Music Reality - captured in user friendly symbols and processed for understanding. Music The Idea Channel I attribute the large size of the audience here not to my drawing powers but to the fact that the topic is one that everybody in this room and in this country has a very deep and personal interest in. We are all involved in devoting about 40 percent of our working lives to supporting governmental activities. We all have some of them that we like and some that we dislike, but there are very few of us indeed who believe that we are getting our money's worth for the 40 percent of our income that is being used to support state, local, and federal governments and yet that percentage keeps growing. Here we are, and this is the real dilemma, the real problem that we want to talk about and consider: how is it that if you were to conduct a poll among the people of the United States, if you were to ask them, each and every one of them, do you think you are getting your money's worth for the 40 percent of your income that is being spent on your behalf by governmental bureaucrats, the number of people who would say yes to that would be very small, and all of those would be employees of the U.S. government. There might be a few state employees in it, too. On the other hand, we have a democratic system. We have elected representatives, they do what the public at large wants, and year by year they vote on our behalf to spend more and more of our money. How do we explain that dilemma and what can we do about it? What is it that produces a result that seems so clearly not in line with the fundamental wants of the people? That's really our topic tonight and that's what I mean by asking is tax reform possible. Everybody agrees on its desirability, but is it possible? My answer is going to be it is possible but not by the usual route. We are not going to get tax reform by a congressional committee in Washington or in the state house in this or other states voting lower taxes or voting an improved structure of taxes. That way is hopeless. It's a way we have been trying for years on end and has gotten us nowhere. The only effective tax reform is tax reduction. There is no other way in which we are going to get anything approaching reform, and even that is too ambitious a target at the moment. The most we can hope for in my opinion in the near future is to stop the steady increase in the fraction of our income that is effectively being spent by government. And, to go the last step of this argument, in my opinion the only feasible way of stopping tax increases is via constitutional limitation on government spending and government taxing. That in brief is the theme and the proposition that I want to set before you tonight. To render this view plausible I think we have to start by clearing away some of the misconceptions about taxes. We must dispose of some erroneous views that are widely held. There are three sets of erroneous views that I am going to talk about. The first of them is the Orwellian newspeak that is promoted by government, the saying of one thing when the substance of it is opposite. But the second erroneous idea that we need to clear the underbrush of is the erroneous idea of what constitutes fiscal responsibility that has been held by so-called fiscal conservatives. Those of us who regard ourselves as fiscal conservatives have a good deal of blame to share with the representatives of government who tell us fairy tales. And third, we have to dispose of the view that tax simplification is possible rather than a pipe dream. Let me start with Orwellian newspeak. I'm sure you all remember that great book 1984, and unfortunately we're getting all too close both to the date and the reality. In that book you will remember that one of the chief devices used by the government to keep its citizens in line was newspeak. The great slogan of that regime was the slogan "War is Peace." Well that's the kind of talk which always emanates from Washington. Let me give you the most immediate and most recent example. We have had a lot of talk from Washington about proposals to cut taxes. President Carter says he recommends a $25 billion cut in taxes. Other people are trying to outbid him, to cut more or some to cut less. But the plain fact is that nobody is proposing to cut taxes. What is being proposed is simply to shift taxes from one kind to another. In the first place, the increases in the Social Security payroll tax plus the increases that are being proposed under the so-called energy bill--which is not an energy bill at all but, a major tax bill--between them amount to as much or more than the proposed tax cut. But in the second place, without anybody voting for it, your taxes are going to go up because inflation inevitably drives more and more of your income into the higher brackets. The increase in the taxes that the people of this country will bear as an indirect result of inflation without anybody voting for it will be more than the proposed cut that President Carter is talking about. So even if you look at taxes in the narrow and literal sense, taxes are going up not down. But even that isn't the whole story because the real tax that the American people bear is not measured by those payments that are called taxes. The real tax on the American people is what government spends. If the government spends 60 billion dollars more than it takes in, in the form of taxes, which is roughly what President Carter is proposing, who do you suppose pays that extra $60 billion? Do you think Santa Claus is going to pick up the check? Or maybe President Carter is counting on the Arab sheiks to pick it up, or maybe there is a tooth fairy out there who will pick it up. Those are fairy tales. You are going to pick it up because that's going to be paid for, but instead of being paid for directly in the form of income taxes or excise taxes or payroll taxes it will be paid for indirectly in the form of inflation, a hidden tax which nobody has to vote for but which people have to bear and pay. There is no other source. The proposal to cut explicit taxes is simply a proposal to raise less money in the form of income, excise, and so on taxes, and more money in the form of the hidden tax of inflation. Well you may say to me, "But there's still another alternative. The government can borrow it." But when the government borrows, that's also only another form of hidden tax. If the government borrows, there is less available to build houses or machines or factories; that imposes a larger burden in the form of future interest on our debt payments. That's really a hidden tax on your wealth and your children's future wealth. It's also an indirect form of taxation. Government spending corresponds to that part of the national income which you and I cannot control as we wish but which is spent for us, on our behalf, by our supposed servants in accordance with our supposed instructions through the representative method. In no way is anybody proposing to cut taxes because President Carter has proposed an increase in federal government spending, an increase which is larger than the anticipated increase in prices; so it's an increase in real terms and indeed a larger increase than that which appears in his official budget because of the continued use and invention of more and more sophisticated methods to conceal actual spending, the latest gimmick being to treat subsidies given by the government as refunds of taxes collected from somebody else. Now that's a nice notion, isn't it? I can understand subtracting a refund to me from the tax I pay, but a refund to you from my taxes? That's government spending; that isn't a reduction in tax receipts. So the first example I would give you of newspeak is the slogan "Higher Taxes Are Lower Taxes." The second is the notion that somehow there are taxes on business and there are taxes on people. There has been a great deal of talk and I use only the most recent proposals of President Carter for illustration because the same kind of talk has emanated from every Administration, Republican or Democratic. There is talk about how "we're not going to raise taxes on people; we're going to raise them on business, on corporations." The most obvious example is with Social Security tax. Supposedly that tax is half on employee and half on employer but that's a fake; it's all paid by the employee. It adds to the wage cost of hiring a person. If an employer has to pay in addition to a wage--what is it currently?