One of the paradoxes of our economic crisis that has intrigued me most is that liquidity is both in short supply and is at the same time overwhelming the system. One of the main drivers of financial speculation, after all, is too much money sloshing around that has nothing productive in which to invest in the real economy. But at the same time, there are reasons why a 'credit crisis' can, potentially, push us off the proverbial cliff; it is not a riskless catastrophe that can simply be ignored.
The answer I keep coming back to is wealth concentration. It's the two Americas, the haves and have nots, or however you like to describe it. It's the difference between the people who wait in lines to be dehumanized by TSA agents to fly in Greyhound buses with wings and those who base their private jets at entirely different airports.
In short, it's not just that extreme wealth concentration violates some metaphysical notion of fairness. Apart from that, gross inequality undermines the very stability of the system. Normally in a time of economic contraction, one wouldn't advocate tax increases, because that takes money out of the economy right when it's needed most. But these aren't normal times.
The money at the top is precisely what is causing our troubles. Let me offer the case for why taxing that money away (or perhaps more accurately, taxing it back) is the best solution we've got.
A brief summary of speculation.
This is naturally going to grossly oversimplify the situation. Deal with it.
There is a certain amount of volatility that's inherent in anything allocated via a pricing mechanism. When prices rise or fall dramatically, though, it's important to attempt to understand why. Did something become more expensive to produce? Are more people consuming it? Is money pouring into it to try to profit from the increasing price (or out of it to avoid losses)? The first two answers deal with fundamental changes; that last one is speculation. Speculation itself is amoral, not immoral. But the consequences become dangerous when it gets out of hand, when marketing becomes scams and fraud, when the value is dependent not upon the asset, but upon finding the next greater sucker or fool.
Take oil, for example. There are several legitimate things to worry about, from wars to trade sanctions to peak oil. But how much of that explains these data points:
year nominal inflation-adjusted
1976 $13.10 $49.66
1977 $14.40 $51.22
1978 $14.95 $49.47
1979 $25.10 $73.89
1980 $37.42 $98.07
1981 $35.75 $84.93
1982 $31.83 $71.20
1983 $29.08 $63.00
1984 $28.75 $59.71
1985 $26.92 $53.98
1986 $14.44 $28.41
1987 $17.75 $33.69
1988 $14.87 $27.16
1989 $18.33 $31.88
1990 $23.19 $38.17
1991 $20.20 $31.99
1992 $19.25 $29.59
1993 $16.75 $25.02
1994 $15.66 $22.78
1995 $16.75 $23.71
1996 $20.46 $28.12
1997 $18.64 $25.05
1998 $11.91 $15.77
1999 $16.56 $21.39
2000 $27.39 $34.29
2001 $23.00 $28.03
2002 $22.81 $27.33
2003 $27.69 $32.47
2004 $37.66 $42.97
2005 $50.04 $55.21
2006 $58.30 $62.36
2007 $64.20 $66.66
July 2008: $145
December 2008: $37
In a year, did demand for gas skyrocket and then plunge? Did the cost of extracting oil in Venezuela or Canada or Saudi Arabia or the US or Mexico expand and then contract massively? Nope. The price of oil went up because money had nowhere else to go. In fact, one of the ultimate ironies is that rise of the price of oil itself helped spark our downturn's turn for the worse in 2008. Remember, the first few months or so of the recession weren't that bad in terms of percentage job losses. Calculated Risk has been running an ongoing chart that illustrates this inflection point really well (not to mention the disconcerting fact that recent recessions are taking far longer to recover their previous employment levels than earlier post war recessions).
Oil is not an exception. Rather, it's an easy way to see the rule as we have benchmark, publicly available pricing data that can't be kept hidden from FOIA requests or shadow inventories. Money, specifically, dollars, has been flooding into 'things' like commodities and stocks and bonds and houses and commercial real estate in various ways over the past decade (you might even think of the Beanie Baby phenomenon in this light, something of a smaller scale so it's easier to comprehend). Even gold, that magical quasi-money, quasi-commodity on the periodic table of the elements has experienced a lot of volatility in its dollar price (in the last two years alone, the dollar price of gold has crashed over 25% and increased over 50% - whatever words you might use to describe that, 'stable' ain't one of 'em).
