Ten Myths About the U.S. Tax System (Update) | Freakonomics Radio

This episode of Free Economics Radio features an updated discussion with Jessica RLE, a tax policy expert renowned for her nonpartisan, critical approach to Washington's fiscal policies. RLE, currently a budget and tax fellow at the Brookings Institution, argues that the federal debt crisis is far worse than commonly perceived and that much of what people believe about US tax policy is incorrect. She has been sounding the alarm on the national debt since 2001, viewing her career as an "abject failure" in stemming its growth. RLE's interest in budget and tax policy was sparked in high school by a *US News and World Report* challenge to balance the federal budget. She finds the field compelling because it delves into philosophical questions about the role and size of government. She highlights a concerning projection from the Wharton School, where economic models crashed when attempting to project the US economy over 30 years under current deficit trends, indicating an unsustainable path. Having worked for a quarter-century in Washington, RLE's career spans roles at the Heritage Foundation, as chief economist to Senator Rob Portman, and on presidential campaigns for Marco Rubio and Mitt Romney. She chose not to run for office due to her aversion to fundraising and an unwillingness to pander, which she believes would lead to swift removal from office. RLE also shared her personal transition from Brian to Jessica, expressing gratitude for the supportive and positive response, hoping her gender identity would blend into the background, allowing her economic research to remain the focus. RLE's "cold economic truths" have often angered political figures. She recounted a time early in her career at the Heritage Foundation when her reports criticizing Bush's spending and rising deficits led to the Bush White House attempting to silence her. Despite being banned from the White House, her "just the facts" approach eventually won over many Bush economists, leading to future collaborations. She specifically critiqued Bush-era policies like defense spending hikes tied to discretionary spending, the 2002 farm bill's 80% increase in subsidies, and the 2003 Medicare drug entitlement, viewing them as fiscally irresponsible. Characterizing herself as pragmatic and right-of-center, RLE finds both the Biden and Trump administrations' economic policies problematic. She criticized Biden's administration for adding $4 trillion in new spending, tariffs, and increased deficits, leading to inflation, advocating for a more moderate, bipartisan approach. The spending increases under Biden included the American Rescue Plan, discretionary spending, veteran spending (PAC Act), the infrastructure bill, and student loan bailouts. Similarly, she noted Trump's first term added $8 trillion in new spending and tax cuts, and his second term appears poised for trillions more in tax cuts with "empty promises of spending cuts," pushing deficits higher. She described Trump's economic policies as "aggressively inflationary," citing proposed tax cuts, increased spending, tariffs, immigrant deportations, and pressure on the Federal Reserve to keep interest rates low, all contributing to rising prices. RLE's article, "Correcting the Top 10 Tax Myths," was born out of frustration with misinformed debates on tax policy, particularly given the consequential tax policy year of 2025. She aimed to provide accurate information for a more informed national debate, addressing both conservative and liberal myths. She noted that while the Trump administration's agenda often appears dominated by other issues, there might be a strategic "blitz of activity" to distract from ongoing tax and spending debates in Congress, such as the extension of the 2017 tax cuts. RLE identifies "false narratives" from both political sides. Conservatives, she argues, "vastly overrate the positives of tax cuts," believing they pay for themselves or force spending cuts ("starve the beast"), neither of which typically happens. Liberals, on the other hand, promote an "equity distribution narrative," claiming the middle class bears the tax burden while the wealthy and corporations pay nothing, and that deficits can be solved by taxing the rich more, similar to Europe. RLE asserts this narrative is "extraordinarily exaggerated," as the rich pay most taxes in the US, and the American tax system is the most progressive in the OECD, more so than Europe. She attributes these misperceptions largely to politicians who create narratives to justify policies their base desires, essentially promising "a free lunch" to voters. RLE then systematically debunks 10 common tax myths: 1. **Tax cuts pay for themselves:** They rarely do. 2. **Tax cuts starve the beast:** Historically, tax cuts lead to increased spending, while tax hikes lead to spending cuts. 3. **Middle class pays higher tax rates than the rich:** The top 1% pays 33% in federal taxes, the middle class 12%, and the bottom roughly zero. 4. **1950s 91% tax rates generated significant revenue:** Few actually paid this rate, and those brackets raised minimal revenue. 5. **Europe funds big governments by taxing the rich more:** Europe taxes the rich similarly to the US; its higher revenue comes from value-added taxes (national sales taxes) on the middle class. 