--close to 6 percent of the wage, well that's that much less that he has available to pay as wages in trying to hire somebody or bid somebody away from somebody else. But more fundamentally, businesses can't pay taxes. A business isn't a person. Only people can pay taxes. A corporate executive may write the check, he may sign his name to it, but who is paying it? It either comes from the customers or it comes from the workers or it comes from the stockholders. Where else can it come from? Again, is there somehow or some way in which some people can pay or some funds can be gathered with nobody paying it? I give you another example of the same kind of misleading talk about taxes on business and taxes on people in connection with a local initiative here in the state of California, the Jarvis-Gann initiative to reduce property taxes. The opponents of that are saying, "Oh, that's a fake; that isn't going to reduce taxes on people," because, they say, "a lot of that property is owned by business; that's going to reduce taxes on business." Well, tell me, how does business pay taxes? They don't get the money from the heavens. They don't have printing presses in their basements. The only way a business can pay taxes is by collecting it from customers. And if they pay it over to the government, that's not available to cut the price to their customers; it's not available to pay wages to their employees; it's not available to pay dividends to their stockholders. So of course all taxes are borne by people and by nobody else. I may say that this same illusion is fostered by businessmen. The businessmen of this country use exactly the same language. They send their lobbyists down to Washington and say, "We want relief from taxes on business." That's nonsense. There are no taxes on business and by talking that way they are only fostering the illusion that somehow or other, if I may again word it as Orwell would word it in newspeak, there is no free lunch but there are free taxes. A third example of newspeak is the double standard of fairness which is always being used, one for tax cuts and the other for tax increases. The proposals that have been made by the White House propose to substitute a tax credit for a personal exemption. You are now permitted in the tax code to deduct a small sum as a personal exemption before you compute the income on which taxes are levied. It is now proposed that instead of your being allowed to deduct that from your income you have a credit of so many dollars which you can deduct from your taxes. Said Secretary Blumenthal a few weeks ago on a nationwide TV program, this was fair because, if you increase the tax credit, you reduce the tax for everyone by the same dollar amount; if you make a tax credit $20 higher, everybody gets a $20 reduction in taxes; whereas, he said, if we make the exemption higher, if we add an extra $100 to a personal exemption, that only saves $14 for somebody in the lowest bracket but it saves $70 for somebody in the highest bracket. And therefore, he said, that's not fair. Now suppose you turn that around. If fairness consists in reducing the taxes of everybody by the same number of dollars, when you come to increased taxes does fairness consist of increasing the tax on everybody by the same number of dollars? I don't think even Mr. Blumenthal would have the effrontery to say to a nationwide audience that fair tax increases consist of $20 increases in taxes on the man with a $1,000 annual income and the man with the $100,000 annual income. So he is essentially employing a double standard in discussing tax reductions and tax increases. To give another example of the newspeak that unfortunately Mr. Blumenthal has been engaging in, in discussing the proposed tax change, he used the following language which is very, very common among governmental officials discussing taxes. He said, "In our proposal we are giving so many billions of dollars to business." Now what do you think of that? Anything he doesn't take from you, he's giving to you. That's exactly the same philosophy that's behind another beautiful semantic invention. Have you ever heard of the semantic invention of "tax expenditures"? That was invented in order to refer to taxes that were not collected because of so-called loopholes. A simple example is that you are allowed and permitted to deduct interest that you pay in computing your taxes. The Treasury has figured out that because of that deduction taxes are lower by so many billions of dollars than they otherwise would be, and that lower amount of taxes is described as a tax expenditure--namely, the government is spending that money; it's spending it by letting you keep it. All of these newspeak items, or at least the last few I have referred to, are all part of the same approach. The fundamental philosophy that underlies this approach is that you belong to the government. Your income is the government's income, but of course like any slave owner the government wants to maintain productivity--it has to keep you working--and for that purpose will let you keep a little bit of your income so that you can pay for your food, but the minimum amount only, not for those three martinis. You may keep a minimum amount so that you can pay for enough food, clothing, and housing to keep you working, and it will have to let you keep a little bit of the extra that you earn so that you have an incentive to work. On these grounds that's the only justification for having a personal exemption; it's the only justification for having a tax of less than 100 percent. I suggest to you that if you look carefully at the language that emanates from tax collectors all over world, fundamentally, and the reason why this whole problem is so important, the underlying theme is that the government is the master, the citizen the slave, his income belongs to government, and he is allowed to keep some of it by the generosity and majesty of Big Brother. Now that's the first set of erroneous views that we need to dispose of, that taxes are measured by government spending not by tax receipts, that people and only people can pay taxes--there are no taxes on business, and that people belong to themselves and not to the government and that we should be deciding how much we're going to spend through government for things that we as citizens want and not handing over to the government the reins to decide how much we can spend. But I want to turn to the second of these sets of erroneous views that I think impedes proper tax reform and this is the erroneous view that has been held by so-called fiscal conservatives that the real test of fiscal responsibility is whether you have a deficit or not. This is the view that is incorporated in the ideas of many well-meaning citizens who have been seeking to get a constitutional amendment to require on the federal level a balanced budget. Now I am not against a balanced budget but I submit to you that by emphasizing