The housing market crashed and the price of oil skyrocketed, and we've suffered from both of those events. The absolute level of stocks isn't so much the problem as how big the swings, both up and down, have been over the past couple of years. There is no 'public good' that has come out of developments like these. Quite the contrary, much loss has been socialized onto the rest of us. Even the cost of storing all the oil and taking care of all the abandoned houses ultimately gets born by those end consumers and community members left trying to pick up the pieces.
The natural political question is, are there better uses for the money?
If the needs of the real economy were being met, this wouldn't be much of an issue. But there are huge swaths of our economy that are deprived of capital because various scams and fraud and gambling can't capture the gains privately. The way we deal with that challenge of the public commons is to use public dollars for the investment. It's why virtually everyone supports a military and a court system that are funded by taxation; no private actor can capture enough gain to make it worth the cost. It's why a majority of Americans support many more public outlays, from Social Security to Medicare to public schools to parks & wilderness areas to transit and so forth.
There was a recent post on Interfluidity that addressed this issue really well. What's wrong with the 'great moderation' is that distorted asset prices cause distortions in how resources are allocated in the real economy. Here's the money paragraph on this particular part of the story:
So what's the problem? First, in exchange for apparent stability, the central-bank-backstopped "great moderation" has rendered asset prices unreliable as guides to real investment. I think the United States has made terrible aggregate investment decisions over the last 30 years, and will continue to do so as long as a "ride the bubble then hide in banks" strategy pays off. Under the moderation dynamic, resource allocation is managed alternately by compromised capital markets and fiscal stimulators, neither of which make remotely good choices. Second, by relying on credit rather than wages to fund middle-class consumption, the moderation dynamic causes great harm in the form of stress from unwanted financial risk, loss of freedom to pursue nonremunerative activities, and unnecessary catastrophes for isolated families. Finally, maintaining the dynamic requires active use of policy instruments to sustain an inequitable distribution of wealth and income in a manner that I view as unjust. In "good times", central bankers actively suppress the median wage (while applauding increases in the mean wages driven by the upper tail). During the reset phase, policymakers bail out creditors. There is nothing "natural" or "efficient" about these choices.
We know we have infrastructure crumbling around us. We know our schools and hospitals need investment. We know it's time for reinvigorating our rail systems. We know wind and solar energy have to replace at least some of our coal and natural gas power plants. We know people like parks, big and small. And we know that having large numbers of unemployed persons is damaging to our social cohesion.
When private markets can't (or won't) deliver such investments, it's the role of government to step into the breach. One of the unique attributes of our time is that the taxation necessary to fund these efforts isn't counterproductive. It's actually a key part of the solution.
Andrew Kaplan captured this description well a couple months ago in a post called "The Savings Rate Has Recovered...if You Ignore the Bottom 99%"
My favorite bit:
The story goes something like, “consumers took a little time to recognize that their home equity had disappeared, but now they’ve adjusted their savings rates toward the desired level to reflect the fact that they need to save a larger proportion of income for retirement...so this effect will no longer be a drag on growth in coming quarters.”
This is the kind of conventional wisdom which could only emerge among folks in the 99th income percentile who spend their time primarily with other folks in the 99th income percentile. You don’t have to look at the data (mortgage delinquencies, foreclosures, credit card defaults, bankruptcies) all that hard to see a very different picture. In fact, it is almost certainly true that the savings rate for 99% of the US population is negative. These people (a/k/a “all of us”) are drowning. And to the extent that our savings rate is less negative than it was one or two years ago, that simply reflects the reality of reduced home equity and unsecured credit lines rather than any conscious effort to reach a “desired level” of savings.
All of the marginal savings in our economy are accruing in the wealthiest households. It's simple numbers; that's the source of the destructive speculation and it's the source of potential taxation that could be invested in projects that return value to the real economy. The great blessing we are left with is that we weren't hit by an asteroid or nuked by the Russians. Our (real) wealth is still there. But to realize its potential, we have to tax back some of the idle capital and put it to use. And the longer we wait, the more we let things crumble, the greater the costs of moving forward.
