Individuals Pay Very Little Individual Income Tax on Capital Income

This column first appeared on TaxVox.

Most capital income earned never is taxed at the individual level, in part because assets are often not sold and their gains never subject to income tax, in part because capital income benefits from a long list of tax preferences, and in part because of outright evasion.

In a recently-published study, Jenny Bourne, Brian Raub, Joseph Newcomb, Ellen Steele, and I used estate tax data linked to individual income tax return data. In the study, we found that most wealthy individuals report an effective taxable return on their wealth of less than 2 percent on their individual income tax returns, with the richest filers reporting the lowest returns. That is, for each $1 million of wealth, the annual amount of taxable dividends, interest, capital gains, and other returns is less than $20,000. Among those with more than $100 million in net worth in 2007, close to 40 percent reported annual taxable returns of less than 1 percent of their wealth. More than two-thirds reported taxable returns of less than 2 percent.

These results are similar to what I found in a study covering the more inflationary 1970s. In yet another study, I found that a select group of owners of businesses and farms subject to estate tax reported even lower taxable returns. And in a book published in the early 1980s, I showed how net income from capital reported on all individual tax returns was less than one-third of total capital income in the economy.

Keep in mind, regardless of what they report on tax returns, top wealthholders often achieve very high actual returns on their assets. The merely wealthy commonly earn stock market returns of 7 to 10 percent per year, while truly rich investors often attained that status by earning even more. Warren Buffett revealed in one income tax return that he recognized only about 1/50th of 1 percent of his wealth as taxable income even though his primary asset, Berkshire-Hathaway stock, had been earning about 10 percent annually.

How do those with capital income achieve such low taxable earnings?

  • Capital gains are not taxed until the assets are sold and the gains realized, providing an incentive to hold onto assets as they appreciate. As long as they are unsold, there is no taxable income to report.
  • They take advantage of tax preferences. Real estate investors, for example, can defer taxable gains by swapping one piece of property for another through a “like-kind” exchange. The preferential tax rate on long-term capital gains acts as an effective reduction in taxable income, as it has been in most years when the preference was provided as an exclusion.
  • Asset holders may avoid capital gains taxes by arbitraging tax laws. For example, they may offset gains with losses. Or they may establish tax shelters that produce current deductions in exchange for lightly taxed or untaxed capital gains.
  • The returns from homeownership—the rent saving that comes from equity ownership—are not taxed.
  • Retirement saving is heavily favored by the tax system, meaning that asset appreciation and capital income may not be taxed as they occur.

Homeownership and retirement saving provide the primary opportunities for middle-income and moderately-wealthy households to avoid or defer tax on capital income. As a result, they, too, pay limited tax on their returns from capital.

But for very wealthy individuals, the most common tax-avoidance strategy is simply to not sell assets at all and never realize the taxable gains. For example, a shareholder in a publicly traded company may accrue capital gains over time that remain untaxed until she sells her shares. If she holds the asset until death, those accrued but unrealized capital gains are excluded altogether from tax. The assets passed along as a bequest will have basis equal to the value at the date of former asset holder’s death.

Because so little capital income is taxed through the federal individual income tax, corporate and estate taxes have been important tools for taxing those with significant wealth. However, Congress has cut both those taxes over recent decades, most recently in the 2017 Tax Cuts and Jobs Act. Those reductions may have a far larger impact on the effective tax rate on capital income than changes in the statutory individual income tax rate since that levy only applies to income that is realized.

Unfortunately, the fight over capital income taxation usually focuses on how much is collected rather than on the most equitable or efficient way to tax it. Advocates on each side often will accept capital tax increases or decreases any way they can get them. Nor do the debates result in consistent treatment of people at different levels of wealth.

The Trump Administration reportedly is considering reducing taxes on capital income by indexing capital gains taxation for inflation. But at this point, the better question may be how best to distribute the taxes borne by capital owners, not simply how to tax some of them less.


Indexing Capital Gains For Inflation Addresses A Real Problem But Ignores Existing Law

This column first appeared on TaxVox.