primarily the deficit, fiscal conservatives have ended up being the front men for big spenders. The typical process has been very straightforward: the big spenders have voted governmental expenditures that have produced a deficit; the fiscal conservatives have scratched their heads and said, "That's terrible! We mustn't have a deficit," and so they have gone to work to get higher taxes. As soon as the taxes have been increased and the deficit is coming within reason, the big spenders are off again and the end result is more and more government spending. This point is very closely related to the point I was making earlier: the real tax is what government spends not what it takes in, in the form of so-called taxes. The real problem is not the deficit; the real problem is not the government debt. The real problem is government spending. I would much rather have a federal budget of 200 billion dollars with a 100 billion dollar deficit than to have a government budget of $400 billion with no deficit because the government budget of 400 billion dollars is simply twice as much taken from the disposition of the citizen and spent on his behalf by government. That's the real problem. Let me show you how shortsighted is the concentration on the deficit. If you as an individual engage in a deficit, if you spend more than you take in, then you will find that your debt grows or your assets shrink. But the federal government has been having a deficit year after year and yet the federal debt today is lower in real terms, lower as a fraction of the national income, than it was right after World War II. How can that be? Doesn't that violate the laws of arithmetic? Not at all, because the government has been imposing a tax, namely inflation, which does not show up in the books as a tax but which has been paying off the debt. The debt is a lower fraction of national income today than it was twenty years ago because we have had so much inflation in the meantime that the real value of the debt, the debt measured in terms of purchasing power, has gone down and not up. In that sense we haven't been having a deficit; it has been a fake. What we've been having is the use of a very bad form of taxation. In any event, to stress my main point, the effect of putting major emphasis on the deficit has been to convert fiscal conservatives into the front men for the big spenders. The big spenders get the political gain from the spending, the fiscal conservatives get the political cost of raising the taxes to pay for it, and the result is higher and higher government spending and a higher and higher true tax burden. Now I want to turn to the third set of erroneous views and that is the view that somehow tax simplification is possible rather than a pipe dream. The question there is--that's not as easy as it might seem--why is it that the tax system is so complicated? Why are the rates so graduated? Why do we have a tax system which has an almost infinite number of rules and regulations, so that nobody in this room could possibly know them all, with tax rates for an individual that start at 14 percent on the personal income tax and go up to 70 percent, and that's on top of corporate taxes so that the owners of corporations pay a double tax? Why do we have such a system? One argument people might make is that it's for equity, but it's not so. You can go from the left of the political spectrum to the right and have a hard time finding anybody who will say that our present personal income tax system is an equitable system. People who are fundamentally in the same economic position will pay very different taxes according to all sorts of accidental elements--the form in which their property is, whether they have been clever or not at getting tax shelters, all sorts of things that ought to have nothing to do with the tax burden. Well then if we don't have it for equity, maybe we have this complex and highly graduated system for revenue. Not so. It doesn't yield any revenue. Let me demonstrate that to you in a very simple way. Suppose you were to consider the following change in the law: you leave the personal income tax exactly where it is except you replace every tax rate which is higher than 25 percent by 25 percent; don't make any other change. So the 70 percent rate becomes 25 percent, etc.--the highest rate becomes 25 percent. Now you might say to me, "Well, that'll cost you a lot of money." Not so. In the first instance if you supposed that under that system everybody reported exactly the same amount of income that he now reports, tax receipts would go down by 7-1/2 percent. But that would be only the first. If the top rate were 25 percent, would it pay you to spend 50 cents on the dollar to get a tax shelter? Would it pay you to hire these expensive tax lawyers to avoid 25 cents on a dollar? You know in 1929 the top rate was 25 percent. If you take the number of people who reported high incomes in 1929 and adjust for what has happened to the price level, the population, and so on, there were ten times as many as there are today. That isn't because the income distribution has changed that much; it's because with our present tax system the private enterprise system has been very efficient in finding ways to avoid those high taxes, but not without cost. If you had a top rate of 25 percent the amount of income that would be reported for tax purposes would go up sharply. I guarantee you that if you take the time to look at the detailed figures you will agree with me that there is no doubt whatsoever that a top rate of 25 percent, with the law otherwise the same, would yield more revenue than you get now. The Treasury would get more money and the taxpayer would be better off. Now how can that be? That looks as if somehow or other I'm getting a free lunch. Not at all. You must distinguish sharply between the revenue from a tax system to the Treasury and the cost to the taxpayer of paying those taxes. Your taxes are really higher than the checks you send to the government. In addition you should include in the cost of taxes the cost to you of tax shelters; the cost to you of decisions that are made on tax grounds, of spending one way rather than another because that will avoid taxes, of not engaging in activities because it just isn't worth it given that for every dollar extra you earn you will only get to keep a little. There is no doubt that the total revenue to the Treasury would go up and the total cost to the taxpayer would go down and nobody would get hurt except for two important groups, which is why this reform is impossible. Who are those two groups? Well, one of them is very obvious; it's the tax lawyers and accountants. The other is less obvious but more important; it's the members of Congress. You put a 25 percent top rate on the tax system, and what do congressmen have to sell in order to raise campaign funds? I am not saying this as a pleasantry; it is literally true. If you are a congressman you have to engage in activities which will enable you to get re-elected. One of the most important of those activities is making the tax system more complicated. By making the tax system more complicated, on the one hand, you get people who are willing to contribute to you and work for you in order to try to get a special provision which will benefit them. On the other hand, you play the other side of the street as well. You have people who are willing to contribute to you and work for you in order to avoid having a special burden placed on them. If you had a simple tax system of a kind which undoubtedly would be preferable that possibility would disappear. Let me put this in another way. You might think offhand that there is a real basis for compromise between what for simplicity I'll call the left and the right on this issue. If you talk to people on the left they will say our personal tax system is unconscionable because of all the loopholes, all of the special deductions, the tax shelters that can be created. And they would say to you if you asked them, "Would you be willing to accept lower tax rates in order to get a broader base?"