Normative Narratives


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With Tax Reform, America Must Go “Back to the Future”

Tax reform is not “sexy”, there is no getting around this fact. It is, however, a very important issue, as every government program is funded either by tax dollars or debt. While the specifics of tax policy may be difficult to comprehend, almost everyone has their own beliefs on taxation and the role of government.

Looking at these preferences, the majority of Americans believe the government does not do enough to help poor and middle class people. Relatedly, a full three quarters of Americans feel that the wealthy aren’t paying their fair share of taxes.

Against this backdrop, lets consider Trump’s tax proposal:

  • Fewer tax brackets at lower rates for the wealthiest. The plan sets three tax brackets for individuals — 12 percent, 25 percent and 35 percent — down from the existing seven rates (which top out at 39.6 percent).
  • Lowering the corporate tax rate from 35 to 20%. While our corporate tax rate is too high, due to loopholes the actual rate paid is much lower (particularly for large corporations who can afford the best lobbyists, lawyers, and accountants). Based on actual taxes paid, the U.S. ranks comparatively low among developed countries. The corporate tax rate should only be lowered if the revenue lost if offset by closing the right loopholes. Trump has not specified which loopholes, if any, he plans to close.
  • Cutting the “pass-through” tax rate, which is what individuals who file their corporate earnings as personal income pay, from the current highest income tax rate of 39.6% to 25%. This rate cut would almost exclusively benefit the wealthy, and is one to watch closely-in recent years more and more businesses have begun filing as “pass-throughs” in order to minimize their tax bill.
  • Repeal of the alternative minimum tax, which is essentially in place to ensure wealthy people pay a certain minimum amount as they use their accountants to game the tax code. But it will make the tax code fit on a post card! And thats what matters!
  • A lowering an eventual repeal of the inheritance tax, which is only paid on the largest estates. This is being billed as a move to help family farmers, which is an audacious spin of the issue to be sure.
  • Trump’s plan has been light on details about capital gains taxes. However, there is nothing to suggest his financier-stacked Cabinet (Mnuchin, Cohn) will want to do anything but lower these rates as well.

All these proposed ideas would reduce taxes paid by the wealthy, compromising the government’s ability to further help poor and middle class people. So the question is, if these ideas are so unpopular, how is Trump selling them to the American public?

For some, it is enough to say that lower taxes will promote growth, increase employment, and pay for themselves. People who drink this “supply-side” Cool-Aid are outliers, and notably the vast majority of economists disagree with these claims. But remember, we are talking about many of the same people who disagree with 97% of climate scientists on climate change, so this is actually a consistent (if not irrational) repudiation of “experts”.

Most reasonable people, however, believe what the overwhelming majority of experts in a field conclude. For these people, support for Trump’s plan likely comes from being told they will receive a “massive” tax cut. But when you look at it, the “massive” cuts in Trump’s plan are reserved for those with the highest incomes.

Consider the distribution of income tax cuts, as shown on the table below. 77% of the cuts go to people earning more than $143,100 a year. That is hardly the “middle class”.

It’s more of the same when it comes to corporate tax cuts. According to the nonpartisan Tax Policy Center, “middle-income taxpayers would receive less than 10 percent of the benefit of a corporate rate cut while the top 20 percent would receive about 70 percent. The top 1 percent would see about one-third of the benefits and the top 0.1 percent would get about one-fifth.

Trump’s plan would increase our national debt by well over a trillion dollars. The IMF has warned the plan will increase inequality and will not lead to higher growth. Wall Street is betting it will lead to greater investments in automation, not workers. The Fed has even waded into the debate to issue a rare warning, saying the proposed plan could lead to high inflation.

For all these negatives, middle class earners will only get a small tax cut, if that. Treasury Secretary Mnuchin admitted some middle class earners may not get any cut at all. This is coming from the man who also said it is “hard to create a system where you’re not going to also cut taxes on the top 10 percent“. Maybe if you are a derisive elitist with zero consideration for societal well-being, who has no business governing, it is difficult to imagine not cutting taxes for the wealthy. For most people, it is extremely easy to imagine.

So Trump’s plan is unpopular, and those who support it are either irrational, have been misled, or are wealthy and likely to benefit personally. Just like with healthcare, the GOP has no tax reform plan that works for the vast majority of Americans; hopefully its tax reform efforts will meet a similar defeat.