The idea of indexing capital gains for inflation is getting a lot of attention these days. Larry Kudlow, who heads  the White House National Economic Council, has long suggested  Treasury should do this by regulation, while several members of Congress have introduced bills to make the change by modifying the tax code. Exempting purely inflationary gains from tax can be a good idea in principle, but easily flawed in practice. To understand the consequences of such a shift, it is helpful to think about it in terms of a revenue-neutral tax change, not merely another budget-busting tax cut.

In a revenue-neutral context, indexing the basis of assets in computing capital gains could create significant winners and losers among investors. Ordinary shareholders could come out ahead, while private equity firms could be big losers. The effects would largely be dependent on rates of inflation and market returns.

First, though, some background: The argument for indexing rests on the principle that the income tax is meant to tax real, not nominal, income. If my investment returns 8 percent and inflation is 8 percent, then my real income gains are zero. Why should I pay tax on zero income?

To make matters worse, if we taxed all returns to saving with no offset for inflation, we could enormously overtax nominal returns to capital. If returns averaged 8 percent and but inflation was 4 percent, subjecting the full 8 percent nominal return to tax would essentially double the statutory tax rate on capital income.

In the 1984 Treasury study that led to the Tax Reform Act of 1986, these considerations led us to propose indexing the basis of assets that generate capital gains for inflation. But we attempted to apply the principle consistently. We would have indexed capital gains but also indexed other elements related to investment returns. We would have indexed depreciation allowances for inflation but also would have repealed the investment tax credit and set depreciation allowances to approximate economic depreciation.   We also would have indexed interest receipts and interest payments for inflation.

Building on the old Treasury plan, imagine Congress indexes the taxation of capital income in a way that would neither gain nor lose revenues over time.  Such a change would have many effects on the taxation of investment, but here are two significant ones:

First, such a reform could redistribute the tax break to investors who tended to get lower returns over time from those who through luck or skill were big winners.  Consider a reform proposal that substitutes indexing of capital assets for the preferential tax rate on long-term capital gains.  The following table shows how this might work for a specific example.

For example, suppose you and I invested $100 ten years ago. Inflation was 2 percent annually over the period, and assume that we’re both in a 35 percent income tax bracket with a current maximum tax rate on long-term capital gains of 20 percent.  Suppose that I earned a 3 percent nominal annual return per year and you made 10 percent. With indexing, we’d both reduce our gains by $22 (the amount of inflationary gain on the $100 investment). That would leave me with taxable income of about $12 out of my $34 profit. But you’d have taxable income of $137 out of your $159 gain (10 percent compounded over 10 years).  With indexing and no preferential tax rate on capital gains income, we’d both pay the 35 percent rate but only on the real income amounts.  Under current law, we’d each pay the 20 percent tax rate on our nominal capital gains ($6.80 tax for me and $31.80 tax for you).  This translates in an effective tax rate on my real income of 55 percent and  23 percent for you.  So, this proposal would treat all inflation adjusted returns the same, compared to current law, which favors investors with large inflation-adjusted gains.

Second, in a period of high inflation and moderate appreciation of assets, indexing gains for inflation while ending other preferential tax treatment for capital income might lower the amount of such income subject to tax. To illustrate this point, note that if inflation were 8 percent per year and the value of an asset increased at 8 percent per year, there would be no tax due under an inflation-indexing regime, but a positive tax liability under current law (even with the preferential tax rate on long-term gains).  In contrast, in a period of low inflation and unusually high appreciation of asset values, such as in recent years, the indexing proposal likely would increase effective tax rates.

To see whether advocates really believe in the principle of excluding inflation from taxable gains, ask them if they would be willing to accept those consequences.  In effect, would private equity and hedge fund managers be willing to transfer some of their existing tax breaks to help average investors?

I could make a solid case that such an exchange would be fairer and more efficient since it would provide less reward for get-rich-quick efforts and shift business incentives toward long-run success over short-run profits. This is a concept President Trump endorsed just last week.