One final reason why taxation is the proper method is that it targets those who have benefited most from the public investments of the past. The other alternative, which we are currently pursuing, of printing money, of inflating our way out of the crisis, punishes savers instead because it reduces the value of the savings they have set aside.
What kinds of taxes could we implement?
The need to target the taxation is very important. If you raise taxes for somebody with a high marginal propensity to consume (ie, 'working class folks' or people 'living paycheck to paycheck' or 'We the People'), that taxation simply trades off with other economic activity (the 'crowding out' effect). The key is capturing the idle capital, the stuff literally sitting around in oil tankers and storage facilities all over the globe (just Google 'contango'), not to mention private jets, private yachts, private vacation resorts, private islands, private household management, and so forth. So, I'm going to lay out several options, roughly in order of ascending 'radicalness'. Note, that doesn't mean they get more 'liberal'. It means they get farther from our current tax code. What's interesting politically is that there is much room for compromise all up and down the traditional partisan aisle.
1. Add a couple more income tax brackets.
This one is so basic, I think it might even happen. Income tax rates were higher under Bill Clinton. Income tax rates today are at historically low levels. Somehow Reagan survived much of his presidency with a 50% marginal tax bracket. Nixon had 70%. For some years in the 20th century, the highest bracket was over 90%. Today? 35%.
2. Eliminate the income cap on Social Security taxes (OASI and DI trust funds).
This would have three important effects. First, it would help shore up the the trust funds. Second, it would shut up the corporatist privatizers yapping about how all these unfunded mandates are ruining the country (nevermind that Social Security's financial difficulties don't happen for decades into the future and I've never seen a CIA budget called an unfunded liability). Third, it would remove one of the minor, but bizarre, disincentives to hiring additional workers. It actually costs employers more in OASDI taxes to have three employees making $80,000 a year than two employees making $120,000 a year, even though the total wages in both situations is the same.
3. Temporarily implement a small financial transactions tax (ie, a 'Tobin tax').
Personally, I'm extremely reticent to use the tax code for any purpose other than raising revenue; there are just too many special interest groups and unintended consequences. However, given the particular place financial excesses have played in arriving at our current situation, I have come around to thinking a small tax on each transaction is a good way to raise revenue directly from one of the sources of instability in our system, the number of short duration transactions that occur. I would emphasize, though, that really addressing trading issues has to involve regulation and criminal statutes; a tax is not sufficient to align incentives.
4. Set a firm estate tax exemption at $2 million. Tax everything over that at 90%.
There are lots of ways people can pass money on to their children or other heirs. Currently, you can gift $12,000 per year per person completely tax free. The notion that tens of millions of dollars, let alone more, should pass along as inheritance is fundamentally undemocratic and anti-capitalist. If anything is the antithesis of the American experiment, it is aristocracy and nobility. And if you're worth $10 million at death, you can still pass on $2.8 million after whatever you've given away when you were alive. That's about $2.799 million more than most people start with. Remember, we're talking about money that's completely undeserved. Unlike the original entrepreneurs, heirs cannot even appeal to any of the claims of 'hard work' or 'skill' or any such notion.
5. Make all percentage tax deductions refundable tax credits of 20%.
Right now, we use the tax code to incentivize all sorts of behavior. This is extremely inefficient and inequitable. A tax deduction requires tax liability exceeding the standard deduction to begin with, and using marginal tax rates means higher income filers are paid more for doing the exact same activity. If we're going to use the tax code to pay people to own homes, or save for retirement, or donate to charity, and on and on, we should at least change these to be refundable tax credits. The value of the payment from the IRS should depend upon the activity in question, not the relative income and expenses of the recipient.
6. Double the Medicare payroll tax percentage for incomes exceeding $100,000 (the HI trust fund).
This is pretty self-explanatory; you tend to either agree or not. Healthcare is an area where there are significant costs. Either those who are more healthy and wealthy help subsidize those who are less, or they don't. There's no 'economic' answer to this question; it is pure politics.
Ultimately, of course, it would be great if the Hospital Insurance trust fund evolved into a single payer, Health Insurance trust fund covering all physical and mental healthcare needs of all Americans regardless of age (or any other factor).
