How Capitalism Will Save Us (36 page)

That rationale accounts for the trend over the last twenty-five years toward targeted excise tax increases—sin taxes on tobacco and alcohol—in place of raising income and sales taxes. According to the
New York Times
, “across the country, politicians, eager to avoid anything that looks like a tax increase, are turning to levies on… ‘unhealthy behaviors’ to finance education. Kentucky, Maryland, Missouri, Tennessee, Utah and West Virginia are among the states that have shifted part of the cost of
schooling from income, sales and property taxes to levies on gambling and nude or topless dances in the last few years.”
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Not only are states turning to sin taxes to fund programs and services. They’ve also begun developing a whole spate of new “sins” to be taxed—from polluting to eating junk food, playing video games, or even drinking bottled water.

As Daniel Clifton and Elizabeth Karasmeighan explain in a recent report on this trend for Americans for Tax Reform, sin taxes are palatable to people who would like to see less of the behaviors the states are taxing. After all, you don’t have to pay if you don’t indulge in the “sinful” activity being taxed. As the authors point out, “By targeting their tax increases to narrower segments of the population, legislators divide taxpayers into smaller groups and minimize voter backlash.”
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Sin taxes are what economists refer to as a “Pigovian tax” intended to correct a market’s “negative externalities.” That’s economist speak for undesirable behavior. Sin taxes are supposed to be justified because, the thinking goes, they “adjust” a product’s price to reflect its “actual cost” to society.

Pigovian taxes are named not for the swinish behavior they’re supposed to control but to honor economist Arthur Pigou, who developed the thinking behind such taxes. Because sin taxes provide a disincentive to negative behavior, many people see them as a more palatable alternative to regulation. Creating a tax disincentive does not require the costly bureaucratic manpower that would be needed to enforce a new law.

The problem is that sin taxes don’t really work as advertised. They present a host of unintended economic and social consequences—in addition to raising moral questions.

That cigarette smoking has declined is a consequence less of taxes on smoking than of greater public awareness of its health effects. New York State has the highest cigarette taxes in the nation. And New York City prohibits smoking in public places. But this has not stamped out smoking. What it has done is increase smoker determination to buy cigarettes from cheaper states and Indian reservations and on the black market, increasing opportunities for cigarette smugglers and criminals.

That’s why Father Robert Sirico, a Catholic priest and head of the Acton Institute, which studies moral and economic issues, is an outspoken critic of these levies:

He concludes, “The temptation to impose sin taxes is one that should be resisted for economic and moral reasons.”
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Indeed, some sin tax proposals are more than a little morally ambiguous—like when Texas governor Rick Perry advocated funding education by imposing taxes on exotic dancing. Not surprisingly, the plan, ridiculed in the media as “tassels for tots,” went nowhere.

Sin taxes often don’t work because states end up dependent on the very activities they’re supposed to be taxing out of existence. When the activities decline, so do tax revenues. In 2008 the city of Chicago enacted a levy on bottled water. Five months later, experts predicted that it would bring in less than half the revenue estimated in its first year.

The state of Maryland doubled the cigarette tax to two dollars a pack to pay for expanded health-care coverage. But as the
Wall Street Journal
reported in 2008:

There’s also the issue of “fairness.” Like other excise taxes, sin taxes are regressive, which means they take a greater percentage of the income of low earners. A National Center for Policy Analysis Report, “Taxing the Poor,” explains why:

Also, lower-income people often spend more on the activities commonly taxed. About one-third of lower-income adults smoke versus one-fifth of middle- and high-income earners, according to the Centers for Disease Control and Prevention. The NCPA points out, “The portion of income spent on alcoholic beverages by the lowest fifth of earners is double that of middle earners and more than three times that of the highest earners, on the average.”

Father Sirico asks whether we truly want a tax system that is financially dependent on people’s bad habits, while the addiction to wasteful government spending is totally ignored. He concludes,

I
n 2003, the Bush administration cut capital gains taxes from 20 percent to 15 percent. The cuts are supposed to expire in 2010. Tax hikers—who included Barack Obama when he ran for president—have proposed letting the cuts expire or even raising the tax as high as 28 percent. While a hike would score political points in some quarters, it would be disastrous for an economy struggling to emerge from the worst recession in nearly three decades.

Cutting taxes on capital gains is frequently derided as a giveaway to the rich. In fact it’s anything but. Millions of Americans depend on stock market gains for wealth-building savings and retirement. Thirty years ago, only about 13 percent of Americans owned stock. At least 50 percent of American households do today.

Capital gains taxes, of course, are not paid only on stock sales. They apply to income from the sale of other investments, such as a business or work of art. Some capital gains are exempt from the tax. For example, a couple doesn’t have to pay the tax on the first $500,000 of gains from the sale of their primary residence if they buy another home within two years.

The tax is paid on the “gain”—the difference between proceeds from the sale and the asset’s original price. One problem with the capital gains tax is that the “gain” is not necessarily real profit. The tax has what policy analyst Stephen Moore and others refer to as an “inflation penalty.” Moore explains, “The seller pays tax not only on the real gain in purchasing power” realized by an asset sale, “but also on [an] illusory gain attributable to inflation.”
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In the 1970s, the cruel reality was that people paid punitively high rates of almost 50 percent on inflated gains that were essentially illusory. In effect, the tax was confiscating principal, wealth that had already been taxed. No wonder the seventies were a decade of stagnation and paltry investment.
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Capital gains have traditionally been taxed at lower rates than income. That’s partly because, unlike salaried income, the gains are achieved after an individual or corporation has placed capital at risk. Experts like Stephen Moore believe that the reward for risking capital isn’t big enough and that the capital gains tax in fact contains a “bias” against risk taking. Why? Because if your risk taking doesn’t work out, you get to deduct only part of a loss—up to three thousand dollars a year.

Experts agree that capital gains tax cuts produce an especially large bang for the buck. They’re a great way to boost the economy. That’s because high capital gains rates cause what is called a “locked-in” effect. Investors hold off on selling assets to avoid the tax. But if capital gains taxes are cut, those same people sell—and invest. “Locked-in” wealth is released. Growth soars, along with a surge in tax receipts.

The Bush administration’s 2003 capital gains tax cut was a key reason that the economy finally recovered from the 2000–2001 recession. Donald Luskin, chief investment officer of Trend Macrolytics, LLC, analyzed the Congressional Budget Office’s annual “Budget and Economic Outlook” report in 2006. He concluded that the cuts actually ended up generating more money for government, not less, as had been feared. “Instead of costing the government $27 billion in revenues, the tax cuts actually earned the government $26 billion extra.”
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