--almost every one of them will say yes. Suppose now I go to the so-called right and I say to them, "Would you be willing to accept a broader base and fewer deductions in order to have lower rates?" Almost everybody will say yes. Offhand it looks as if there is a compromise here, there's a deal, that you can get both right and left together on a great simplification of the tax system which would eliminate a great host of deductions and subtractions and would sharply lower the rates. You know how low those rates could go? If you kept present exemptions and eliminated all deductions and simply taxed at a flat rate all income in excess of present exemptions and strict occupational expenses, the best estimates are that it would take a flat rate of about 16 percent to raise the same revenue that you now raise from these rates going from 14 to 70 percent. Almost everybody would be better off under that arrangement, and as I say you might think you have a deal for it but you don't. Why not? For three reasons. The first is that neither side trusts the other and both are right. The left would say, "We make this deal and the first thing that'll happen is that those deductions will creep back in." And they're right; that's exactly what would happen. The right would say, "We'll make this deal and the first thing we know those rates will start to rise and become more graduated." And they're right; that's exactly what would happen. So this is not a deal that can be carried off except only if you could do it through constitutional amendment which would really freeze it. The second reason is the importance of appearance versus reality. Everybody really knows deep down that these highly graduated taxes do not produce any equity, everybody knows deep down they don't produce any revenue, but you have to maintain appearances. Everybody wants to be on the side of equity, everybody wants to be on the side of revenue, and so we have the people operating in this political marketplace who will tell you, "We have to maintain those high rates because we must appear to be taxing the rich on a different rate than the poor." The third reason and the most important of all is the one I have already mentioned. If you made such a deal and got such an arrangement and such a simplified tax system Congress would be out of business. It would be very, very difficult for them to have something to sell. How can we proceed then? I submit that the way we have to proceed is by facing up to our situation and asking what is the fundamental explanation. Why is it that we have been having a situation in which in a democratic society government spending has been going up as a fraction of the income even though very few people feel that they get their money's worth? I believe that the fundamental explanation is that there is a defect in our political structure and that we must not kid ourselves into thinking that we are going to remedy it by the easy way of electing the right people to office. That will not work. Once they get into office they are going to be subject to the same pressures and the same drives as the people we might regard as the wrong people. In fact I have often said that the right solution is not to elect the right people to office but to make it politically profitable for the wrong people to do the right thing because, unless it's politically profitable for the wrong people to do the right thing, the right people won't do it either. I should think by this time we have had ample experience to demonstrate the validity of that proposition. But what is this defect? Why is it this happens? I believe the fundamental defect is that the way in which a government budget is constructed is by voting individual pieces and then adding them on. With respect to each individual piece there is a group that feels very strongly about it. They are going to make a big effort to get that in. The cost is very little and it is spread over everybody, and nobody makes a big effort to stop it. The result is that you get one little piece piled on top of another, the total adds up to more than the public at large would like to spend, but the public at large never gets a chance to vote on that total. When they come to vote for their individual representative, they are much more likely to vote for him on the basis of the special measure that they feel strongly about than they are to vote for him on the basis of some kind of overall reduction. Consider your own position. I've talked to members of state legislatures and federal congressmen and they will say to you, "Now here are these people who come to me and say we have to have more money spent on, let's say, education, or on mental health facilities, or on water resources--you name it. And I say to them, well you know that's fine, but where are we going to get the money? Our budget is already too big. And they say to me, 'You mean you're a hard-hearted, cold-blooded fellow who wants to stamp on mental defectives,' or on the ill or on whatever other emotional group you can bring up." Now a legislator will tell you, "This particular measure by itself is going to raise taxes by a dollar a person. There is nobody who comes around and knocks on my door and says, 'Don't you put that extra dollar on my taxes.'" If you look at the record, the plain fact is that increasing government spending has always been politically more profitable than reducing taxes. And the reason, as I say, is because the expenditures are concentrated and people know that they are benefited. The taxes are diffused. Moreover, there is a second point that needs to be emphasized. You get all these measures passed and you might say, "Well, but then why are people dissatisfied with the total? After all you got what you wanted; he got what he wanted "Why is it that this 40 percent of government spending doesn't correspond to what the public wants? Why does the public feel that they are getting cheated, that they are not getting their money's worth? The answer is because, once you start giving somebody else's money away or spending it, somebody will compete to try to get it and the effect of that will be that there are no benefits from the government spending. Government sets out to spend a billion dollars--whatever it is--for a good purpose. That means it's worth somebodys efforts to spend a billion dollars to get that billion dollars. You may spend that billion dollars in the form of propagandizing congressmen to get it passed, in the form of election contributions, but you may spend it in much more complicated forms--in lawyers' fees, in preparing projects, in knocking at the door of government officials who have it to distribute. So the fact is that there is an enormous difference between the benefits people get from government spending and the benefits people get when they spend their own money, and that difference derives from the fact that governments are always spending somebody else's money. The competitive market is a marvelous invention; it works. It works in the economic sphere and it works in the political sphere, and the way in which it works is that market competition tends to lead people to spend nearly as much money to get the subsidies as the subsidies are worth with the result that everybody feels cheated. The net benefits are much smaller than the gross expenditures. The