The Case for Higher Top Rates

Remember, Trump’s plan sets three tax brackets for individuals, down from the existing seven. While the U.S. tax code has become overly complicated due to deductions and loopholes, the complicating factor is not the number of income tax brackets. Like any misdiagnosis, reducing the number of tax brackets would not solve any problems, and would likely make the situation worse.

Republicans in Congress plan on including a fourth higher bracket in their proposal, but this is not enough. There should be even higher brackets and rates for people with 7 and 8 digit incomes.

After a certain point, the higher your income, the less it is connected to working harder, and the more it is related to the risks one takes and the carefully constructed, trade-based global economy in which we operate (infrastructure, government R&D, international peace and trade rules, strong judicial systems, educated workforces, relatively prosperous customer bases, etc.). Notably these characteristics are all, to varying degrees, financed by tax revenue. 

I can already hear people moaning at this point and calling me a socialist, so allow me to clarify with an example. Take someone who manufactures clothing. Decades ago, the owner of this company would more or less be constrained to selling his or her goods domestically. Despite working very hard, their overall earnings were capped (at least by today’s standards). Today, the same person, putting in the same amount of work, can sell their goods all over the world through the internet, earning a lot more money. The work these two owners from different eras put in is roughly equivalent, but the modern day entrepreneur can potentially earn a lot more. In fact, this is half of the story of increasing extreme global inequality.

What about my other point, about these systems being financed to varying degrees by tax revenue? Well this is certainly true of the internet (whose origins were in defense research). It is also true of all of the spending that promotes international peace and fair trade practices (defense spending, development aid, contributions to international organizations like the WTO, etc.).

While the risks people take should be rewarded, the context in which wealth is earned should not be ignored. This is not to say “you didn’t build it” or “you didn’t work hard”, it is simply acknowledging that outside factors play a role in how much wealth one can amass. Ignoring this reality does not make it go away, but it does risk underinvesting in making sure it continues into the future.

A Quick Lesson on Marginal Tax Rates

I think that much of the opposition to higher tax brackets comes from misunderstanding how marginal tax rates work. When you enter a higher bracket, only the amount you earn over the higher threshold gets taxed at the higher rate.

Lets take a look at a hypothetical numerical example. If the rate below $100,000 is 20%, and the rate above is 30%, when a person earns their 100,001st dollar, only the amount over the threshold–the one dollar–is taxed at the higher 30% rate. The rest, the first $100,000, is still taxed at the lower 20% rate. People do not become poorer by moving into a higher tax bracket.

In recent history, before the Reagan era tax cuts, top income tax rates were around 50%. This seems like a reasonable number if not for its roundness and inherent fairness, but the exact optimal number of brackets and rates is not what’s most important. More important is recognition by people across the political spectrum that the wealthy must pay their fare share of taxes. Based on the survey results cited earlier, most people already do share this belief–it is well past time their elected representatives acted on it.

The tax code should be used neither to venerate the wealthy as infallible job creators, nor to vilify wealth so much as to stifle innovation. Simply put, the tax code must allow us to adequately invest in the very systems which enabled America to become the wealthiest nation in the world in the first place. Anything else is a short-sighted failure of governance.

“Back to the Future” (With Some Help From Our Friends)

Trump’s base often talks about “Making America Great Again”. To a small minority, this is a thinly veiled embrace of our country’s racially charged past. To others, I’d like to think most people, making America “great” is about (re)creating an economy that rewards anyone who is willing to work hard.

So how can we make sure that, as a country, we can afford to make the investments needed to get back to this “Golden Age”? Not surprisingly, some of the answers lie in the past; America has historically had both more income tax brackets, and higher tax rates for top earners. These were the good old days many low-tax advocates are pining for!

There is nothing uniquely American about these higher historic rates either. According to the Organisation for Economic Co-operation and Development (OECD)top personal income tax rates in rich nations had fallen to 35 percent in 2015 from an average of 62 percent in 1981.To put a bow on an earlier point, this is the other half of the story of increasing extreme global inequality.

Now admittedly some things have changed in the past few decades. The rise of information technologies has led to irreversible changes in financial markets. When people can move their money around the world instantly with the click of a mouse, it is important to have some level tax coordination between countries in order to fight tax evasion (in its many forms). In today’s globalized world, countries and international institutions such as the OECD must work together to ensure the ultra-wealthy are not getting a free ride.

If America wants to be able to adequately invest in the very systems that made and continue to make it great, and if we want to be able to give working class people a tax cut without greatly increasing our national debt, we must hold the wealthiest Americans economically accountable.

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