A basic tenet of tax policy is that you should tax what you want to discourage and avoid taxing what you want to encourage. America has long had some confused incentives and some that are clearly not justifiable, but in recent times U.S. policy has been increasingly directed towards punishing responsible behavior, a phenomenon driven by a desperate desire to avoid having to use the word “tax”. We will not achieve rational policies or a healthy economy until politicians become willing to admit when they are raising revenue.
Dishonesty has long undermined the sense in our system. For example, we provide a federal deduction for mortgage interest, and justify this by saying that it promotes home ownership. At the same time, though, local governments impose steep property taxes. (As a further complication, the feds grant a deduction for those property taxes, but then take it away again through the AMT.) So, a person with a $400,000, 4% mortgage with get a deduction for $16,000 in interest, which at a 28% rate gives a tax subsidy of $4,480. However, they will commonly pay property tax of $10,000 or more, for a net penalty on homeownership of over $5,000. So what we really have is a policy of encouraging borrowing from banks to buy a home, not a policy of encouraging home ownership.
As another example, we treat income from work and from speculation differently. You might think that we would encourage people to work to produce actual goods and services, rather than to speculate and manipulate markets in the manner that trashed our economy in 2008. You would be wrong. Take a professional couple making $80,000 a year each doing productive labor. They would pay income tax at a marginal rate of 33% plus FICA taxes at 15.3%, for a total marginal rate of 48.3%. If they received the same income from gambling in or manipulating the markets, they would be taxed at a 15% rate. So productive labor is taxed more than three times as heavily as speculation. Why? Rich people give an awful lot of money as campaign contributions. In 2010 persons with incomes over $1,000,000 made up 0.33% of all tax returns filed, i.e. 1 in 300. They had 12.8% of all income, but only 5.7% of wage income. On the other hand, they had 46.0% of all qualified dividends (taxed like capital gains) and 69.4% of long-term capital gains. So, guess which classes of income are taxed the most lightly? Venture capitalists, i.e. rich people who can fund start-up companies, do not even have to pay that “heavy” 15% tax. They do not have to pay any tax at all on up to $10,000,000 per year of gain from selling corporations they helped fund, and they can avoid any tax on gain above that amount, potentially forever, by reinvesting it under section 1045. These measures are excused as being an attempt to stimulate investment, as if the wealthy would otherwise put their money under the mattress. In reality, it is an attempt to stimulate further campaign contributions while fooling the American public.
That, however, is merely corrupt. The new variety of dishonesty is actively stupid. Let’s begin with the largest and worst. In 2007 the average U.S. home mortgage interest rate was 6%, and the average 5-year bank CD rate was 5.5%. In 2012 the average home mortgage rate was 3%, and the average 5 year CD rate was 1.5%. So, in 2007 a bank earned a 9% mark-up on money lent over money borrowed, while in 2012 they received a 100% mark-up, 11 times the profit they made before. Why? Because the government is keeping interest rates artificially low by offering banks essentially free money, which enables the banks to earn huge profits. This, in turn, allows the banks to gradually deal with those toxic assets we heard so much about in 2008, but which then quietly dropped out of sight without ever being really addressed. “Aren’t we wonderful?” said the government. “We made the economy-crushing toxic assets disappear without spending the trillions of dollars on bail-outs that you feared!” No they didn’t. They knew that admitting that the government was borrowing or raising taxes to fund those bail-outs would make voters unhappy. So, they lowered interest rates “to stimulate the economy”. The economy was not especially stimulated because business was already sitting on a huge pile of cash and consumers were already drowning in debt. However, bank revenues soared, bank executives started taking huge bonuses again, and the bankers gradually recognized the losses on the bad mortgages. They did not write them all off quickly because that would prevent those big bonuses, and they knew they had the government locked into the Big Lie.
So, who is paying for the bailout? Bank executives? Hardly. The Wall Street speculators and hedge-fund managers who fueled the financial meltdown? No, they are making money hand over fist, most of it taxed at favorable rates. The people who borrowed wildly and spent like sailors? They got debt write-offs and rate reductions. It is bank depositors, the responsible retirees and middle-class savers who did the right thing all along hoping to put their kids through college and have a low-stress retirement. They planned on earning 5.5% on their deposits. Because of the bail-out, they are earning 1.5% if they are lucky, or 27% of what they would have earned absent the government action. That amounts to a 73% tax on their savings income, before income tax comes along and takes more, with the proceeds going to banks and borrowers. By imposing this 73% secret tax on savings income the government funded the bail-out without taxpayers having any idea what was happening. This was very clever politics, but it came at the cost of placing the whole burden on the one group of people that had NOT contributed to the problem. What incentive does that provide for doing the right thing in the future?
