Public choice theory explains and interprets politics as the interaction among

Transcription

1 Economic Perspectives Volume 1, Number 1 Summer 1987 Pages Tax Reform as Political Choice James M. Buchanan Public choice theory explains and interprets politics as the interaction among constituents and agents seeking to advance or to express their own interests. Applied to an observed political event like the 1986 tax reform legislation, any such analysis must identify the effects on separate interests and make some presumption concerning the perception of these effects. The linkage between assigning gains and losses from the 1986 tax changes and explaining these changes depends critically on the model of political choice. Political reality presumably embodies some mix of models of consensus, conflict, and agents' discretion. These three models are examined separately, with features from each retaining some explanatory value. A Consensual Calculus: All Taxpayers Secure Utility Gains The salient features of the 1986 tax legislation are rate reduction and base broadening for both individual and corporate taxpayers. The overall revenue-neutrality constraint implies that the trade-off or exchange between lower rates and a broader tax base occurs within the inclusive set of taxpaying units; there is no direct cross-budget "exchange" with expenditure program beneficiaries. Within aggregate revenue neutrality, there may be gainers and losers in terms of estimated tax payments before and after the change. Although the gains of low-income earners whose income tax liabilities are eliminated by the reform are exaggerated in the political rhetoric due to the neglect of how increased corporate taxes affect them, these low-income James M. Buchanan is Harris University Professor and General Director of the Center for Study of Public Choice, George Mason University, Fairfax, Virginia. He received the 1986 Nobel Prize in Economics.

2 30 Economic Perspectives earners are clearly net gainers. The existence of pecuniary gainers implies the existence of offsetting pecuniary losers, but need not suggest the existence of utility losses on the part of any taxpayers. All taxpayers may possibly secure utility gains. This consensus model is examined first since it implies that the reform legislation may have secured broad support by taxpayers. 1 Consider an individual who is fully informed as to the incidence and effects of taxation and can assign to himself an accurately estimated share in overall tax liability. This taxpayer may be assumed to be in a position of full equilibrium, before the reform. His after-tax risk-adjusted rate of return is equalized between taxable and nontaxable earning or investment opportunities. 2 The rate of return on nontaxable opportunities is lower than the pretax rate of return on the taxable opportunity by the rate of tax. The taxpayer's resources are not efficiently allocated; he suffers the excess burden of altered earning and investment choices in addition to the direct burden of tax payments. The change in tax law reduces the rate of tax on taxable opportunities and, at the same time, makes earnings from previously untaxed opportunities fully taxable. This exchange will, under plausible values for response elasticities, make possible a postreform equilibrium in which tax payments are the same as before, but in which the taxpayer's resources are allocated more efficiently. In this setting of individual revenue neutrality, the taxpayer's excess burden is reduced; the taxpayer enjoys net utility gains while paying the same amount. If individual revenue neutrality is possible, however, there must also exist some range over which the taxpayer attains equilibrium after the reform with both increased payments and increased utility. The increased revenue collected from taxpayers in this position may be available to allow for a class of taxpayers who secure net pecuniary gains from the reform through lowered tax payments. The latter will, of course, also enjoy utility gains. In this setting, all taxpayers support structural shifts in the tax structure along the general lines of the 1986 changes. The possible applicability of this consensus model to the changes in personal income taxation may seem clear, while extending it to changes in corporate taxation may appear more questionable. Note, however, that taxpaying units in both sectors experience a rate-reducing, base-broadening "exchange." Corporations, like individuals, will be led to allocate resources more efficiently. Despite the substantial increase in tax payments projected for the corporate sector, the rate of return on investment need not be reduced after 1986 if the offsetting gains in allocative efficiency are sufficiently large. 1 For a more formal presentation of the consensus model, see Brennan and Buchanan (1986). 2 The nontaxable opportunities may be those that are legally exempted or those that arise in the underground economy. Analytically, these two categories are identical. For expositional simplicity, I limit discussion to adjustment among income sources, which presumes that taxes are levied on sources rather than uses of income and that the base-broadening involved in the change consists in making previously nontaxable sources taxable. The analysis is, of course, identical in the case of income uses, whether as a base of tax, or as a means through which, pre-1986, tax liabilities were reduced.

