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Tax code favors rich Americans
By Laura Tyson |
November 30, 2012, Friday
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Print Edition
Print Edition
AMERICA'S recent presidential election answered the question of whether an increase in revenues will be part of the country's long-run deficit-reduction plan. The answer is yes: there is now bipartisan agreement on the need for a "balanced" approach that includes revenue increases and spending cuts.
But there are still deep political and ideological divisions about how additional revenues should be raised and who should pay higher taxes. If a preliminary agreement on these questions is not reached by the end of the year, the economy faces a "fiscal cliff" of $600 billion in automatic tax increases and spending cuts that will shave about 4 percent from GDP and trigger a recession.
The majority of citizens agree with President Barack Obama that tax increases for deficit reduction should fall on the top 2-3 percent of taxpayers, who have enjoyed the largest gains in income and wealth over the last 30 years. That is why he is proposing that the 2001 and 2003 rate cuts for these taxpayers be allowed to expire at the end of the year, while the rate cuts for other taxpayers are extended.
So far, Obama's Republican opponents are adamant that the cuts be extended for all taxpayers, arguing that increases in top rates would discourage job creation. This claim is not supported by the evidence. Recent research finds no link between tax cuts for top taxpayers and job creation. In contrast, tax cuts for the bottom 95 percent have a positive effect on job growth.
A recent review of the economic literature by three distinguished academics found no convincing evidence that real economic activity responds materially to tax-rate changes on top income earners, although such changes do affect their tax-avoidance behavior.
So Obama has evidence on his side when he says that allowing the tax cuts for high-income taxpayers to expire at the end of the year will not affect economic growth.
Republicans have proposed tax reforms in lieu of rate hikes on high-income taxpayers to raise revenues for deficit reduction. Obama has signaled that he is willing to consider this approach, provided it increases tax revenues from the top 2-3 percent by at least the same amount as higher rates while protecting other taxpayers.
The federal tax system is certainly in need of reform.
Tax expenditures - which include all deductions, credits, and loopholes - account for about 8 percent of GDP. Indeed, the US tax code is riddled with special preferences and contains large differences in effective tax rates across individuals and economic activities.
Distortions
These differences distort decisions about investment allocation and financing. Reforms that made the tax system simpler, fairer, and less distortionary would have a beneficial effect on economic growth, although economists concede that the size of this effect is uncertain and impossible to quantify.
Because tax expenditures are so large, limiting them could raise a significant amount of additional revenue that could be used both for deficit reduction and to finance across-the-board cuts in income-tax rates.
Reducing large regressive tax expenditures like preferential tax rates for capital gains and dividends and deductions for state and local taxes, and replacing deductions with progressive tax credits, could generate enough revenue to finance rate cuts for all taxpayers, increase the tax codes overall progressivity, and contribute meaningfully to deficit reduction.
But the odds of such an outcome are very low: what is arithmetically feasible is unlikely to be politically possible. Efforts to cap popular tax expenditures will encounter strong opposition from Republicans and Democrats alike. Nonetheless, some tax reforms are likely to be a key component of a bipartisan deficit-reduction deal, because they provide Republicans who oppose increases in tax rates for high-income taxpayers with an ideologically preferable way to increase revenue from them.
Unfortunately, it will take time to negotiate tax reforms - more time than remains until the end of the year, when the 2001 and 2003 tax cuts are scheduled to expire for all taxpayers.
But there is still time to negotiate an agreement that extends these cuts for the bottom 98 percent, and that contains temporary measures to cap deductions and credits for high-income taxpayers in 2013. Such an agreement could help to break the political impasse over whether and how much these taxpayers' rates should rise next year, thereby preventing the US from falling over the fiscal cliff and back into recession.
Laura Tyson, a former chair of the US President's Council of Economic Advisers, is a professor at the University of California, Berkeley. Copyright: Project Syndicate, 2012.www.project-syndicate.org
But there are still deep political and ideological divisions about how additional revenues should be raised and who should pay higher taxes. If a preliminary agreement on these questions is not reached by the end of the year, the economy faces a "fiscal cliff" of $600 billion in automatic tax increases and spending cuts that will shave about 4 percent from GDP and trigger a recession.
The majority of citizens agree with President Barack Obama that tax increases for deficit reduction should fall on the top 2-3 percent of taxpayers, who have enjoyed the largest gains in income and wealth over the last 30 years. That is why he is proposing that the 2001 and 2003 rate cuts for these taxpayers be allowed to expire at the end of the year, while the rate cuts for other taxpayers are extended.
So far, Obama's Republican opponents are adamant that the cuts be extended for all taxpayers, arguing that increases in top rates would discourage job creation. This claim is not supported by the evidence. Recent research finds no link between tax cuts for top taxpayers and job creation. In contrast, tax cuts for the bottom 95 percent have a positive effect on job growth.
A recent review of the economic literature by three distinguished academics found no convincing evidence that real economic activity responds materially to tax-rate changes on top income earners, although such changes do affect their tax-avoidance behavior.
So Obama has evidence on his side when he says that allowing the tax cuts for high-income taxpayers to expire at the end of the year will not affect economic growth.
Republicans have proposed tax reforms in lieu of rate hikes on high-income taxpayers to raise revenues for deficit reduction. Obama has signaled that he is willing to consider this approach, provided it increases tax revenues from the top 2-3 percent by at least the same amount as higher rates while protecting other taxpayers.
The federal tax system is certainly in need of reform.
Tax expenditures - which include all deductions, credits, and loopholes - account for about 8 percent of GDP. Indeed, the US tax code is riddled with special preferences and contains large differences in effective tax rates across individuals and economic activities.
Distortions
These differences distort decisions about investment allocation and financing. Reforms that made the tax system simpler, fairer, and less distortionary would have a beneficial effect on economic growth, although economists concede that the size of this effect is uncertain and impossible to quantify.
Because tax expenditures are so large, limiting them could raise a significant amount of additional revenue that could be used both for deficit reduction and to finance across-the-board cuts in income-tax rates.
Reducing large regressive tax expenditures like preferential tax rates for capital gains and dividends and deductions for state and local taxes, and replacing deductions with progressive tax credits, could generate enough revenue to finance rate cuts for all taxpayers, increase the tax codes overall progressivity, and contribute meaningfully to deficit reduction.
But the odds of such an outcome are very low: what is arithmetically feasible is unlikely to be politically possible. Efforts to cap popular tax expenditures will encounter strong opposition from Republicans and Democrats alike. Nonetheless, some tax reforms are likely to be a key component of a bipartisan deficit-reduction deal, because they provide Republicans who oppose increases in tax rates for high-income taxpayers with an ideologically preferable way to increase revenue from them.
Unfortunately, it will take time to negotiate tax reforms - more time than remains until the end of the year, when the 2001 and 2003 tax cuts are scheduled to expire for all taxpayers.
But there is still time to negotiate an agreement that extends these cuts for the bottom 98 percent, and that contains temporary measures to cap deductions and credits for high-income taxpayers in 2013. Such an agreement could help to break the political impasse over whether and how much these taxpayers' rates should rise next year, thereby preventing the US from falling over the fiscal cliff and back into recession.
Laura Tyson, a former chair of the US President's Council of Economic Advisers, is a professor at the University of California, Berkeley. Copyright: Project Syndicate, 2012.www.project-syndicate.org
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