7. Create a national unemployment insurance system (UEI trust fund).
Many people don't realize this, but we have a very fractured, state-based, employer-taxed unemployment system. This leaves many people uncovered and places taxes on businesses that really should be covered by a broader pool of taxpayers. Modeled after the Social Security insurance system, we could add another dedicated trust fund from a withholding tax on workers. Then, we could standardize the eligibility and application process to streamline the system and provide universal coverage.
8. Reduce corporate income tax rates.
No, that's not a typo. I'm not a fan of treating corporations like natural persons. Ultimately, actual people control income and wealth. That's where taxation should occur. This does three main things for us. First, (kind of like #2 and #7) it helps us counter those blathering nonsensically about tax and spend liberals. Second, it actually brings us more in line with the rest of the world. Third, it removes some of the gamesmanship of corporate accounting, carrying over losses and hiding income and so forth. This is more politics than substance, you might say, but I think important for a broader narrative of realigning our tax policy. It's not business per se that is the problem, but rather, the private accumulation by insiders of the wealth created by business. Similar to #9, what is different about taxing corporate 'income' is that it's not really a tax on income; it's a tax on profit. That leads to significant gray areas that don't exist in taxing income, because profits are a variable relationship between income and expenses.
[Yes, for those of you more uncomfortable with capitalism or business, that statement presupposesbusinesses create value. That is a purposeful assertion, not an accidental slip. It is of course open to debate, but it's a much more philosophical debate. If private property doesn't make us better off, that indicts our whole system of resource allocation. Even Kos Media, LLC is a business, and not just any type of business; it's a corporation.]
9. Eliminate negative income (ie, 'losses').
This is a funny quirk of the tax code. The government actually reimburses you for investment losses. If you're in, say, the 25% tax bracket and you lose $2,000 on some shares of stock you sell, you have a capital loss of $2,000. Currently, you can deduct that from your taxable income. In other words, taxpayers will cover $500 of your loss (25% times $2,000). I can't think of too many things that can possibly incentivize excessive risk-taking more than using taxpayer dollars to cover individual losses.
10. Treat all income as income.
We have a very clever system of having an 'income tax code' where we calculate things like 'adjusted gross income' but at the same time magically define certain kinds of income differently than others. Of course dividend income is double taxation. All taxation is double taxation (and note, if we do #8, the 'double taxation' meme drops significantly). In fact, technically, we might say all taxation is infinite taxation; that's what happens in any closed system, from taxation to the water cycle. Taxation is simply a means of funding government operations that generate a positive return. Wages, tips, commissions, interest, dividends, capital gains, etc; they should all be treated as income for the purposes of the income tax code. In addition to the fairness of this approach, there's also the simplicity; this would make filing taxes very simple for almost everyone.
11. Treat all compensation as compensation.
Similar to #10, there are also interesting differences in different types of compensation. Some compensation isn't subject to payroll taxes, for example. It shouldn't matter whether an employer paid you a 'wage' or a 'stock option' or anything else; if it's consideration you received in exchange for your labor, it should be treated as such, subject to all the same withholdings and taxes and reporting and whatnot.
12. Make income taxes something that can be filed on a postcard.
The most radical improvement to the income tax code is to simply eliminate all the special interest loopholes. In other words, stop using the tax code to subsidize behavior. If a particular activity is publicly beneficial, subsidize that activity directly. If we want to encourage payments to charities, then match donations. If we want to encourage homeownership, then make explicit payments to homeowners. If we want to encourage retirement savings, then contribute monies directly into retirement accounts. Etc.
Or, a less radical version of this would be to significantly increase the standard deduction. For example, if the standard deduction were $15,000 for a single filer or $30,000 for a married couple, that would simplify the filing process for many people as it would no longer make sense to itemize deductions.
