How Unfair Are Taxes?

Today is tax day. I got mine in on time. Most Americans-- barely most Americans (55%)-- think they pay a fair amount of taxes. That's a decrease from around 60% in recent years. Democrats, independents, liberals and moderates all tend to feel the system is fair. Needless to say, Republicans and conservatives feel they pay too much. An OpEd by James Livingston in Sunday's NY Times made a good suggestion that would make most people feel much better about paying their income taxes: "why not tax corporations as if they were natural persons, in accordance with their newly discovered rights of free speech?"

Indeed, we used to do just that. For most of the 1950s, corporate income at large companies was taxed at 52 percent, according to the nonpartisan Tax Policy Center. The federal government, meanwhile, collected about a third of its revenues from this source. Today, thanks largely to the “reforms” ushered in by President Ronald Reagan, the ostensible tax rate on corporate income is no higher than 35 percent-- and the corporate-tax share of federal revenue has fallen to about 9 percent.

...By slashing corporate income taxes and forcing a new reliance on payroll taxes to finance government spending, we have redistributed income to the already wealthy and powerful. Our tax system has actually fostered inequality.

The fiscal problem we face is not, then, a lack of revenue sources. We can finance any amount of transfer payments and “entitlements” by taxing corporations’ profits in the same way we tax personal income, using a progressive formula. If necessary, give them a mortgage deduction-- they already get something like it in the form of accelerated depreciation allowances on their purchases of capital equipment-- but make them pay higher taxes on their income. Do that, and the federal deficit goes away.

The now-familiar objection to a tax increase on corporate profits is that it will discourage private investment and thus dampen job creation. The retort is just as obvious: since when have tax cuts on corporate profits led to increased investment, faster job creation and higher per capita consumption out of rising real wages? It didn’t happen after the Reagan Revolution, it didn’t happen during the Clinton boom of the 1990s, and it sure didn’t happen under George W. Bush.

Nor is it happening now, as corporate profits soar and full-time job creation languishes. American corporations are now sitting on $4.75 trillion in cash, according to the Federal Reserve Bank of St. Louis.

The other well-worn objection to an increase of corporate income taxes is that it would encourage companies to invest and hire overseas, where tax rates are presumably lower. Here, too, the retort is obvious: the tax code already works exactly this way by postponing taxes until profits from investment overseas are repatriated. American companies routinely avoid taxation by moving their idle cash offshore.

In view of these facts, there’s no downside to replacing payroll taxes with increased taxes on corporate profits, wherever they’re made or held. By doing so, we make the tax code more progressive, and mobilize capital that is otherwise inert. In other words, we can lay solid foundations for economic growth simply by going back to the tax principles we used to have. What could be more conservative than that?

Nobel-winning economist Joseph Stigliz isn't a Republican or a conservative, but he also feels the tax system is unfair-- stacked against the working class and the middle class. He reminds us that Oliver Wendell Holmes said that taxes are the price we pay for civilized society. "But in recent decades," writes Stiglitz, "the burden for paying that price has been distributed in increasingly unfair ways... [P]ut simply, the very rich don’t pay their fair share."

The richest 400 individual taxpayers, with an average income of more than $200 million, pay less than 20 percent of their income in taxes-- far lower than mere millionaires, who pay about 25 percent of their income in taxes, and about the same as those earning a mere $200,000 to $500,000. And in 2009, 116 of the top 400 earners-- almost a third-- paid less than 15 percent of their income in taxes.

...What should shock and outrage us is that as the top 1 percent has grown extremely rich, the effective tax rates they pay have markedly decreased. Our tax system is much less progressive than it was for much of the 20th century. The top marginal income tax rate peaked at 94 percent during World War II and remained at 70 percent through the 1960s and 1970s; it is now 39.6 percent. Tax fairness has gotten much worse in the 30 years since the Reagan “revolution” of the 1980s.

...With such low effective tax rates — and, importantly, the low tax rate of 20 percent on income from capital gains-- it’s not a huge surprise that the share of income going to the top 1 percent has doubled since 1979, and that the share going to the top 0.1 percent has almost tripled, according to the economists Thomas Piketty and Emmanuel Saez. Recall that the wealthiest 1 percent of Americans own about 40 percent of the nation’s wealth, and the picture becomes even more disturbing.

