What’s the Purpose of Taxes?

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Many are wondering if it is time to construct a better system (Photo: Getty Images)

President Obama, the Republicans and even Congressional Democrats seem very close to ending their debate for now on what should be done with taxes for 2011 and in part 2012. But the tax deal and Obama’s debt commission are opening up a much bigger debate about taxes: Why do we have taxes in the first place?

It may seem obvious. Someone has to pay for all the stuff government does. But Daniel Henninger in today’s Wall Street Journal makes a very good case for why we should be looking more closely at the questions of why taxes and for what. Here’s why:

Henninger starts off by saying even Republicans don’t seem to agree on this issue. Sarah Palin and Mitt Romney and many in the Tea Party are against the tax deal. Newt Gingrich and most of the Republicans in Congress are for it. So is that split a reflection of a difference of opinion on what taxes are for, and not just political posturing? Maybe.

Whether the tax rates in place for most of the past 10 years are extended for two more years this week or next month is politically interesting but doesn’t get to the more important question we should be asking Govs. Palin, Romney, Pawlenty and the rest: What exactly do you think taxes are for? Do we pay taxes to support federal, state and local government, to reduce the deficit, or just maybe for something else?

Henninger’s point is an interesting one. Taxes can do a lot of things. They can pay for services. They can make life easier for future generations by either reducing the nation’s debt burden, or by building bridges and tunnels that our children will use. (My generation has not come up with a way to cross the East River in New York, yet I am able to go back and forth between my home in Brooklyn and my job in Manhattan with ease. Thanks, grandpa.) Taxes can transfer wealth from future generations to today by increasing the deficit. They can change behavior like in the case of cigarette taxes, soda taxes and the mortgage interest rate tax deduction. So it is useful to talk about what we want taxes to do before setting where they should be.

Henninger says both parties are ready for tax reform. But he also tells that there is a hidden agenda in Obama’s willingness to make a deal on taxes and to talk about tax reform.

Barack Obama won’t say it, but a school of thought linked to his presidency no longer sees a justification or need for U.S. primacy. That posture would indeed make it easier to maintain the “parity” between taxes and outlays that Mr. Summers seeks on behalf of the public sector.

Perhaps. But there is a hidden agenda behind the way that Ms. Palin, the Tea Party and others believe they can reach tax parity as well. They would like a government that delivers significantly fewer services than the one we have today. So yes, no mandated health care system. But no policing of pollution. No support for medical research. Fewer federally funded cultural institutions. Public transportation? Probably not.

So what should we think about when we think about taxes? Henninger’s answer is growth.

In the hypercompetitive world we will inhabit for at least a generation, might not it be time to rewrite the textbook? To ensure American well-being, the pre-eminent purpose of a modern tax system should be to achieve the highest possible level of growth in the private economy with a competent, efficient state in a supporting role.

But the problem is that’s not really an answer about that to do about taxes. It only brings us to what is the real debate: What exactly is a pro-growth tax policy? Pretty much everyone seems to agree these days that a long-term growing budget deficit is bad for growth. Eventually we will have to pay that money back. So I would argue that raising taxes to lower the deficit would ensure lower interest rates for perhaps decades to come. That to me is a pro-growth tax strategy. We have settled on a different policy. The current tax deal cuts taxes to put more money in everyone’s pocket so they will spend more. That perhaps is pro-growth, but only for now. Eventually we will will get to a point where lowering taxes will only make it obvious we have no real plans to pay back what we owe to the Chinese and others. At some point, we are going to have to take the Obama or Palin option. Just lowering taxes is not going to be pro-growth forever, or perhaps for much longer.