question is, how can you remedy this defect? I think myself that there is fundamentally only one way in which you can remedy it and that is by a political change in the form of constitutional provisions which will set a limit to government spending. Every individual in his private life has a budget to spend. If he considers whether to spend more on one thing he has to ask himself, "Where is it going to come from? Where am I going to cut?" But our legislators don't have that kind of budget limit. They can vote to spend more and they will say, "Where will it come from? Oh, somewhere; the taxpayer will pay for it." What we need is to give our legislators a budget, to say this much and no more; then the special interests can fight with one another instead of the special interests ganging up on you and me and themselves. Don't kid yourself; we're all special interests, we're all guilty, we're not innocent. There is nobody in this room I am sure who has not at one time or another favored what he would recognize as special interest legislation. Of course it's different when it's our special interest. We all know that what's good for us, well that's good for the country, too. It's not a question of holier than thou. It's a question of having a setup under which we in trying to fight for our special interest have to fight within a limited budget. As you know, I am describing the proposal that got started in the state of California under Proposition 1 four years ago. I have no hesitancy in discussing that because I am proud to say that I was involved in that campaign and in the design of that amendment and in trying unsuccessfully to get it passed. The interesting thing to me about the Prop 1 amendment was that at the time we were drawing it up here in the state of California to set a limit on government spending, to say that the state government shall spend no more than X percent of the personal income of the people, we made it extremely complicated because we tried to cover every possible loophole. We took it for granted that if it were enacted the legislators would try their best to evade it. I believe now that that was a mistake. The one respect in which I have changed by opinions greatly since then is to discover that if you could once get this through you could count on the members of state legislatures and of the federal legislature to be your open or secret allies in making it effective. Why? They are decent public-spirited human beings, no different from you and me. They are now subject to very difficult pressures, of those I have described, but they would be in so much better a position with that amendment because now somebody comes to them and says, "You've got to vote more money for this good cause or that good cause," and they say, "I agree with you; that's a good cause. Where shall I cut? I have a total budget. We can't vote more unless we vote less for something else. What shall we vote less for?" So it would provide the legislator with protection, enable him to perform his function more effectively. The question at issue is, is there any reason for hope that we will get this fundamental defect in our political structure reformed? I believe the answer is that there is. There is an enormous ground swell of taxpayer revolt. You are feeling it in this state with the large number of people who signed the petition for the Jarvis-Gann amendment. You are feeling it in every state throughout the country. The taxpayers are simply getting fed up with the burden of government and with the disproportion between what they see as the benefits from government spending and the cost of government spending, and I have been impressed with how rapidly the ground swell for constitutional limitation is growing. In the state of Tennessee a constitutional convention has recently introduced a spending limitation into a proposal that will go before their citizens this spring. It may well be the first state in the country that will have an explicit limitation on government spending in its constitution. In the state of Massachusetts, of all states--it's a state which has gotten the nickname of Taxachusetts because it's a state which has one of the highest levels of state government spending in the country. But, in the state of Massachusetts a citizens group has gotten through the first stage in a process for a constitutional amendment along these lines. It so happens that their constitution requires a long time before amendment--three or four years. This amendment was tried as you know a year or two ago in Michigan. It was defeated in Michigan narrowly by exactly the same groups that defeated it in California, namely the special interest groups who wanted to see larger government spending led, I'm sorry to say, by the educational associations of the state--the Michigan Educational Association in Michigan and the corresponding California association here. Don't misunderstand me. Many of the individual teachers are strongly in favor of it but the bureaucracy, the organization, the administration of education is strongly opposed to it--and for very good reasons. Because they are right; they are pursuing their own interests; because they see that under such a limitation it would be more difficult for them to get ever-increasing expenditures to raise their salaries and perquisites. They are not working against their interests, and they have been enormously effective in both Michigan and California, but I think that we are learning and that the public sentiment for this is growing, and sooner or later you'll get it passed. After all we must remember that very few major changes in government have ever been enacted the first time. You have to stick with them and that's a good thing because we only want things to be done insofar as the public at large is really persuaded that they are desirable and effective. In state after state there is a movement of this kind, but there is also such a movement on the federal level. The Southern Governors Conference about two or three years ago appointed a task force, led by Governor Edwards of South Carolina, and they constructed a constitutional amendment for the federal government that would limit federal government in the same way to a certain percentage of the national income. That's at a very early stage. But in my opinion in the long range that is the only hope we have for stopping the growth of government, for holding it back. As a final rather curious reason for hope, I might cite to you the example of the United Kingdom. Great Britain which has been preceding us down this road, Great Britain whom we have been imitating, where government spending is not 40 percent of the national income as it is in this country but close to 60 percent, has been having a very effective tax revolt. A Labour government for two years in a row has been led by political pressures to reduce government spending as a fraction of income. I don't know how long that will last but it is a sign that it is possible for the public at large to express its views and for those views to be effective. If we are to be effective, I think we have to direct our efforts along the lines of reforming and improving our constitutional structure. That's the kind of reform that's possible. We must not waste our efforts and suppose that we're going to be successful in getting tax reform of the other kind, of any substantial improvement or simplification in the tax system, any reduction in total government spending by attacking one particular expenditure or another. We must look at the thing as a whole and go to the fundamental source of our problem. Thank you. Dr. Friedman, you stated that the Administration's energy proposal is really a tax program