If these numbers still don’t impress you as being unfair, consider them in comparison with other wealthy countries.

The United States stands out among the countries of the Organization for Economic Cooperation and Development, the world’s club of rich nations, for its low top marginal income tax rate. These low rates are not essential for growth-- consider Germany, for instance, which has managed to maintain its status as a center of advanced manufacturing, even though its top income-tax rate exceeds America’s by a considerable margin. And in general, our top tax rate kicks in at much higher incomes. Denmark, for example, has a top tax rate of more than 60 percent, but that applies to anyone making more than $54,900. The top rate in the United States, 39.6 percent, doesn’t kick in until individual income reaches $400,000 (or $450,000 for a couple). Only three O.E.C.D. countries-- South Korea, Canada and Spain-- have higher thresholds.

Most of the Western world has experienced an increase in inequality in recent decades, though not as much as the United States has. But among most economists there is a general understanding that a country with excessive inequality can’t function well; many countries have used their tax codes to help “correct” the market’s distribution of wealth and income. The United States hasn’t-- or at least not very much. Indeed, the low rates at the top serve to exacerbate and perpetuate the inequality-- so much so that among the advanced industrial countries, America now has the highest income inequality and the least equality of opportunity. This is a gross inversion of America’s traditional meritocratic ideals-- ideals that our leaders, across the spectrum, continue to profess.

Over the years, some of the wealthy have been enormously successful in getting special treatment, shifting an ever greater share of the burden of financing the country’s expenditures-- defense, education, social programs-- onto others. Ironically, this is especially true of some of our multinational corporations, which call on the federal government to negotiate favorable trade treaties that allow them easy entry into foreign markets and to defend their commercial interests around the world, but then use these foreign bases to avoid paying taxes.

...Economists often eschew the word “fair”-- fairness, like beauty, is in the eye of the beholder. But the unfairness of the American tax system has gotten so great that it’s dishonest to apply any other label to it.

Traditionally, economists have focused less on issues of equality than on the more mundane issues of growth and efficiency. But here again, our tax system comes in with low marks. Our growth was higher in the era of high top marginal tax rates than it has been since 1980. Economists-- even at traditional, conservative international institutions like the International Monetary Fund-- have come to realize that excessive inequality is bad for growth and stability. The tax system can play an important role in moderating the degree of inequality. Ours, however, does remarkably little about it.

One of the reasons for our poor economic performance is the large distortion in our economy caused by the tax system. The one thing economists agree on is that incentives matter-- if you lower taxes on speculation, say, you will get more speculation. We’ve drawn our most talented young people into financial shenanigans, rather than into creating real businesses, making real discoveries, providing real services to others. More efforts go into “rent-seeking”-- getting a larger slice of the country’s economic pie-- than into enlarging the size of the pie.

Research in recent years has linked the tax rates, sluggish growth and rising inequality. Remember, the low tax rates at the top were supposed to spur savings and hard work, and thus economic growth. They didn’t. Indeed, the household savings rate fell to a record level of near zero after President George W. Bush’s two rounds of cuts, in 2001 and 2003, on taxes on dividends and capital gains. What low tax rates at the top did do was increase the return on rent-seeking. It flourished, which meant that growth slowed and inequality grew. This is a pattern that has now been observed across countries. Contrary to the warnings of those who want to preserve their privileges, countries that have increased their top tax bracket have not grown more slowly. Another piece of evidence is here at home: if the efforts at the top were resulting in our entire economic engine’s doing better, we would expect everyone to benefit. If they were engaged in rent-seeking, as their incomes increased, we’d expect that of others to decrease. And that’s exactly what’s been happening. Incomes in the middle, and even the bottom, have been stagnating or falling.

Aside from the evidence, there is a strong intuitive case to be made for the idea that tax rates have encouraged rent-seeking at the expense of wealth creation. There is an intrinsic satisfaction in creating a new business, in expanding the horizons of our knowledge, and in helping others. By contrast, it is unpleasant to spend one’s days fine-tuning dishonest and deceptive practices that siphon money off the poor, as was common in the financial sector before the 2007-8 financial crisis. I believe that a vast majority of Americans would, all things being equal, choose the former over the latter. But our tax system tilts the field. It increases the net returns from engaging in some of these intrinsically distasteful activities, and it has helped us become a rent-seeking society.