But if one wants to lower the taxes on return to saving, would adding indexing of capital gains to existing tax breaks be the best way to do it? Would it be superior, for instance, to a corporate income tax rate cut or a simple tax break for the investors living off their bonds?

Simply adding another capital gains tax cut would create new incentives to game the tax system. For example, if I can borrow at 5 percent and invest the money in an asset increasing in value by 5 percent per year, I have done no real saving and earned no real income. Yet, under current law, I can deduct the full 5 percent in interest costs in computing taxable income while paying tax at a reduced rate on my future realized capital gains. Exempting the effects of inflation only from capital gains that are subject to a preferential tax rate, but not adjusting interest deductions also, would increase the incentive to engage in these types of arbitrage games.

Taxing inflation is a problem that tax reformers might want to address. But offering revenue neutral options provides a litmus test for whether that is really the problem advocates for capital gains indexing want to address.


Beyond Wayfair, Can Nations and States Cooperate in Collecting Taxes?

This column first appeared on TaxVox.

The brilliant Tax Notes columnist Marty Sullivan once summarized one of the great dilemmas in taxation: “It’s simply impossible to put a precise geographical subscript around ‘where’ taxes should be collected.” He mainly had in mind locating the source of capital income, but geography again reared its head recently when the Supreme Court’s South Dakota v. Wayfair, Inc. decision tackled the question of when states can require online retailers to collect sales taxes.

In both cases, it is difficult, if not impossible, for taxing jurisdictions to resolve these issues on their own. But they create important opportunities for these authorities to work together to develop solutions that are fair to taxpayers while assuring that government collects tax that is legitimately owed.

The issues are not easy to resolve. Countries struggle to sort out where a firm’s income is earned when its headquarters, production, marketing, research, and patents can be located anywhere in the world, when its sales routinely cross borders, and when some goods and services can be transferred or sold multiple times as intermediate products along the way toward a final sale.

This environment even affects charities, many of which routinely violate state and national laws simply by maintaining websites that can receive donations from anywhere but have not registered in every jurisdiction that might require it.

The Supreme Court’s Wayfair decision added to these boundary disputes. The Court ruled that states can obligate an on-line retailer to collect and remit sales taxes even if that firm’s website and physical facilities (such as manufacturing and headquarters sites) reside outside their jurisdiction.

Senator Heidi Heitkamp (D-ND) at a recent Tax Policy Center (TPC) event, as well as my colleague, Howard Gleckman, have noted how, for decades, Congress has failed to enact federal legislation to smooth out the administrative nightmares that online and catalog sales can create. But neither have the 50 states been able to agree on a coherent collections model.

However, there are examples of progress both internationally and among the US states.

My TPC colleagues Richard Auxier and Kim Rueben have detailed the various state efforts to use a streamlined sales tax agreement to address common measurement and registration issues caused by the evolution of on-line sales taxes.

Internationally, the OECD and G20 Base Erosion and Profit Shifting (BEPS) project laid out fifteen actions that nations can employ to increase transparency and adopt common standards for treating issues such as interest income, transfer pricing, and controlled foreign corporations.

So far, most of these multilateral efforts have been voluntary. Governments could be more aggressive in developing common practices if legislation or treaties made them mandatory. That big step is often opposed by those who benefit from the status quo, either through existing legislative favoritism or their ability to evade/avoid the laws. Yet pressure to resolve these issues continues to grow.

For example, the federal government could pre-empt some state actions by adopting a nationwide retail tax that it shares with the states according to a fixed formula. For many years, the federal government granted a credit against federal estate tax of up to 100 percent for payments of a state estate tax that included certain features. That gave states a significant incentive to adopt a common estate tax base since failing to do so effectively meant turning revenue over to the federal government.

Similarly, the European Union aims for a standardized tax base for the value-added tax, though its member countries may still set their own rates and are allowed some flexibility in defining their tax base.

In the face of growing complexity, even businesses are embracing common standards, at least up to a point. For instance, brick-and mortar retail firms have complained about their competitive disadvantage when on-line sellers do not collect tax for selling the same goods and services. In a sense, these firms are arguing for a common tax base to apply to both physical and on-line or mail-order sales.