in disguise. Would you elaborate on that or explain what you really mean by it? Yes, it's very straightforward. The proposed energy program would impose a very heavy tax as you know on crude oil with a very large sum of revenue coming from it. That tax would be disposed of by government for various governmental purposes. The statement is that it would be refunded, but if it were really given to people in accordance with the amount of energy they use the tax wouldn't serve its alleged purpose. Its alleged purpose is to give people an incentive to conserve. Well I have no incentive to conserve if what I spend with the left hand is going to be given back to me with the right. And if you look at the actual proposals for using those funds, it's not at all clear that they are intimately related to the purpose of energy. That's what I mean by saying it's a tax program in disguise. If you really want to serve the function that the energy program should serve, namely to have a more rational and sensible allocation of energy in this country, we all know how to do it. That would be to abolish the Department of Energy, to eliminate price controls on natural gas and on oil, let the market work, and you would find the so-called energy problem would disappear faster than you could say James Schlesinger. Dr. Friedman, in a Newsweek article last month you stated that inflation in 1977 was higher than in 1976; also in 1978 it would be higher than in 1977. How much higher will it be and when will it stop going up? The easy questions we answer at once; the difficult take a little longer. It's not too hard to say where inflation will be in 1978 because that's already largely determined. The rate of inflation in any year is largely a function of what happened to the quantity of money two years earlier--not entirely but largely. So we can already say what's in store for us, and I have estimated that something like a 7 to 9 percent rate of inflation is what's probably in store for us in 1978. Where it will go beyond that in 1979, it will be somewhere in that range but how much higher it will go depends on the policies that are followed from here on out. All of this is not predetermined; we have a choice about the course of events. In my own opinion the likelihood is that sometime in the next two or three years inflation is likely to get up to 10 or more percent. Where we will go from there on out is more complicated. What has happened in fact over the last several decades is that we have been on a roller coaster. Inflation rates have risen; when they get up to a high enough point there's great public pressure to bring them down, they are brought down, then there's a great excitement about recession and unemployment, and they are brought up again. But each peak is higher than the preceding peak, and each trough is higher than the preceding trough. Now we're on the upgrade of one of those roller coasters. The preceding peak was up around 11 or 12 percent. If history continues to repeat itself, the next peak will be higher than that. Sooner or later the public will demand that it be stopped, and when that happens it will be stopped because inflation is a disease that we know how to cure. What's needed is not the knowledge; it's the will. It's the political will and willingness to take the measures that are necessary to stop it. Now again, don't misunderstand me. Inflation is not produced by evil people; it's produced by you and me. It's produced by exactly the same political forces that have sent our government spending skyrocketing. It's because we say to government, "We want you to spend more and more, but we don't want you to tax more and more." So Congress listens, it spends more, it doesn't tax more, and it pays for the difference by printing money. And that's why we have the inflation. I'm a free enterpriser I feel. I find income tax totally antagonistic to true free enterprise. Can we run the country without income tax? There's a sense in which all taxes are antagonistic to free enterprise and yet we need taxes. We have to recognize that we must not hope for a utopia that is unattainable. I would like to see a great deal less government activity than we have now, but I do not believe that we can have a situation in which we don't need government at all. We do need to provide for certain essential government functions--the police function, the national defense function, the function of preserving law and order, of maintaining a judiciary. So the question is, which are the least bad taxes? In my opinion, and this may come as a shock to some of you, the least bad tax is the property tax on the unimproved value of land, the Henry George argument of many, many years ago. The next least bad tax is a flat-rate tax on income above an exemption. So in answer to your question, if I could design my ideal tax system it would contain an income tax, but it would not be the kind of monstrosity we have now. It would be a flat-rate tax on all income, from whatever source derived, less only a personal deduction and strict occupational expense, and that kind of income tax I think would be the least inconsistent with a strong free enterprise system. You know it's an interesting thing, if you're talking about taxes, about why it is that the property tax is so unpopular. It's not unpopular for good economic reasons. It's unpopular in my opinion for one simple reason: it's the only tax left on the books for which people have to write a big check. The income tax is a far worse tax but--and I have to admit that I have some part of the guilt in this process because during World War II I worked at the Treasury and helped to design the withholding system; my wife has never forgiven me for it, but with respect to the income tax we have arranged it so that it's taken off bit by bit, and it's almost painless. With respect to the sales tax, we pay a little bit of it each time. With respect to the corporate tax and excise taxes, they are hidden in the price of things we buy; we don't even know we're paying them. But with respect to the property tax, that remains a tax that we as individuals have to pay and that we have to write a big check for. That's the fundamental reason in my opinion why it's so unpopular. In fact--I hate to say this because it's giving hostages to fortune--if you wanted to reduce the unpopularity of the property tax, the way to do it would simply be to provide for an effective method whereby it could be withheld at source in small payments and that would eliminate a large part of the objection to it. Dr. Friedman, in light of the current farmers' strike for higher farm price supports and the complaint that they are going broke, can you offer any comments on your opposition to any farm price supports? It's a very interesting sign of the change that has occurred in this country. The farmers have always complained, so have the rest of us, but the interesting change that impresses me is the change in the focus of their complaints. If you go back a century, to the farmer protest movements of the nineteenth century, the Greenback movement, it was always directed against Wall Street. The complaint was that the money-changers in the temple--the financial people, the people in Wall Street, the banks--were the ones who were forcing the farmers to pay high prices for what they bought and receive low prices for what they sold. But as we have shifted from a free enterprise society to a welfare state, the farmers no longer complain about Wall Street; I haven't heard a single complaint from them about Wall Street. Now it's Washington they complain about. Of course the farmers have many complaints, so do the rest of us, but in my opinion there is no justification