It doesn’t have to be this way. We could have a much simpler tax system without all the distortions-- a society where those who clip coupons for a living pay the same taxes as someone with the same income who works in a factory; where someone who earns his income from saving companies pays the same tax as a doctor who makes the income by saving lives; where someone who earns his income from financial innovations pays the same taxes as a someone who does research to create real innovations that transform our economy and society. We could have a tax system that encourages good things like hard work and thrift and discourages bad things, like rent-seeking, gambling, financial speculation and pollution. Such a tax system could raise far more money than the current one — we wouldn’t have to go through all the wrangling we’ve been going through with sequestration, fiscal cliffs and threats to end Medicare and Social Security as we know it. We would be in sound fiscal position, for at least the next quarter-century.

The consequences of our broken tax system are not just economic. Our tax system relies heavily on voluntary compliance. But if citizens believe that the tax system is unfair, this voluntary compliance will not be forthcoming. More broadly, government plays an important role not just in social protection, but in making investments in infrastructure, technology, education and health. Without such investments, our economy will be weaker, and our economic growth slower.

Society can’t function well without a minimal sense of national solidarity and cohesion, and that sense of shared purpose also rests on a fair tax system. If Americans believe that government is unfair-- that ours is a government of the 1 percent, for the 1 percent, and by the 1 percent-- then faith in our democracy will surely perish.

Remember, the top 60 multinational companies would have paid $455 billion in taxes if they didn't hide profits offshore

UPDATE: A Tax Day Guest Post From Frank Clemente

Wanna stop the cuts? Let's talk corporations

by Frank Clemente, Campaign Manager, Americans for Tax Fairness

While there is good reason for progressives to fight like hell to protect cuts to Social Security, Medicare and other vital programs following the release of President Obama’s budget, we always seem to find ourselves on defense. It’s time to go on offense to protect vital services and benefits and to promote a more just economy by making sure that big corporations and the richest 2 percent pay their fair share in taxes.

For the past two weeks, Americans for Tax Fairness-- a coalition representing more than 280 national and state groups co-chaired by the Center for American Progress, AFSCME and National People’s Action-- has been stepping up pressure on Congress to raise $ 1 trillion, in part by closing corporate tax loopholes. We’ve been exposing a “Corporate Tax Dodger of the Day” leading into April 15-- the always stressful “Tax Day.”

It’s not always the preferred topic-- raising taxes-- but let’s face it: millions of working families pay more in taxes some years, or pay a much higher income tax rate, than some of the biggest and most profitable corporations in America pay. Think ExxonMobil, General Electric, FedEx, Verizon, Wells Fargo and more. That’s wrong and I know I’m talking to folks who agree.

Today our coalition released a report that highlights a top ten list of companies screwing over the rest of us.

So where do we go from here? Let’s start with the release of President Obama’s budget. There were a lot of good things in Obama’s budget about taxes. He would raise more than $600 billion over the next 10 years from the richest 3 percent, mainly by limiting their tax deductions to the same rate as middle-class Americans. And he would close nearly $350 billion in corporate tax loopholes that go to companies that shift profits and jobs overseas, subsidize polluters, and coddle Wall Street.

Unfortunately, the President did not propose to use the savings from closing those corporate tax loopholes to protect Social Security or to reduce the deficit. Instead he has proposed that the money saved be plowed right back to corporations by lowering their income tax rate and by providing other subsidies. That’s unfair. And it’s just plain misguided.

Average Americans believe in fairness. Everything we care about-- healthcare, education, roads, public safety-- depends on a shared investment and everyone paying their fair share of taxes. That’s why our campaign isn’t just working inside the beltway, we’re in communities and neighborhoods across the country.

Let me be blunt: We need your help. Now is the time for us to mobilize to make sure corporations pay up. On Tax Day our coalition will mobilize events in over two dozen states under the brand "WHO PAYS" that show how tax breaks for the rich and loopholes for corporations increase burdens on our families. Details of the events are online but even if there is not something happening near you, please join us and keep involved in this fight as it builds over the next few weeks.