasized the historical contingency of fiscal policy; its embedded-ness in the social and ideological context in which it operated. In practice, this meant drawing on the lived experience of modern industrial life to critique the classical liberal divisions between public and private, and between the laissez-faire state and the self-possessed individual; and forging a much larger role for the state in mitigating the economic inequality and conflict inherent in modern industrial capitalism. The progressive economists strove to accomplish all this, moreover, while steering clear of the more “communal” and redistributive views of their German mentors. To do so, Ajay writes, they needed to “graft continental ideas onto the stock of Anglo-American thought; they needed to make German economic theories palatable for modern American institutions and culture.”
The ability to pay theory of taxation, with its new vocabulary of duty and solidarity, proved essential to this project because it allowed the progressive economists to explain how an income tax regime that featured a high exemption and steeply graduated rates could shift a greater share of the tax burden to the wealthy, without undermining the principal tenets of market capitalism. As an intellectual history of this process of grafting, or translation, Making the Modern American Fiscal State is an engaging and instructive read. But it is also much more than that.
It is fundamentally a study of ideas in action—as Ajay writes, of how “[s]ocial movements, political activists, public intellectuals, powerful lawmakers, and key government administrators engaged in a highly contested, contingent, and uncertain battle over the ideas, laws and institutions that would come to define the fiscal polity.” (p. 25) To tell this story, Ajay expertly interweaves several parallel histories. Public intellectuals responding to broad structural economic forces like industrialization, corporate consolidation, and cyclical economic depression occupy a central role in Ajay’s analysis. But Making the Modern American Fiscal State is also a political history of the long-running battle between Republican defenders of the “regressive” federal tariff, and Democratic and Populist advocates of progressive income taxation; a constitutional history of the Pollock case (striking down the first federal income tax), the adoption of the 16th Amendment, and the Supreme Court’s post-Amendment decisions mostly ratifying emerging federal tax policy; and an administrative history of how tax reformers, lawmakers and Treasury officials created a more centralized and professionally administered fiscal bureaucracy.
Finally, and most surprisingly for me, it is also a history of American citizenship—specifically, of how the act of paying taxes became imbued with the citizenly virtues of ethical and patriotic duty, and of equal sacrifice for the benefit of the public. I have to confess that when this theme was first introduced, I wondered whether it might be somewhat overdrawn, and I was skeptical that citizenship had been more than a rhetorical trope used by advocates of a progressive income tax. But that skepticism dissolved once I encountered abundant evidence drawn from a rich and varied array of sources, and I came away highly persuaded that Ajay describes what was, in fact, a fundamental change in the very meaning of paying taxes, not only for tax reformers and policymakers, but also for many of the wealthy taxpayers who bore the brunt of the graduated income tax.
Now I’d like to turn to the long-run consequences of abandoning the benefits theory of taxation, and think about Making the Modern American Fiscal State specifically as a history of the present. Ajay argues that, by rejecting the benefits rationale so emphatically and completely; by stigmatizing all consumption taxes as hopelessly regressive; and by defining fiscal fairness exclusively as a matter of reallocating tax burdens according to the ability to pay, the progressive economists and their political allies created a kind of “fiscal myopia,” foreclosing consideration of broad-based, European-style consumptions taxes as a way to finance modern social welfare spending.
As I’ve been thinking about this and other various historical legacies of the transformation that Ajay describes, I keep returning to the famous “You didn’t build that” controversy of the 2012 Presidential campaign, which was prompted when President Obama mangled a passage of a speech intended to make the basic point that people don’t acquire wealth in a vacuum, independent of various public, tax-payer funded resources. Senate candidate Elizabeth Warren made a similar argument much more effectively it in a 2011 youtube video that's been viewed more a million times. As she told a group of supporters:
There is nobody in this country who got rich on his own — nobody. You built a factory out there? Good for you. But I want to be clear. You moved your goods to market on the roads the rest of us paid for. You hired workers the rest of us paid to educate. You were safe in your factory because of police-forces and fire-forces that the rest of us paid for. You didn't have to worry that marauding bands would come and seize everything at your factory — and hire someone to protect against this — because of the work the rest of us did. Now look, you built a factory and it turned into something terrific…. God bless — keep a big hunk of it. But part of the underlying social contract is, you take a hunk of that and pay it forward for the next kid who comes along.
Now, neither the President nor Senator Warren adheres to the 19th-century benefits theory, in the sense of wanting to limit tax contributions to the measurable benefits that each individual and business receives in return. But perhaps it’s nevertheless telling that leading contemporary advocates of progressive fiscal policy feel the need to invoke the social contract, and to make the argument that business owners do, indeed, benefit from public expenditures; and further, that reminding people of that fact inevitably elicits charges of “socialism.”
At the very least, it suggests that the vision of fiscal citizenship that Ajay describes is less robust today than many of us might like. But it also made me consider whether, for all of the limitations of the benefits theory (it’s regressive, transactional, atomistic, etc.), at least it had the virtue of reminding us as taxpayers that we do, in fact, receive reciprocal benefits for the payment of taxes—a fact that today is no longer a truism. In other words, I wondered whether the defeat of the benefits theory a century ago has made it possible to deny any element of reciprocity, and thus to assert a kind of fiscal atomism that’s more strident than ever. So the question is, should we add to the list of unintended consequences a second variety of fiscal myopia—specifically, an inability or unwillingness to see the embedded-ness of economic success in the broader matrix of publically financed amenities in which that success is achieved?
It would be nice to see a strong thread of Murphy/Nagel/Elizabeth Warren in the political dialogue about the distribution of the public benefits paid for by taxation. Matthew's post also makes me think of a perhaps more practical, more public-choice-y issue with for example tying a VAT rhetorically to certain kinds of public spending. This is the concern (as in Australia and New Zealand) that the VAT system would be sticky, but the demogrant-like redistributive public spending initially tied to it (though not the benefits that help the factory owner) would erode away under future legislatures.
Posted by: Susie Morse | Jun 11, 2014 12:33:32 PM