Many firms’ finance and accounting officers complain about having to comply with a wide range of rules for defining income or sales tax bases among multiple jurisdictions. A multinational firm, for instance, may have to file income, sales, and value-added tax reports in thousands of jurisdictions. Even without foreign sales, a US firm may file hundreds of tax returns in the 50 states and numerous cities and counties. To address these concerns, third-party providers and software firms have jumped into this market by selling products to ease the burden on taxpayers and governments alike.

The evolution of the modern economy is only increasing pressure on taxing jurisdictions to cooperate and for federal systems to adopt laws or treaties that encourage or even require such cooperation among sub-national governments. Such efforts extend to registration, filing requirements, reporting, transparency, and definition of tax bases, and, sometimes, minimum tax rates.

These efforts always will be incomplete and ongoing, given legitimate pressures for tax competition and jurisdictional independence. But South Dakota v Wayfair, Inc. is an important step along this meandering path toward sometimes-workable conformity.


Why Government Budget Estimates Are Often Wrong

This column first appeared on TaxVox.

Government budget and tax analysts who estimate future federal revenues and spending are among the most talented people I know. They probably are a lot more accurate at what they do than typical academics or business consultants. However, their estimates frequently understate the true long-term costs of tax cuts or spending.

When estimators miss on the low side, it is often because they are trying to project costs of those government programs and tax subsidies that are both permanent or “mandated,” absent new legislation, and essentially open-ended.

Unlike programs where the government appropriates a fixed amount of money each year, the costs of mandated programs don’t need to be appropriated to be spent. Meanwhile, open-ended programs leave important determinants of cost, such as demand or price or definitions about who or what qualifies for the program, to decisions made by beneficiaries or service providers. When the two elements are combined, Congress effectively cedes long-term control of the costs to private individuals acting in their own, not necessarily the public’s, interest.

Estimation is simpler for mandatory programs or permanent tax benefits that are not open-ended. For example, estimators know that the cost of the child tax credit will equal the amount of the credit times the number of eligible children. Similarly, Social Security retirement benefits might grow rapidly but can be estimated with fair accuracy because they are set by formulas based on lifetime earnings that provide only limited discretion to recipients.

That is not so for Medicare, where beneficiaries and providers have often been allowed to appropriate resources to themselves. Consumers demand more access to healthcare treatment even as providers—who mostly are compensated based on volume—happily increase the supply of those treatments. Because there is little effective market discipline, health care provided by government creates a perfect fiscal storm. For example, suppose a drug company markets a new drug under government patent protection; it then sets a price; consumers demand the drug to address the ailment it treats; and—often—Medicare pays.

A similar phenomenon occurs with the open-ended tax subsidy for capital income, which is taxed at lower rates than ordinary income. Since ordinary income is taxed at a top rate of 37 percent while long-term capital gains are taxed at a top rate of 23.8 percent, taxpayers have an enormous incentive to recharacterize their income to benefit from the lower rate. The classic recent example: Hedge funds that have converted a share of their managers’ labor compensation income into lower-taxed long term capital gains income (carried interest).

Over the years, Congress and the IRS have played a game of whack-a-shelter with respect to preferential tax rates for capital income. Smart lawyers find a new way to turn ordinary income into lower-taxed capital gains, government (through either legislation or regulation) shuts it down, and then taxpayers and their advisors find another approach. That process makes it impossible to estimate government revenues for the long-run since estimators are supposed to assume the permanence of what is an inherently unstable law.

Forecasting capital gains revenue is even more difficult because investors can choose when to realize gains and, thus, pay the tax. As a result, gains can be earned over decades but are not taxed (and this generate no revenue) unless “realized” through an asset sale.

In a classic article, Nobel prize winning economist Joseph Stiglitz explained how individuals could take advantage of these arbitrage opportunities to reduce the taxes they pay. Given their voluntary nature, a large share of gains is never taxed because they are held until death—when their assumed cost in the hands of the heir is “stepped-up” to the market price at the time the person making the bequest passes away.