3 Buchanan 31 Corporations do not vote, but the model of political consensus must allow some method of translating corporate tax liabilities into individual gains and losses. If individual taxpayers are presumed to be unable to trace out the incidence and effects of alternative corporate tax structures, the observed support for the 1986 tax law changes may have reflected a failure to make the translation from corporate to individual tax accounts. This possibility raises the interesting issue, however, of whether perceived or "genuine" fiscal interests should be relevant for evaluating tax reform. Non-Consensus: Utility Gainers vs. Utility Losers The consensus result sketched out in the previous section emerges, of course, only with a limited set of rate-reducing, base-broadening proposals, and the 1986 changes may or may not fall within such a set. For some taxpayers, the rate reductions do not fully offset the greater revenue raised by broadening the tax base. Despite the reductions in their excess burden, they will suffer net utility losses. These taxpayers would have opposed the change, provided only that they acted on the basis of an informed consideration of their own interests. In contrast, the reform would have been supported by those who secure reductions in payments, along with utility increases, and by those who secure utility gains even when making higher tax payments. In this setting, the rate-reducing base-broadening tax reform separates taxpayers into three distinct groups, those who will experience: (1) lowered tax payments and increased utilities; (2) increased tax payments and unchanged or increased utilities; (3) increased tax payments and reduced utilities. These three sets of taxpayers may be considered to correspond to differences in their capacity to take advantage of nontaxable income-earning or income-using opportunities under the pre-reform tax code. Persons in Group 1 may have been unable to shift resources into nontaxed uses; members of this group lose nothing from base broadening and gain from the rate reduction. Persons in Groups 2 and 3 pay more from the broadening of tax base, but will have a post-reform incentive to allocate resources under their control more efficiently. Persons in both Groups 2 and 3 will secure reductions in excess burden, but only those in Group 2 will benefit enough to offset the higher tax payments from base broadening. In a majoritarian political setting, persons in Group 2 may find themselves in the median position. Taxpayers in Group 1 support any rate reduction; taxpayers in Group 3 oppose any base broadening. Taxpayers in Group 2 insure that the rate reductions are sufficiently large to maintain or increase their utilities. Any proposal to reduce tax rates by a smaller amount, along with the same broadening of base, might have been opposed by taxpayers in Group 2. The widely observed difficulties in generating political support for any post-reform maximum rate of personal income tax much beyond the 30 percent range may well have reflected some such calculus, at least indirectly.

4 32 Economic Perspectives As with the consensus model, the observed behavior of taxpayers in supporting the 1986 reform may not have embodied unbiased information concerning the incidence, effects, and assignment of post-reform taxes. To the extent that people fail to sense themselves as bearing part of the burden of corporate taxation, whether as owners of capital assets or as consumers of final products, their behavior might suggest that they perceive themselves as members of Group 1 or 2, whereas their genuine interests might place them in Group 3. Post-1986 Predictions. The 1986 changes allow the same aggregate revenue to be collected at a smaller efficiency loss, at least for a majority of taxpaying constituents. The benefits from federal spending are now available at a reduced opportunity cost. This shift in the terms of "fiscal trade" may generate subsequent changes in both taxing and spending levels. If political pressures for increased spending were roughly matched by those for reduced taxation under the pre-reform tax structure, then the 1986 legislation can be interpreted as displacing the budgetary equilibrium with predictable consequences. The disequilibrium will be corrected by expansion in spending and tax rates (under the post-reform tax structure) and a new budgetary equilibrium will be attained with a somewhat larger budget. By contrast, if the 1986 legislation was itself a response to an emerging political disequilibrium, no such prediction can be made. If under the pre-reform tax regime pressures for tax reduction were becoming relatively more effective than pressures for expanded spending, and if further recourse to nontax sources for financing (such as public debt and inflation) was not available, the tax structure changes become the instrument for correcting the political disequilibrium without cutting spending. In this scenario, the 1986 fiscal action was equilibrating rather than disequilibrating, and political efforts to increase budgetary expenditures in the next few years should not be successful. The Interests of Political Agents The preceding analysis has assumed that taxing choices reflect constituency interests and that political agents seeking to further interests of their own exert no independent influence. But any public choice interpretation with plausible claim to generality must allow some consideration of these agents. Their self-interests may differ very substantially from the interests of constituents, and electoral control instruments may be too crude to bring the two sets of interests into correspondence. Within broad threshold constraints, those empowered to take political action may exercise discretionary authority, with respect to taxation or anything else. Political agents seek to maximize their rents, subject to the general legal constraints against corruption, and to the temporal and survival constraints imposed by the electoral and institutional structure. The magnitude of rents will be positively related to the size of public outlay, and to the frequency of shifts in the pattern of this