6. **Tax cuts for the rich cause large deficits:** Since 2000, tax cuts account for 2% of GDP, with 0.6% on the rich, while spending increased by 6% of GDP. 7. **Taxing corporations and millionaires can eliminate the deficit:** Even seizing all their wealth wouldn't come close to balancing the budget. 8. **Most 2017 tax cuts went to corporations and the wealthy:** While they received larger dollar amounts, as a share of taxes paid, it was a proportional income tax cut for most. 9. **Returning to the 1980 tax code would painlessly reduce the deficit:** This would dramatically increase the tax burden on the middle class. 10. **America's corporate taxes are far below international standards:** Until 2017, the US had the highest corporate tax rate; even now, it's in the top 1/3, and total business taxes collected are slightly higher than other countries. RLE clarifies that while Warren Buffett's secretary might pay a higher *rate* than him due to capital gains taxation, overall, high earners pay significantly more. She criticized the Biden administration's calculation of rich people's tax rates as dishonest, as it included unrealized wealth and excluded corporate and estate taxes. She observes that many economists, once in positions of power, become "hacks," playing a "dirty game" of political expediency rather than maintaining intellectual integrity. The ultimate cost of widespread tax policy misunderstanding or manipulation is a "disaster of a tax code" that is complicated, inefficient, and fails to raise enough revenue. RLE estimates that since 2000, about one-third of the rise in deficits is attributable to tax policy and two-thirds to spending policy. While she advocates for tax code improvements like eliminating deductions and preferences, she believes that even an optimal tax policy would only raise revenues to about 17-20% of GDP, which is insufficient to address spending projected to reach 33% of GDP. The national debt, currently around $39 trillion (124% of GDP), is a significant concern. Interest payments alone have tripled since 2021 to nearly a trillion dollars, surpassing Medicaid, defense, and Medicare as the second-largest budget item. RLE identifies the federal government's inability to control spending as the main culprit. She notes that politicians, since 2000, have engaged in an "arms race" of promising big tax cuts and spending increases, believing they cannot win elections otherwise. She describes Washington as a "flock of tweens" with access to easy credit, acknowledging that lawmakers privately admit the irresponsibility but fear public backlash. To address the debt, RLE proposes entitlement reform, particularly for Social Security and Medicare, and raising taxes on the middle class. She highlights that Social Security and Medicare do not pay for themselves through taxes and face a $124 trillion cash deficit over 30 years. She suggests reforms like raising the retirement age, increasing taxes, and lowering benefits for high earners, advocating for means-testing for Social Security benefits. She believes that means-testing, while a "third rail" politically, is logical, as Social Security is meant to be a poverty prevention program, not a "universal huge get-rich benefit." She speculates that a bipartisan approach, with both parties making sacrifices, is the only viable path to reform, but fears partisanship would prevail if one side initiated such changes. RLE argues that it is "mathematically impossible" to balance the budget solely by taxing the rich. She asserts that the American middle class is "dramatically undertaxed" compared to other developed nations. According to IRS data, the median earning family pays a 3% income tax rate (12% including other federal taxes), which is less than half what it was 40 years ago and the lowest since before World War II. The bottom 40% collectively pay a negative income tax rate and almost no taxes overall. The US tax system has become substantially more progressive over time, with 90% of income taxes paid by the top 20% of earners. RLE favors consumption taxes over income taxes for their economic benefits, though she acknowledges the political challenges of implementation, especially concerning seniors and progressivity. She recognizes the behavioral economics problem of people prioritizing short-term gains over future consequences but finds inspiration in how young people have rallied around climate change, despite its distant effects. She hopes a similar long-term perspective can be applied to the national debt. In an email update from early 2025, RLE noted that the first year of the second Trump administration showed the difficulty of reining in deficits. A Republican Congress made the 2017 tax cuts permanent and added new ones, bringing the 10-year cost to $5 trillion. She observed a shift in Republican tax reform from "broaden the base and lower the rates" to "create new tax loopholes and lower the rates." On spending, she criticized the "Doge" initiative for ignoring major spending categories and focusing on "culture war totems," yielding no significant savings. With Trump opposing Social Security and Medicare savings while demanding defense spending increases, government spending is set to continue its ascent. RLE concludes that while the math of economics always wins, the current environment is dominated by partisan tribalism, making principled empirical research increasingly difficult.