13. Federalize the funding of public school districts.
Local control of public school districts is an excellent feature of the American experience. Keeping school boards separate from all political powers, from the Mayor's Office to the Oval Office, is a great separation of powers in our society. However, local funding via property taxes is not working out well. It creates and engenders significant disparities even within rather localized geographic areas. So, instead of a school board going to the community to vote an a tax bond, they would instead go to the federal Department of Education (or some other entity) to apply for funds based on some basic criteria like number of students, use of funds, etc. We could then also apply uniform financial reporting and auditing standards on public school districts and have all that information publicly available in a federal database. As the housing crash has illustrated, personal property does not make for a stable tax base. Rather, it tends to accentuate the volatility.
14. Replace sales taxes with federal block grants.
The most radical overhaul of the overall tax system I'd propose is eliminating sales taxes. This one is a bit trickier logistically as well as politically, but the story is easy enough. Sales taxes are extremely regressive and relatively expensive to administer. We already have an income tax system; it doesn't cost any more to just increase those tax brackets to compensate for the loss of sales tax revenue. And sales taxes encourage people to circumvent them. After all, that's Amazon's entire business model, and it's why there's a significant gray market in cash-only services, from daycare to landscaping to nails to selling cigarettes. Income taxes face similar problems, but on a lesser scale, because there are countervailing forces, like third party employer reporting and the need to declare income for other purposes (like securing some kinds of credit). One of the factors legitimate local businesses have to compete with is the explicit tax subsidy given to e-commerce and vendors who do not report sales to the proper local and state taxing authorities. And for municipalities that want a higher level of service, they can always institute a local income tax. Many cities already do this.
Or, conversely, to see this conceptually, expand the definition of what is taxable. Have you ever wondered, for example, why you pay a sales tax on a gallon of gasoline, but not on a futures contract for West Texas Intermediate crude oil? Why is jewelry taxed, but not a gold ETF? Are education and real estate and healthcare consumption or investment? In short, what's the difference? And who gets to decide what that difference is?
There is an effort along this line of thought, but in the other direction, called the Fair Tax movement, which is seeking to use a national sales tax to replace the income tax (as well as payroll, estate, and basically all other federal taxation). I like the call for a radical overhaul of the tax code. Where I differ is I think they're moving in the wrong direction. The 16th amendment (income taxes) wasn't a step backwards, it was progress. Sales taxes are regressive, they require making bureaucratic decisions about what 'counts' and what doesn't, and they're more easily avoided because there is less declaration and third party reporting. As far as the estate tax in particular is concerned, sales taxes don't prevent the tendency for aristocratic wealth concentration from one generation to the next.
The way to see this problem is to look at the compromise solution that has garnered some Democratic support, a prebate of a certain amount of sales taxes each year (analogous to the standard deduction for income taxes or the amount exempted from estate taxes). If we made the prebated amount equal to, say, $30,000 in annual consumption per person, that would actually be a very fair, mostly progressive, equitable tax system (the Fair Tax program calls for a prebate up to the federal poverty level). But that would require such a high percentage tax on consumption in excess of $30,000 (or, cuts to federal spending like Social Security and Medicare) that it's simply not politically feasible. So, in practice, what we would end up with would be a much lower threshold, which would in effect be a transfer of wealth from lower middle class families to the wealthy, depending on exactly how the major expenditures of the wealthy are excluded: education, healthcare, real estate, financial services, travel, and so forth.
Let me close with a couple of observations.
First, I don't possess any particular insights into the tax code; these are just summaries of ideas that have been floating around from people far more knowledgeable about our tax policy. We don't have to reinvent the wheel here, just implement sound policies that we know work. Second, a big part of the problem with our tax code is lax enforcement. Whatever rules we create, it's critical that we enforce them, particularly on the wealthiest tax cheats who are by far the worst offenders. Finally, this is not an exhaustive list. Rather, this is a resource to show that when we think critically about the tax code, there are many improvements that can be made. As we deal with our ongoing economic situation, taxation isn't something to set aside for a future day. Rather, it's a key part of the solution for us to embrace.
It's not average Americans who are afraid of taxation. Rather, it's a few wealthy tax avoiders and tax cheats who are doing everything they can to keep from investing in the promise of America. And it's not as simple as 'us verse them'; many wealthy Americans understand the predicament, too. Unfortunately for us, though, betting in the derivatives market is way more exciting these days for many wealthy families than building a library. Or even just paying the taxes they owe under our current laws.