5 Tax Reform as Political Choice 33 outlay and the pattern of financing. Budgets will be larger than they would be in an ideally constrained "democratic" decision procedure, and the rules for budgetary allocation and for the distribution of tax shares will be modified more often. If the pre-reform political equilibrium embodied an excess spending bias because of the influence of agents' interests, agents would have had a related interest in the rate-reducing, base-broadening enterprise of Whereas political agents might have preferred base broadening alone, with the concomitant revenue and spending enhancement, they may have interpreted the "exchange" as a necessary way station toward revenue enhancement in a post-reform budgetary equilibration. This interpretation of the events of 1986 suggests that the reform exercise may have been promoted by political entrepreneurship of self-interested agents who exploited the temporary coincidence between their own and general constituency interests. Some of the discussion that followed the passage of the legislation supports this argument. If political agents are presumed to be totally unconstrained by electoral constituency feedback, the pre-reform tax structure should have approached its revenuemaximizing limits; that is, higher tax rates would lead people to respond by choosing less efficient but less taxed investment and earnings options, with little revenue gain. Given the availability of nontaxable opportunities, this model predicts that pre-reform rates would place some classes of taxpayers even beyond maximum revenue limits. The 1986 revenue-neutral trade-off served to relocate all classes of taxpayers on their response functions in such a way that, in the near future, rates can again be increased with secure and substantial revenue gains, above and beyond the possible limited spending increases that might emerge from genuine constituency demands. 3 The rents of political agents are related also to the frequency of political change, most notably changes in the patterns of spending and taxing. Long-term stability in fiscal structure is a highly desirable feature for institutional efficiency because of the reduced costs of taxpayer-beneficiary adjustments. In this sense, an old tax is, indeed, a "good" tax. But such long-term stability need not be in the interests of those who make decisions as agents, especially when electoral turnover is allowed as a means of shifting the set of agents. At the date of any initial change toward favored treatment, agents have an interest in conveying the idea that changes are permanent. Once in place, however, any part of the structure is vulnerable to the temptation of agents to renege on the earlier "promise" of permanency. The 1986 broadening of the tax base by closing several established loopholes and shelters offers potential rents to those agents who can promise to renegotiate the package, piecemeal, in subsequent rounds of the tax game. The special interest lobbyists, whose clients suffered capital value losses in the 1986 exercise, may find their personal opportunities widened after 1986, as legislators seek out personal and private rents by offering to narrow the tax base again. In one fell swoop, the political 3 For analysis that models government as revenue maximizing, see Brennan and Buchanan (1980). For analysis that relates revenue maximizing to the time period of taxpayer adjustment, see Buchanan and Lee (1982a, 1982b).

6 34 Economic Perspectives agents may have created for themselves the potential for substantially increased rents. This rent-seeking hypothesis will clearly be tested by the fiscal politics of the post-1986 years. To the extent that agents do possess discretionary authority, the tax structure established in 1986 will not be left substantially in place for decades or even years. As Puviani (1903) noted, political agents find it in their interest to modify the fiscal consciousness of citizens, and to do so in predictable fashion. Tax impositions will be made to seem less onerous than might otherwise be the case. A disturbing feature in the rhetoric of 1986 was the impression that fiscal illusion was deliberately fostered by rent-seeking politicians, aided and abetted by journalistic discussion. Although overall revenue neutrality was maintained, the ultimate incidence of the corporation tax was almost totally neglected. Public choice considerations suggest that, to the extent that the shift from personal to corporate taxation stems from fiscal illusion, there will be some efficiency loss in the allocation of resources between the private and public sector. Normative Evaluation This public choice explanation or interpretation allows for a normative evaluation of the legislation if we accept the desirability of correspondence between the preferences of citizens and the patterns of fiscal outcomes. From this democratic-individualistic perspective, it is the process of fiscal choice that must be tested rather than the particular results this process generates. Have the changes in tax law enacted in 1986 made the fiscal choice process more "rational" in the sense that they have promoted a less wasteful and better informed matching of the costs and the benefits of governmental programs? The answer seems necessarily to be mixed. The broadening of the bases for taxation in both the personal and corporation income tax will reduce excess burdens. The marginal costs of payment for public program benefits should be lower than they were before the 1986 changes for all taxpayers, even for those who may have suffered utility losses in the exercise. On the other hand, the major shift of taxation from the individual income tax to the corporate tax base will reduce, perhaps substantially, the individual voter's ability to perceive the costs of program benefits. This effect may be especially pronounced for those taxpayers whose individual income tax liabilities were eliminated in the 1986 changes. Program benefits will seem to be available without tax-cost if these people do not effectively translate increased corporate tax liabilities into their individual accounts. After 1986, fewer economic resources will be wasted through efforts to avoid taxes, but a higher value of resources will tend to be channelled into public sector outlay. To the extent that this budgetary expansion is a result of fiscal illusion generated by the 1986 changes, the new political equilibrium may embody more rather than less overall distortion and "waste." Before the 1986 reform, taxpayers generally may have been paying "too much" for the program benefits they enjoyed;

7 Buchanan 35 after the reform, taxpaying citizens may approve levels of program benefits higher than those that would be dictated by their illusion-free preferences. I appreciate comments from my colleagues Jennifer Roback, Robert Tollison, and Viktor Vanberg. References Brennan, Geoffrey, and James Buchanan, "Tax Reform Without Tears." In Aaron, Henry and Michael Boskin, eds., The Economics of Taxation. Washington: The Brookings Institution, 1986, pp Brennan, Geoffrey, and James Buchanan, The Power to Tax. Cambridge: Cambridge University Press, Buchanan, James and Dwight Lee, "Politics, Time, and the Laffer Curve," Journal of Political Economy, August 1982, 90, Buchanan, James and Dwight Lee, " Tax Rates and Tax Revenues in Political Equilibrium: Some Simple Analytics," Economic Inquiry, July 1982, 20, Puviani, Amilcare, Teoria della illusione finanziaria. Palermo: Sandron, 1903.

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