whatsoever for any government involvement in the pricing of farm products either up or down. The pricing of farm products ought to be determined in the market as should other prices. The farmers, like the rest of us, regard anything good that comes along as only their just due and so a few years back when farm prices were very high and farm incomes were higher than they had ever been in recorded memory, I didn't hear of any farm strikes against those high prices. I didn't hear of any voluntary action by farmers to pay extra taxes because their incomes were higher. Well, you've got to take the good with the bad. The farming business is a very large-scale capitalist business in these days with a wide range of incomes. It's going to be good some years; it's going to be bad some years. A free enterprise system is a profit and loss system, and never forget the loss part. If you have a system in which losses are eliminated, you will eliminate the heart of a free enterprise system which is to make people responsible for their own actions and to provide a system under which they are induced to use their resources effectively, under which if they engage in bad ventures they get out. That's the fundamental difference between the market and government. When government engages in a losing venture, you know what happens. It gets doubled in size. But in a market system if somebody engages in a losing venture, he has to go out of business. That's more important really than the profit side in my opinion. Well, that applies equally to the farmers so I do not see any justification. But more important, suppose they got their way. We've been down that road before. What does it lead to? It leads to government control over agriculture. If the government is going to set the price, if that price is higher than the market price, then you either accumulate stocks as we did at one time or else you have compulsory reductions in acreage and production by the farmers and they will complain about that. I want to say one other thing of a very different kind. I believe that the farm protest has been enormously exaggerated in the news media in terms of where it comes from and what it means. You have a very small fraction of the farm population that is engaging in this. The major farm organization of this country, the Farm Bureau Federation, to my knowledge has not participated in these strikes. What you have is a rather small marginal group of farmers who have been able to get a great deal of media attention by engaging in all sorts of picturesque events such as lining up tractors and driving them around Plains, Georgia. Dr. Friedman, you have been quoted as saying the Social Security tax is the worst tax on the books and that in your opinion it should be abolished--the whole system. What would you suggest to use as a substitute in its place? There are different levels on which that question can be answered: one, dealing with the Social Security system as a whole; the second, dealing simply with the financing of present Social Security benefits, so-called, without going into the question of whether those benefits themselves should be changed. Let me limit the question to that second level. Here again is another case where I believe the fiscal conservatives have been on the wrong side of the issue. The fiscal conservatives have tended to support the payroll tax and matching the payroll tax to expenditures. They have tended to support the notion that the Social Security system should be self-financing. In so doing they have been supporting a fiction. The Social Security system is not in any relevant sense an insurance system. The taxes that people are paying under the Social Security system are not in any relevant sense financing the benefits they themselves will ultimately receive. The Social Security system is a combination of a bad tax and a bad expenditure program. I have never heard anybody who would defend either half separately, and taking two bad things and putting them together doesn't generally make something good out of it. Alright now, by supporting the notion of these two being self-financing, the fiscal conservatives have in fact tended to support the fiction that this is really an insurance scheme. It's not an insurance scheme at all. What it is is a scheme whereby people today are paying taxes today to provide payments and benefits to other people today. There is a small relationship between the amount beneficiaries receive and the amount they themselves pay, but that relationship is very small. Insofar as there is that relationship, you can justify an element of payroll tax; but insofar as a large part of Social Security benefits are properly to be understood as subsidies, welfare payments, there is no justification for financing them out of a payroll tax. In my opinion if you are going to finance them, they should come out of federal revenues. Now you will say to me, "Oh my, but that's terrible. Does that mean that you're supposing that we should increase other taxes?" No. Let me go back to the fundamental principle. Government is going to spend whatever the tax system will raise plus a little more--lately a good deal more. The only effective way to keep down government spending is to keep down the amount of money available to government to spend. There is no other way you can do it. The effect of linking Social Security, of having the payroll tax, and of spreading the notion that somehow or other the payroll tax is related to the benefits--the effect of that has been to make the American people willing to bear a larger tax load than they otherwise would bear. I argue the other way; reduce taxes whenever you can. Remember my main point that the deficit is not the thing to worry about. What you want to worry about is total spending. If you reduce the payroll tax and throw the burden on the general tax level, that will be the only effective way of stopping even worse programs. After all you have had a strong movement for a long time for a national health program which would be a disaster. It would mean worse medical care and more expensive medical care for the American people. What has been preventing that from being enacted? Only the difficulty of financing it. Let the fiscal conservatives join in making the payroll tax more acceptable and making the payroll tax higher, and you will be providing the financing mechanism for national health service. Instead, lower the payroll tax, throw this on the general revenue, and you will be taking away the revenue base for programs of that kind. So where are you going to finance it? By not adopting bad government spending programs. That's where I'm going to finance it, and that's where-not, I, I don't mean personally--the political pressures, the realities of the political mechanism, will finance it. And as I say, it's again another example of the way in which the actual effect of measures that people have been taking have been very different from those they intended to take. I wanted to see what you think about this suggestion for focusing public debate more into the free enterprise area and your agent of enterprise and that sort of thing. Up until now stockholders and corporations have been rather unorganized. They have not spoken in a loud voice and have not even had any mechanism. Do you have any ideas of how stockholders could be mobilized a little more, could open up their meetings to more debates of issues that would be relevant to improving the enterprise system, toward making an election of directors a function of how directors promote proficiency, economy, and less burden on the stockholders? Frankly, my answer to that is that stockholders are citizens, that they should express their