This week The Economist has offered something for us to think respectfully about: raising tax revenue through tax reform rather relying principally on increased rates on high-income individuals. (And they do allow that Obama's proposal for a very modest increase in the highest bracket is not a significant problem.) Their approach to tax reform is not at all a new idea--but it is an important one. And unsurprisingly--to some of us, at least--it is very much a part of President Obama's thinking as well. The only ones against it appear to be the Tea Party-led Republican Party.
As a former corporate tax executive, I and others have advocated something like this approach for decades. But there was no sufficient constituency or crisis to inspire or force reform. Today the situation is quite different, of course. But what is most interesting about this proposal is that it now comes from The Economist, among the most principled, socially-accountable, and credible conservative and free-market voices. It is a solution that learned people of a responsible disposition support across the spectrum of political opinion. And while the Tea Party folks appear to listen to no one--knowledgeable, responsible, credible, respected or not--perhaps some winning coalition of responsible Democratic and Moderate Republican statesmen might find common cause around such a compellingly fair and reasonable solution.
From the Economist:
As a former corporate tax executive, I and others have advocated something like this approach for decades. But there was no sufficient constituency or crisis to inspire or force reform. Today the situation is quite different, of course. But what is most interesting about this proposal is that it now comes from The Economist, among the most principled, socially-accountable, and credible conservative and free-market voices. It is a solution that learned people of a responsible disposition support across the spectrum of political opinion. And while the Tea Party folks appear to listen to no one--knowledgeable, responsible, credible, respected or not--perhaps some winning coalition of responsible Democratic and Moderate Republican statesmen might find common cause around such a compellingly fair and reasonable solution.
From the Economist:
[...] The question of whether to tax the wealthy more depends on political judgments about the right size of the state and the appropriate role for redistribution. The maths says deficits could technically be tamed by spending cuts alone—as Mr Obama's Republican opponents advocate. Class warfare may be a loaded term, but it captures a fundamental debate in Western societies: who should suffer for righting public finances?
Leviathan should bear the brunt
[...] In general, this newspaper's instincts lie with small government and against ever higher taxation to pay for an unsustainable welfare state. We reject the notion, implicit in much of today's debate, that higher tax rates on the wealthy are justified because of the finance industry's role in the crunch: retribution is a poor rationale for taxation. Nor is the current pattern of contribution to the public purse obviously "unfair": the richest 1% of Americans pay more than a quarter of all federal taxes (and fully 40% of income taxes), while taking less than 20% of pre-tax income. And knee-jerk rich-bashing, like Labour's tax hike, seldom makes for good policy. High marginal tax rates discourage entrepreneurship, and no matter how much Mr Obama mentions "millionaires and billionaires", higher taxes on them alone cannot close America's deficit.
[...] But there are three good reasons why the wealthy should pay more tax—though not, by and large, in the ways that the rich world's governments currently propose.
First, the West's deficits should not be closed by spending cuts alone. Public spending should certainly take the brunt: there is plenty of scope to slim inefficient Leviathan, and studies of past deficit-cutting programmes suggest they work best when cuts predominate. Britain's four-to-one ratio is about right. But, as that ratio implies, experience also argues that higher taxes should be part of the mix. In America the tax take is historically low after years of rate reductions. There, and elsewhere, tax rises need to bear some of the burden.
Second, there is a political argument for raising this new revenue from the rich. Spending cuts fall disproportionately on the less well-off; and, even before the crunch, median incomes were stagnating. Meanwhile, globalisation has been rewarding winners ever more generously. Voters' support for ongoing austerity depends on a disproportionate share of any new revenue coming from the wealthy.
But how? So far most governments have focused on raising marginal income-tax rates, something most rich people respond to quickly (see article). Capitalists shift their income into less-taxed forms, such as capital gains; they move; they work less; they take fewer entrepreneurial risks. Even if it is hard to be sure how big these effects are, the size of the very top level seems to matter, so Britain's 50% rate is more dangerous than Mr Obama's proposal to raise America's top federal income-tax rate from 35% to 39.6%. Somebody earning $1m pays more tax in London than any other financial capital—madness for a place with so many mobile rich people. The excuse that it was worse in the 1970s hardly inspires confidence.
Simpler, bolder, better
Given the rich world's need for faster growth, governments should be wary of sharp tax increases—especially since they are unnecessary. Indeed, the third argument for raising more money from the rich is that it can be done not by increasing marginal tax rates, but by making the tax code more efficient.
The scope for doing so is most obvious in America, which relies far more than other countries on income taxes and has a mass of deductions on everything from interest payments on mortgages to employer-provided health care, so taxes are levied on a very narrow base. Getting rid of the deductions would simplify the code and raise as much as $1 trillion a year. Since the main beneficiaries of the deductions are the wealthy, richer folk would pay most of that. And since marginal rates would be untouched (or reduced), such a reform would do less to discourage them from creating wealth.
In Europe, where tax systems are more efficient, one option would be to shift more of the burden from income to property, which would collect more from the rich but have less impact on their willingness to take risks. The "mansion tax" proposed by Britain's Liberal Democrats would thus do less damage than the 50% rate. And on both sides of the Atlantic there is room to narrow the gap between tax rates on salaries and bonuses and those on dividends and capital gains. That gap explains why Mr Buffett, most of whose income comes from capital gains and dividends, has a lower average tax rate than his secretary. It is also the one hedge funders and private-equity people have exploited to keep the billions they rake in.
There is a basic bargain to be had. Imagine a tax system which made the top rates on wages and capital more equal, and which eliminated virtually all deductions. To avoid taxing investments twice, such a system would get rid of corporate taxes. It would also allow for a much lower top rate of income tax. The result? A larger overall tax take from the rich, without hurting the dynamism of the economy. Now that would be worth blowing your horn about.
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