Now consider healthcare. The Administration started with a simple concept that people agreed on, that it was embarrassing for America to have people who had been stricken by expensive diseases through no fault of their own be unable to afford healthcare. However, when they tested the political waters to see if people would be willing to cough up tax dollars to fund charitable help to those poor sick people, the Republicans played the “tax and spend” card, and the Administration became too frightened to admit what they were doing. So they obscured it. “What we are doing”, they said, “is to allow people in high-risk groups or with pre-existing conditions, whether they are rich or poor, to join in pools with low-risk, healthy people, so that the sickly people’s premiums will be MUCH lower, and we will then kick in a small subsidy funded by taxes on the naughty healthcare industry. Oh, we realize that this will cause premiums on healthy people to rise, so we will enact penalties to force healthy people to buy insurance rather than dropping out of the system when they see that their premiums are higher than their medical costs would be if they just paid them themselves.” So, who paid the cost to subsidize the low-income unhealthy people? High-income people paying more income tax? People who spend their money on unhealthy foods and cigarettes and who get no exercise so that they become a burden on the healthcare system? People who demand expensive supercare right down to their last moment of life at age 103? Of course not. Instead the cost went entirely onto the backs of healthy people, who otherwise would have had lower premiums, and those responsible people were forced to subsidize not just low-income unhealthy people, but rich unhealthy people as well. Further, due to insurance industry lobbying, the law made it difficult to charge higher premiums for unhealthy habits, making it that much more certain that the full burden would fall on the group of people who eat right, exercise regularly, don’t smoke, and don’t ask for antibiotics for a cold or demand heroic measures that have a 1% chance of making them live for another week. The one group of people who try to keep healthcare costs down are forced to subsidize everyone else. Perhaps that won’t cause them to go on a Twinkie binge out of spite, but it will likely make them less eager to refrain from demanding expensive medical care. They paid for it, why not take it? Oh, by the way, those taxes on the healthcare industry? They tended to be structured in such a way that they would be easy to pass them through to the customers, or more accurately to the healthy people paying high premiums. The incentives are 100% the reverse of what they should be.
Now consider corporate tax. The Administration likes to sell corporate tax as a tax on the rich. It is easy to perform that sales trick because, again, 46% of taxable dividends go to individuals making more than $1,000,000 a year. But more than a quarter of all dividends go to IRAs, 401(k)s, pension funds and annuities owned by middle-class working people. Those retirement earnings are supposedly not taxed, because the government is supposed to be helping responsible savers to provide for their own secure retirements. But here is the trick. Corporations are not people. They do not really pay tax. They collect tax on behalf of their shareholders. Because this tax is imposed at the corporate level rather the shareholder level, those responsible middle-class retirement savers pay the same 35% tax on this income that the wealthy pay. Charging this tax at the corporate level also has the very nasty effect of pushing corporations to locate their high-profit operations somewhere outside of America, since they can earn up to 54% more on the same pretax profit by moving their operations to Singapore or other countries. Various studies by organizations with differing political views agree that this hurts American wages a lot, with most of the corporate tax burden effectively falling on workers in the form of lower pay. I have suggested to Congressional staff of both parties and to the Administration a mechanism that would shift this tax burden from the corporation to rich shareholders. (This is explained at http://sharedgrowth.blogspot.com .) The response from both parties has been “yes, that would be great for the economy and the workers, but people do not realize that they are really paying the corporate tax today, while the rich people would scream if you move the burden to them, so it’s not politically feasible.” In other words, the government realizes that it would be extremely good for America to collect this same revenue in a different way, but they will not do it because the current structure fools middle-class Americans into paying a big share of the tax while thinking that it is falling on somebody else. The government is willing to trash our economy, cheat responsible savers, and make America lose the globalization game just to keep voters in the dark about their real tax burden.
A final example relates to global warning. The Obama Administration wants to push to reduce carbon emissions. The most effective way to do this is to enact a straight carbon tax and then funnel back some of the revenue to poor people and American manufacturers in a way that maintains the incentive to avoid burning carbon. Industry would respond to such a tax immediately by making appropriate investments in the necessary technology. It would be easy to compute the return on those investments and decide what to do, and they would do the responsible thing. However, a Carbon Tax involves the dreaded T word, so the Administration rejected that idea. Instead they pushed for tradable carbon credits, a complex scheme that makes it impossible for companies to predict what they would save by making a given investment, which means that the companies won’t make the investments. Further, such trading schemes divert a huge amount of revenue to parasitic middle-men and irresponsible scam artists. But that is the path the government wants to follow, over the objection of the business community which would prefer a straight tax, just so that they can fool people into thinking they are not being subjected to a tax.
We know that politicians will always lie. If we trust their promises, then shame on us. If the press swallows a giant lie, such as the lie that the recent tax change was a “tax increase on the rich” when in fact it did not raise a dime of tax on anyone compared to prior law, but rather provided a permanent $400 billion a year deficit increase by tax reduction from prior law, we should be disgusted but not surprised. When the government punishes responsible behavior and subsidizes irresponsible behavior just to cover the lie, however, they have gone too far. If the government thinks that something is worth spending for, they should not hide the cost or push it onto future generations. Instead they should just explain the case to taxpayers. Americans need to demand truth in taxation.