The newest example of an open-ended tax shelter is the Tax Cuts and Jobs Act’s 20 percent individual income tax deduction for income from pass-through businesses such as partnerships and sole proprietorships. It blows a hole in the government fisc so large than a Mack truck could be driven through it—as long as the operator is a sole proprietor. Congress attempted to limit the benefit to some types of earners and some types of businesses, but tax lawyers are busily finding ways to convert excluded businesses into qualified ones, and wage earners into independent business owners.

The structure of these types of laws makes estimating difficult enough. But two other factors make forecasting even more challenging.

The first is that the compounding of cost growth may take place years in the future and congressional scorekeeping conventions generally limit projections to the first 10 years, the so-called “budget window.”  Underestimating a growth rate by a couple percent per year, for instance, compounds to a very large number over time.

The second is that estimators may be reluctant to project very large costs in the absence of empirical evidence. For example, the 20 percent tax deduction for pass-through income is new, and there is little information upon which to predict the magnitude of gaming that will occur. The revenue estimator doubtlessly will assume some gaming, but may not be imaginative and daring enough to forecast without much data a large multiplier for what lawyers or providers, in absence of further whack-a-shelter legislation, will invent for their clients.

Much is wrong with a system that allows enactment of open-ended mandatory spending programs and tax preferences. Until we repair that system, it is worth remembering there is a built-in bias towards underestimating their long-term costs.


Measuring the “Charitability” of Hospitals: Putting Meat on the Bones of the Grassley-Hatch Request

On February 15, 2018, Senators Chuck Grassley (R-Iowa) and Orrin Hatch (R-Utah) requested specific information from the Internal Revenue Service (IRS) on its oversight activities of nonprofit hospitals. Skeptical about whether some or many nonprofit hospitals actually operate as charities, they sought evidence that they provide “community benefits.”

To provide evidence well beyond what the IRS considers, I suggest that they and the hospitals themselves adopt a tool I developed to help assess whether a charity fully utilizes the charitable resources available to it. It turns out that a hospital can qualify for tax exemption and provide community benefits while operating more as a partnership serving its doctors, staff, and managers than as a charity. The main value of this tool, however, is not for a top-down assessment by an understaffed IRS wading through a measurement swamp, but for self-assessment of charitable operations by truly mission-driven hospitals.

This measurement tool is simply a variation on the accountant’s most powerful tools: the income statement and the balance sheet. Using this tool goes beyond the traditional balancing of cash flows in and cash flows out, or of assets with liabilities, to what I call the uses and sources of those “resources” gathered to pursue the charitable activities of the hospital. Of course, it can be used by almost all charities, not just hospitals.

READ MORE AT TAXPOLICYCENTER.ORG


How Recent Tax Reform Sounds a Clarion Call for Real Reform of Homeownership Policy

This column first appeared on TaxVox.

By roughly doubling the standard deduction and limiting the deduction from federal taxable income of state and local taxes (SALT), the Tax Cut and Jobs Act of 2017 (TCJA) significantly reduced the tax benefits of homeownership, especially for middle-income households. Not only does it cap the deductibility of state and local taxes, including local property taxes, it also substantially reduces the number of taxpayers who will itemize deductions at all, including those who pay mortgage interest.

As a result, it raises important questions about the future viability of tax subsidies that primarily benefit higher-income taxpayers who own expensive, highly-leveraged homes. These changes made homeownership tax subsidies even more upside-down than pre-TCJA tax law and provide a tax incentive to further concentrate the distribution of private wealth.

The Congressional Joint Committee on Taxation (JCT) recently released projections on the future distribution of some of the tax benefits of homeownership. Out of 77 million projected homeowners in 2024, only about one-fifth will make $50,000 or less. Yet, they’ll comprise about half of all households, homeowners and nonhomeowners alike. These taxpayers with annual incomes under $50,000 will get only about 1 percent (or less than $400 million out of $40 billion) of the overall tax subsidy for home mortgage interest deductions. Meanwhile, households with more than $100,000 of income will garner almost 90 percent of the subsidy.

