A Capital Writing interview with the author of Taxocracy.
A Capital Writing interview with the author of Taxocracy.
As part of a project for Capital Matters called Capital Writing, I’ll be interviewing authors of economics books for the National Review Institute’s YouTube channel. This time, I talked with Scott Hodge of the Tax Foundation about his book Taxocracy: What You Don’t Know about Taxes & How They Rule Your Daily Life. Below you will find an edited transcript of a few key parts of our conversation as well as the full video of our interview.
Dominic Pino: I was a Tax Foundation intern when I was in college. I learned lots of great stuff about how to think about taxes like an economist. And that is sort of a really good introduction to your book, which is very much trying to get people to think that way. I think most people think about taxes as taxpayers, which is totally understandable because most people are taxpayers. A lot of people also think of taxes in terms of politics. They’ll think about it in terms of what will help me win votes or what will help to make the budget look balanced or what will help to game the budget-scoring rules. Thinking about taxes like an economist is really something different. So if you could, explain, just to start off, what that means to think about taxes like an economist.
Scott Hodge: Well, it really means to look at the consequences of tax policy, how taxes affect not just our behavior, but the economy overall, both on the macro level, the broader economy, but the micro level as well. How it changes incentives for people. How it makes us do things we wouldn’t necessarily otherwise do. Now, economists tend to look at taxes in sort of, math terms, if you will. They’re really big on supply and demand curves or mathematical equations to try to figure out the effects of tax policy. And a lot of my colleagues here at the Tax Foundation do that. We have a very sophisticated model to look at the effects of tax policy. But I’ve always loved stories about tax policy. And I think that every tax can tell a story.
Lawyers always talk about signs: “There’s a story behind every sign.” So, you know, why do you see a sign that says “warning”? Well, probably someone electrocuted themselves, and so the lawyer stepped in and created a sign. Every tax can tell a story about unintended consequences. Because lawmakers often have one thing in mind when they enact a tax. Oftentimes it’s just simply to raise revenues. But there is often an unintended consequence that comes from those policies that the lawmakers really never thought about.
There are a ton of examples like that, both from history and then currently. What I’ve tried to do in the book is share some of those examples, but take the lessons from those and apply it to our current tax code so that people can have a better understanding in their own terms, sort of layman’s terms, of the impact of these tax policies. But then ultimately what I’ve tried to do is provide some advice on how to change things, improve the tax code, so that it can take the tax code out of our lives, and allow us to go through our daily lives without having to think about taxes, which too many of us have to do.
DP: So you called the book Taxocracy. Obviously a democracy would be rule of the people. Taxocracy would be rule of taxes. You just mentioned how the goal of the book and the goal of a lot of the work that you do is trying to get taxes out of people’s lives. What does it mean to be in a country that is ruled by taxes?
SH: Well, we’re in that. In many respects, the tax code sort of takes efficacy away from us, takes self-control away from us, because the tax code is trying to get us to, oh, buy a home and use the mortgage-interest deduction, give to charity, even buy an electric car, quit smoking, drink less. You go through all of these taxes that are in the tax code, and they’re really aimed at some aspect of our daily life or our activities. They’re either trying to encourage us to do something or discourage us to do something. And as a result, that takes away from our autonomy and really puts us in the hands of political decision-makers. And if we move toward what economists call a neutral tax code — one that treats everyone equally, has a level playing field, doesn’t discriminate between one product and another — we can get back our autonomy, we can get back our self-control, and we can get the politics out of the tax code.
DP: This doesn’t necessarily mean taxes will go away, obviously. We still need taxes to fund the things that we want government to do. But it’s more about shifting the focus of taxation away from encouraging or discouraging behaviors and towards actually raising revenue, which is what taxes are supposed to be about. What are some of the other things that a good tax code does? I know you list four different things in the book, four different qualities of a good tax code. What are those?
SH: The first, as I mentioned, is neutrality. And that is the taxes should have a level playing field, treat everybody and every product and every activity the same so that no one can game the system or use the tax system to punish certain types of behavior of people. The second is simplicity. We want a very simple tax code that is transparent. That’s the third aspect of a good tax system, so that we should always know why we’re being taxed, where the money is going, and what it’s being used for. And then lastly, we want a tax code that’s stable. Far too often we have taxes that come and go. You look at the Bush tax cuts, they didn’t last 10 years. And then Obama had some tax increases and those got changed. Our most current, the Tax Cuts and Jobs Act, which was passed in 2017, is now about to expire next year. And so we’re going to go through more upheaval. And so we have this constantly evolving tax code that we’re trying to adapt to. And it’s particularly hard for businesses to be able to predict and make decisions for the future when you have a tax code that’s so uncertain.
DP: You mentioned in the book a famous quote from a former Treasury secretary saying that it would be nice if we just had a tax code that looks like it was designed by someone, that looks like it has some kind of purpose behind it. The way that the tax code is made is through legislation over many different years and many different congresses, and they sort of pile things on top of each other in ways that don’t make sense a lot. Can you talk a little bit about some of those contradictions that we have in our tax code, where even for the politicians who disagree with you and think that we should use the tax code to encourage or discourage behaviors, we actually end up doing the opposite or doing things that are at cross purposes with each other?
SH: Look at things like taxes that are intended to stop certain behaviors. Lawmakers can’t really decide whether this tax is intended to raise revenues or stop you from doing something. And that includes, say, smoking, for instance, where the idea is that if we tax this product, people will use less of it. Well, but we wanted to use that revenue for, let’s say, child nutrition or daycare or something like that. We’ve seen this with sugar-sweetened beverage taxes, for instance, which Philadelphia famously raised their tax to equal that of beer. It was cheaper to buy beer in Philadelphia for a while because the tax on soda was so high. So as a consequence, people went across the border to buy their soda. Soda-tax revenues collapsed. That revenue was supposed to be for child poverty programs or something like that. And so there was less revenues for that. And you see the same thing with things like wealth taxes, where the whole idea is to raise revenues by taxing wealth. Well, are we really trying to tax wealth and get less of it? Or are we trying to raise revenues in order to pay for something else? And those are the kind of contradictions that we see oftentimes in policy where lawmakers really can’t figure out what they’re trying to do with it.
