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Edward D. Kleinbard

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Machiavelli on Tax Policy

Posted: 06/28/11 05:47 PM ET

Niccolò Machiavelli, that sublime analyst of all political instincts, understood contemporary America perfectly. In his greatest work, The Discourses on the First Ten Books of Titus Livy, Machiavelli wrote that truly admirable men remained constant in temperament through good fortune and bad. By contrast, "Not so do weak men behave; for by good fortune they are buoyed up and intoxicated, and ascribe such success as they meet with, to a virtue they never possessed..."

Not much has changed for the fortunate affluent in the intervening 500 years. Wall Street is the perfect laboratory in which to observe the contemporary conflation of success with personal virtues, but it is only the most extreme example. The preferred stock trading desk, for example, might be a sleepy backwater, until some change in securities regulation or tax law, or an unexpected market development, makes preferred stocks the hot thing. Then the head preferred trader will demand (and receive) a huge bonus for his acumen, and lecture other business units on their many failings when compared to his unquestioned genius, as demonstrated by the incontrovertible results his desk has achieved in the marketplace. Only once in my 30 years of working with Wall Street professionals did a senior Wall Street executive confess to me that he was, in his words, "the luckiest Irishman alive."

Of course most great success stories contain large elements of hard work and sacrifice. But so do many stories of only middling material accomplishments, or even outright failure. Those of us who have achieved material success have been fortunate in ways great and small, visible and forgotten. We overlook the fact that our native intelligence, or good looks, are not karmic rewards for past lives well lived, that our good health is not due entirely to our superior self-discipline, and that the parent or teacher or boss who inspired or mentored us found us for reasons not entirely within our control. Instead, we emphasize the risks we took and the sacrifices we made along the way, and believe through our weakness of thought that we overcame the randomness that defines all of life solely through personal perspicacity.

As Machiavelli wrote, great republics, like great men, do not allow prosperity to make them arrogant. Yet in our political discourse as well as our personal lives we habitually ascribe to those fortunate to achieve great material success virtues that they not necessarily possess, at least in the magnitude we imagine, and therefore treat them as beyond the proper scope of governmental inconvenience.

In doing so, we demean the role of government and distort our means of financing it. We do so, for example, when we deprecate any possible utility or insurance function to government spending or regulation. But we do so most explicitly on the revenue side, when it comes time to shape our tax laws. The tax system is a window into the soul of our society, because we use tax law as our principal tool of industrial policy, wage support and income redistribution. Our tax structure tells more about what we as a society believe to be fundamentally fair than does any other aspect of government.

If we believe that our material success is ours alone -- a reflection of our personal virtues, or perhaps the special benevolence of some Higher Power -- and not in part the outcome of the unpredictable caprices of fortune, then we intuitively find repugnant the idea that we should be willing to share those gains through the intermediation of the tax system with those to whom fortune's wheel has been less kind. We reflect this in our tax policy by demanding still lower marginal tax rates on high-income taxpayers, to release their creative juices, or some similar simile. We view it as an innocuous consequence of our various virtues in operation that our society today is more unequal in incomes and in wealth than it has been at any time since the 1920's. We reject the original reason for the income tax, which was to rely on the principle of the diminishing marginal utility of money to make our society -- our community, writ large -- a fairer one. We find it unremarkable that the 400 highest income taxpayers in America pay federal income tax at an average tax rate of only 18%. And we decry a move even to allow the Bush tax cuts simply to lapse, and for us to revert to the tax rates of the 1990's (the last decade of sustained prosperity), as class warfare, in which the rich are to be punished simply for their success. In doing all of this, we become like Tolkien's Gollum, holding onto "our precious" as if it were life itself.

It is not surprising that the affluent have always slipped into the convenient habit of mistaking good fortune for great virtue, and therefore into believing that higher marginal tax rates were a confiscation of the rewards that come naturally to those imbued with virtue. What is new is that the rich seem to have convinced the poor and middle class to believe this as well. As a result, we have drifted dangerously close to the citizens of Erewhon, the fictitious land of the 19th century satirist Samuel Butler. In their country, Butler wrote, "if a man has made a fortune... they exempt him from all taxation, considering him as a work of art, and too precious to be meddled with; they say, 'How very much he must have done for society before society could have been prevailed upon to give him so much money'; so magnificent an organization overawes them; they regard it as a thing dropped from heaven."

Has ever any satirist better foreshadowed contemporary tax politics?

If we could learn to acknowledge the role that the whims of fortune play in all of our lives, then we might perhaps not grasp quite so tightly onto our material success as if it were ours alone. We might be more willing instead to share at least a little bit of our good fortune, not out of pity, but out of gratitude. And if we are unmoved by gratitude, we might at least understand the logic of insurance. Following John Rawls's famous thought experiment, if we were sentient beings not yet born into this world, fully apprised of the randomness with which material rewards would be distributed to the living, would we not reach a compact in which we would agree to chip in some number higher than 18% of the wheel of fortune's largest payoffs to a collective pot for our mutual assistance?

Charitable giving is always desirable, but charity is not a substitute for government. Charity often is distributed randomly; by contrast, the government can act in a coordinated, systematic way to address social problems. Moreover, government has tools available that charity does not. For example, large businesses have done very well in the last couple of years specifically by not rehiring, as was the pattern in past recoveries, but instead investing in technology. In these extraordinary times, unprecedented in the living memories of most of us, there is a special role for government to play, through funding infrastructure projects that will improve the lives of our citizens in decades to come, and will create jobs with dignity today. Charity, by contrast, does not build the Hoover Dam, and working as gardeners to billionaires is not a career path with dignity. Yet we cannot begin even to contemplate a role for public infrastructure investment, much less the revenues required to finance it, if we collectively despise government as the forcible extraction of wealth that is ours in direct proportion to our special virtues.

Progressive income tax rates of the sort we all accepted in the 1990s, and an estate tax, are not an exercise in class warfare, nor are they inconsistent with sound economic thinking. Of course very high marginal tax rates induce avoidance behavior, but no one is advocating a return to 70 percent marginal federal tax brackets (the highest rate when I began the practice of law, in the mid-1970s).

As I described in a previous contribution, simply allowing the Bush tax cuts to lapse, and weaning ourselves off personal itemized deductions, like the home mortgage interest deduction, would by themselves basically resolve the current budget crisis for the next decade or more, giving us time to develop and phase in better-targeted entitlement programs. Together with some judicious trimming of current spending, these moves would give us the budget headroom to invest collectively in America's future, through public education and infrastructure investment.

Moreover, the elimination of personal itemized deductions follows economic logic. Doing so raises revenues without raising the top marginal tax rates; doing so does not penalize business (small or large), because (with the minor exception of unreimbursed employee expenses, which do not properly belong on the list) the itemized deductions are not expenses of earning an income; and the itemized deductions are the paradigmatic examples of "upside down subsidies" -- they are more valuable the greater your income. These tax subsidies are the perquisites of the affluent, not the genuine middle class.

These two recommendations are not soul-crushing burdens to ask us to bear, nor are they exercises in spiteful class warfare. Instead, they are simple, easily implemented, and sane policies that we know will work. What stands between us and their implementation is not simply political fractiousness, but the pernicious myth that we all deserve everything that happens to us.