These estimates for the mortgage interest deductions understate the total value of tax benefits from homeownership. Property tax deductions are also skewed to the rich and the upper-middle class. At the same time, it is more beneficial to build up home equity largely tax-free than to pay income tax on the returns from money kept in a savings account. This additional incentive also benefits the haves more than the have-nots because it is proportional to the amount of equity a homeowner possesses. So those with a large amount of home equity are far better off than new, usually younger, homeowners who rely heavily on borrowing to purchase a home.

There is something of a paradox to the new tax law, however. The increase in the standard deduction, and the caps on deductions for home mortgage interest and state and local tax payments are all steps that make the overall tax system more progressive. And the reduction in tax incentives probably put a small brake on inflation in the value of housing, making it a bit more affordable for both renters and homeowners.

Still, as a matter of homeownership policy, the result is that only a little over one tenth of taxpayers—those who will still itemize after the TCJA—will have the opportunity to benefit from most tax subsidies for homeownership. And that will require advocates for extending ownership incentives to more low- and middle-income groups to make the case not simply for better distributing existing tax subsidies but for maintaining any at all. As the increase in the standard deduction shows, there are a lot of ways of promoting progressivity that do not entail subsidizing homeownership.

The case for homeownership subsidies in the tax code and elsewhere rests mainly on the following two grounds: (1) homeownership is a way of promoting better citizenship and more stable communities; and (2) homeownership helps improve wealth accumulation by nudging many who might not otherwise save to do so by paying off mortgages and making capital improvements on their houses.

The saving argument is one that does apply mainly to low- and moderate income households. Homeownership is the primary source of saving for these households, even more important than private retirement saving. If one cares about the uneven distribution of wealth, and related issues of financing retirement for moderate-income households, then encouraging wealth accumulation through housing may be an appealing strategy.

The bottom line: When it comes to homeownership, the TCJA has left the nation with an upside-down tax incentive that applies to only about one-tenth of all households—nearly all of them with high incomes.

Such a design doesn’t pass the laugh test for political sustainability. The new tax law’s crazy remnant of a homeownership tax subsidy should encourage policymakers to rethink housing policy, including tax benefits and direct spending programs for both renters and owners. Given the structure of the TCJA’s tax subsidies, the bar is relatively low for policymakers to find an improvement.


Donald Lubick: Public Servant

This column first appeared on TaxVox.

The Tax Policy Center is hosting its third annual Symposium in honor of Donald C. Lubick on Monday, April 9 at the Brookings Insitution. Given the chaos that defines tax policy these days, it seems like a good time to explain why we both honor Don and desperately need more leaders like him.

Don served presidents Kennedy, Johnson, Carter, and Clinton, and served on President-elect Obama’s transition team in 2008. That’s public service over more than four decades. He also worked to improve tax policy from Buffalo, NY to Eastern Europe.

A protégé of the legendary Stanley Surrey, Don is guided by basic principles of tax policy: efficiency, simplicity, and the concept of horizontal equity–idea that that equals should be treated equally under the law.

Even though he started out as a Republican, he also believed in progressivity. Yes, Don was once a Republican. His great friend Stu Eizenstat told me that the Kennedy Administration almost didn’t hire Don. The White House asked Stan Surrey why it should give an important tax policy job to a registered Republican. The answer, of course, was that Don was talented about tax policy and that he would serve Democratic Administrations as well as any other.

The principles that are so important to Don do not always lead to exact conclusions about what policy is best, but they create important boundaries that frame policymaking.

As one of Don’s students at Treasury, I learned that while politics requires compromises, the first draft of policy should hew to those principled boundaries.

Don surely didn’t win every battle. He failed to convince President Carter to veto the 1978 tax cut that included almost no reform. And Stu recounts that the only time Don ever read congressional testimony verbatim was when he was asked to defend some energy tax credits.