DP: One of the issues that you talk about in terms of defining what counts as being taxed is that it creates these existential crises with certain goods and products where either bureaucrats or companies have to be Plato and try to figure out what the ideal form of a cookie is. The example you gave is about Pringles: Is a Pringle a chip or is it a different kind of snack? Can you explain some of these ridiculous games that companies have to play? They usually get years in court trying to figure out what a product even is.
SH: That’s exactly right. Anytime you try to define something, of course, the marketplace can change it. A good example here in the United States, for instance, is the hard seltzers, which are taxed like beer rather than alcoholic beverages. And there’s a tax differential between the way beer is taxed and the way alcohol is. And so these hard seltzers end up paying a much lower tax and giving them somewhat of a cost benefit over some of these other products.
As you mentioned, we get into things like Pringles, which is a very famous case in the U.K., in which snacks, like potato chips and whatnot, are taxed at a higher value-added-tax rate than baked goods like biscuits. And so the existential question about Pringles was, since they’re baked using potato dough, rather than actually sliced potatoes, was it actually a baked good, like a biscuit, or was it actually a snack? Well, after a lot of litigation and very high costs for the manufacturer, the courts finally decided it was a snack after all, because less than half of its product was actually potato. There was another big court case in the U.K. about marshmallows. The debate there was are marshmallows food or are they a snack? Well, they decided that ultimately it was a food, so it wasn’t taxed.
Here in the U.S., oftentimes a Hershey bar is taxed like candy, whereas a Twix bar is not. It’s taxed like food. Why is that? Well, a Twix bar has flour in the middle of it, which then qualifies as food. The lesson here is when you create these differentials, you encourage manufacturers to one, try to game the tax, and then two, try to lobby to make sure that their product is in the untaxed category. So we create these opportunities in the marketplace for these kind of distortions: ridiculous attempts to avoid the tax, but also the kind of favoritism and cronyism to try to get a product to qualify as something it may not be.
DP: Let’s talk a little bit about how taxes actually get collected, because you devote a chunk of the book to those questions as well. The IRS, of course, is the agency in the United States that does all of this. They’ve been in the news within the last couple of years, getting a much bigger budget, being able to hire lots more employees to do the work of collecting taxes. We’ve all heard the stories about how outdated their technology is and about how bad they are about responding to taxpayer complaints or taxpayer requests for clarification or information. What is holding back the IRS from being able to be a more modern and a more effective agency to do this essential job of government, which is collecting taxes?
SH: I think the real issue here is that members of Congress, our politicians, cannot decide whether we want the IRS to be a tax-collection agency or a benefit-delivery agency. And right now it’s tilting toward being a benefit-delivery agency. We mentioned things like the child tax credit, which has now gone from being a $500 credit to being over $2 ,000 today. It’s partly refundable, which means if you don’t have a tax liability, you still get that tax credit. There’s a lot of errors in that program, much like there is with the earned-income tax credit, which is meant for the working poor. And right now, we’ve asked the IRS to be a benefit provider and to do things that I don’t think that it’s really designed to do, whether it’s managing welfare programs or housing programs. Now it’s managing transportation programs or electric-car credits. It’s now managing all these green programs that were put into the tax code last year. And you just keep going down the list. And we have now asked it to do the work of every other agency in government. It’s not equipped to do that.
As a consequence, it’s failing at a lot of the basic things, like simply collecting the revenues that we expected. So if we want to save the IRS, we need to dial back all the things that we’re asking it to do. And much of the book is really dedicated to looking at all the aspects of the tax code that the IRS is having to do and simply not equipped to do. I mean, we mentioned the technology. In 1988, the IRS was given about $8 billion to come up with new technology to be able to manage the flow of paper tax returns. They are still working on this 40 years later, trying to come up with technology to deal with paper tax returns. And during Covid, they had a backlog of 24 million paper tax returns. I think you have an agency that’s simply distracted. It can’t focus on what it’s supposed to do because it’s having to do everything else.
DP: What do you see as the next battle on tax reform? I mean, obviously in 2025, we have the issue over the extension or the expiration of the Tax Cuts and Jobs Act, but that’s sort of the immediate tax issue to deal with. Looking beyond that, what do you see as sort of the next thing at the federal level that we could actually do that would be a move in the right direction along the lines that you argue in your book?
SH: In particular, getting to the issue of expensing, allowing business to be able to fully expense the investments that they make in new plant equipment, technology, and so forth. Those elements of the Tax Cuts and Jobs Act are phasing out. Right now, Congress is trying to scramble to patch some of those up. But the more that we can allow expensing to become a permanent part of the tax code, the better off the economy and, I think, workers will be because they’ll have the ability to work with better tools. That’s one.
I do think we need to fix the savings system in America. Our tax system is very complicated when it comes to saving. We have 401(k)s, we have Roth IRAs and regular IRAs. You can save now for education, but you can also save for this. We need a real simple system for saving, and there are other countries, like the U.K. and Canada, that have universal savings accounts, which is kind of the one-stop shop for saving, allowing people to save into a single account and use it the way they want to use it, not the way politicians have said, my gosh, you have to sit down and put your savings into all these little buckets that we’ve created. That’s crazy and inefficient. So we need to move toward that sort of a simple savings program as well. Those two things alone would do wonders for the economy and also for simplifying the system.