values in this sense as individual citizens. I do not believe that businesses are either a proper means for shaping public policy qua businesses or an effective means. You talk about preserving the free enterprise system. Who has been destroying it? The business community must take a large share of the responsibility. I am going off my topic for tonight, but you must separate out being pro-free enterprise from being pro-business. The two greatest enemies of the free enterprise system in my opinion have been on the one hand my fellow intellectuals and on the other the big businessmen--for opposite reasons. My fellow intellectuals are all in favor of freedom for themselves. After all if I say to them, "You know it's terribly wasteful to have ten people do research on the same topic. Don't you think we ought to have a government planning bureau that would assess the priority of various research projects and decide who should undertake them so we could eliminate these terrible wastes of competition?" They will say to me, "Why, don't you understand the process of scientific research? Don't you understand the necessity for academic freedom, for allowing people to choose their own subjects?" Of course I do understand it and I agree with that, but when they come to the rest of the community it's different: it's terribly wasteful to have four gas stations on four corners; we ought to have a government bureau that eliminates that overlapping competition, that assigns priorities, and sees to it that things are done right. So the intellectual is all in favor of freedom for himself and all opposed to it for everybody else. The businessman is very different. I don't mean to be talking about all of them but I'm talking about a very large fraction of them. You cannot get them on a podium without them uttering generalities about the desirability of free enterprise systems, but when I come to their own business that's something else. When the head of U.S. Steel talks about free enterprise, he doesn't mean free enterprise for steel. Oh no, he wants the government to step in and protect him from competition, from those Japanese who are undercutting him. When the oil industry talks about wanting a free market, some years ago they weren't talking about freedom. They wanted percentage depletion, they wanted oil import quotas, they wanted the Railroad Commission to proration oil. When bankers stand up on a platform and talk about the great desirability of free enterprise and of free markets, and I say to them, "You mean you don't want the government to limit the amount of interest that you are required to pay on demand deposits? You want to have free competition." "Oh," they say, "that's different. We like that." So almost every businessman is in favor of free enterprise for everybody else, but special privilege and special government protection for himself. As a result they have been a major force in undermining a free enterprise system. So that in any hope that you're going to protect a free enterprise system, do you really mean to say that you expect U.S. Steel stockholders to propagandize for free trade? Is that what you expect? Don't misunderstand me. I don't blame the executives of U.S. Steel for trying to get limitations on imports or the executives of some other corporations for trying to get tariffs. They are doing what they were hired to do. They were hired to make money for their stockholders, and they're trying to do it. If the rest of us are such fools as to let them make money by getting tariffs or by getting import quotas or by getting other provisions, then we're the ones to blame not they. But stop kidding yourself into thinking that you can use the business community as a way to promote free enterprise. Unfortunately most of them are not our friends in that respect. Now I want to make an important distinction, and that's between the large-scale corporations and small business. The only major business organization in this country that is almost consistently on the right side, from my point of view as a believer in free enterprise, is the National Federation of Independent Businessmen. NAM, the Chamber of Commerce, the CED--I can't predict on which side they'll be. They may be on the right side or they may be on the wrong side, but the small businessman is on the right side. Now that isn't because the small businessman is any nobler, any more ethical, any more moral. It's for two different reasons. It's because first of all he is spending his own money and not somebody else's, but second it's because he knows he can't be effective in government and therefore it's in his self-interest to be for the right thing. Again I'm not decrying that; I'm only describing it. Again, let me emphasize, there are some great exceptions. There are some businessmen who in their capacity as businessmen have been staunch defenders of free enterprise. I don't mean to say there haven't been any exceptions. But do not kid yourself in thinking that the corporation as such is a channel that anybody is going effectively to use to promote free enterprise ideas. Dr. Friedman, do you believe that we ought to have an audit of the gold in Fort Knox and also the Federal Reserve System? No, I believe we ought to sell off the gold in Fort Knox at a public auction at the highest price we can get. I do not see any reason why the storage of gold should be a nationalized industry. I believe private people should be free to own gold to do whatever they want with it. I do not see any more justification for the U.S. government having a large stock of gold in Fort Knox than for its having a large stock of copper or steel or other things. You might justify a small strategic reserve in order to be able to have something that we could use to bribe some people in Africa or Asia if the time emerges, but beyond that use for gold I see no justification. Don't kid yourself in thinking that we're going to have a gold standard again. My remarks are not to be interpreted as saying that an honest-to-God gold standard might not be a good thing; it might be. The kind of gold standard we had in the nineteenth century had something to be said for it, but we haven't had that kind of gold standard since 1914 and we aren't about to have it again. Therefore, in my opinion, the right thing to do with the gold in Fort Knox is to auction it off to the highest bidder. Maybe we ought to do it over a three- or four-year period in order not to spoil the market, but other than that that's what we ought to do. And do you believe we ought to have an audit of the Federal Reserve System? You can have lots of audits of the Federal Reserve System. You know if you are going to ask me about the Federal Reserve System, my ultimate solution is to abolish it and that would eliminate the necessity for an audit. But that isn't going to happen tomorrow; it isn't going to happen the next day. The problem with the Federal Reserve System is not that it needs auditing. The problem with the Federal Reserve System is that it is following the policy which Congress imposes on it, and in my opinion what we want is not a more independent Federal Reserve System; what we want is to require Congress to be responsible for setting forth more specific rules for the conduct of monetary policy. Now you're getting into a very broad and difficult issue and I warn you that what I'm saying now are statements that you could not possibly accept on faith, but that they are statements that are based on a good deal of thought and consideration. But I believe we need a more responsible monetary policy and I do not believe that an audit of the Federal Reserve System would in any way whatsoever contribute to that more responsible policy.