When I first worked with Don, Treasury’s Office of Tax Policy played a much larger role formulating policy for both the President and Congress than it does today. Few outside the office can fully know how they benefit from Don’s work building upon the culture, ethic, and practice of that vital office.

Unfortunately, as the legislative branch reasserted control over each stage of tax policy formulation, and the White House asserted ever more control over the Treasury, decisions became more politicized much earlier in the process, losing focus on those policy foundations that are so important to Don. As we saw last year, Congress has yet to figure out how write that all-important first draft in a way that will sustain a principled basis as that tax legislation moves toward enactment.

Reflecting on that trend, Don famously quips that each of his tours at Treasury was better than the next. He repeatedly answered the call to public service, at significant financial cost. And while in private practice, he forswore the allure of the giant law firm, choosing instead firms where teamwork was more valued. He leads through vision, creates an esprit de corps among those staff with whom he works, makes debates over tax policy exciting, and easily shares credit.

All of us at TPC are pleased to honor a person of such character, whose legacy will long influence how good tax policy is made and help us recognize when it is not.


Pete Peterson and Our Chaotic National Debates

This column originally appeared on TaxVox.

Each person’s death gives us a moment to pause and ask what lessons their lives offer for us. Here is a lesson from the life of Peter G. (Pete) Peterson, who died on March 20, 2018 at the age of 91: We could reduce our current political chaos by shifting more political resources toward efforts to find sensible, consensus solutions to policy challenges.

Pete Peterson played large on the national stage, in business, politics, and policy. In recent years, he focused much of his energy—and his money—on the Peter G. Peterson Foundation.

Pete’s particular concern was government budgets, which is the focus of his foundation. His long-standing push for fiscal prudence has been attacked by some on both left and right, but his concerns rested on two apolitical truths: Debt cannot keep rising faster than income, and the consequences of fiscal policy go beyond budget deficits to affect issues such as how we invest in our children. He sometimes called himself the last of the Rockefeller Republicans, taking on Democrats and Republicans alike.

I worked with Pete as Vice-President of his foundation. The Urban Institute and the Tax Policy Center, where I currently work, receive research grants from his foundation. So, I am not a disinterested party when it comes to either Pete or budget policy. But Pete’s life was an example of how to engage in national debates.

Today, these debates are often dominated by partisanship and what we might call “self-interest” groups. This aspect of politics—and political money– won’t go away, but it’s way out of proportion to how we should be spending our precious resources in engaging policy issues.

Unfortunately, instead of seeking devoting a fair share of resources toward creating a rational common ground, we get sucked into supporting an escalating arms race aimed at opposing those idiots on the other side.

The large national organizations that pursue their own particular agendas–whether the NRA, AARP, Chamber of Commerce, or AFL-CIO–may represent legitimate issues. But by scaring us into believing they are preserving our very lives and liberty, and that we should be offended at any reform that asks us to give up anything, they distort reality, raise more money, and attain even more influence and power.

It is the same with electoral politics. Noncompetitive legislative districts have long elected representatives who serve the median voter in their own party, but not the district as a whole. Interest groups have long figured out how to exploit that system to further divide and conquer.

The media feeds on and amplifies the frenzy. It seeks controversy, which is not the same as seeking truth. Like moths led to a flame, our media has become easily manipulated by those who recognize that controversy creates attention; attention produces fame; and fame enhances power.

So, what does Pete have to do with all of this?  None of what I have noted about the use of power is new, but the way to prevent self-interest groups from dividing us for their own objectives is simple: unite. Stop being so outspent by those groups. Instead of lavishing donations on the arms race of such interest groups and the two major political parties, do what Pete did and focus resources on efforts to create that elusive common ground for rationale dialogue.

Pete had nothing against groups with very specific policy agendas. After all, he funded several. But those groups do not focus on convincing policymakers to shift resources from other special interests for their own benefit. Rather, they argue for budget and trade policy that they believe enhance the greater good. You don’t have to agree with Pete’s priorities to recognize that he was not attempting to promote any political party’s agenda, but to support those who could compromise civilly on common objectives. It is a lesson worth remembering.