Why U.S. work­ers pay twice as much in taxes

Gap could widen more un­der re­form

The Buffalo News - - FRONT PAGE - By Ben Stev­er­man

WASH­ING­TON – Let’s say you and I are neigh­bors. You’re an emer­gency room doc­tor, and I don’t work, thanks to a pile of money my grand­par­ents left me.

You spend your days and nights stitch­ing up gun­shot wounds and help­ing chil­dren sur­vive asthma at­tacks. I’ve got­ten re­ally good at World of War­craft, win­ning eBay auc­tions, and fry­ing shishito pep­pers to just the right crispi­ness.

Let’s also say we both re­port $300,000 in in­come to the In­ter­nal Rev­enue Ser­vice this year. Who pays more in taxes?

You do, by a lot. You owe the IRS about $38,500 more, as­sum­ing each of us pays the max­i­mum with no spe­cial de­duc­tions. I also have more flex­i­bil­ity to lower my bur­den with tax plan­ning strate­gies and other tricks, and I get to skip about $24,000 in pay­roll taxes that you and your em­ployer must fork over each year.

This isn’t some quirk of the U.S. tax code. Politi­cians have in­ten­tion­ally set tax rates on wages much higher than those on long-term in­vest­ment re­turns. The U.S. has a pro­gres­sive tax sys­tem in the sense that well-paid work­ers sac­ri­fice much more than poor work­ers on their “or­di­nary in­come.” But Amer­i­cans with so-called un­earned in­come – qual­i­fied div­i­dends and long-term cap­i­tal gains – get a break. A bil­lion­aire in­vestor can pay about the same mar­ginal rate as a $40,000-ayear worker, a fact War­ren Buf­fett has fa­mously lamented.

The last time Congress

passed com­pre­hen­sive tax re­form, in 1986, it elim­i­nated the gap be­tween work­ers’ and in­vestors’ taxes. Their rates didn’t start di­verg­ing again un­til the early ’90s, when Con­gresses con­trolled by Democrats boosted taxes on wealthy Amer­i­cans’ wages more than on their in­vest­ments. Repub­li­can-con­trolled Con­gresses widened the gap fur­ther by slash­ing rates on rich in­vestors in the late 1990s and early 2000s.

A 1986-style re­bal­anc­ing is un­likely to hap­pen this fall, how­ever, as Pres­i­dent Trump and his fel­low Repub­li­cans in Congress at­tempt to tackle tax re­form. The gap may even widen fur­ther.

A key goal is to “sim­plify the [tax] code so much that you can fill out your taxes on a post­card,” House Speaker Paul Ryan, RWis., said on CNN on Aug. 21. While other de­tails of pro­posed tax re­form re­main fuzzy, Ryan and other Repub­li­cans have been pro­mot­ing a draft of that post­card on so­cial me­dia.

The first line asks fil­ers to write down their pre­vi­ous year’s wages. For you – the ER doc­tor in the fic­tional sce­nario above – that would be $300,000. The sec­ond line asks fil­ers to add just half of their in­vest­ment in­come. For me, that would be $150,000.

The form’s sim­plic­ity makes its pri­or­i­ties clear: No mat­ter what rates are ap­plied or which de­duc­tions or cred­its are al­lowed, a worker would end up pay­ing twice as much in taxes as an in­vestor with the same in­come.

Amer­i­cans in the top 1 per­cent, and es­pe­cially the top 0.1 per­cent, have seen their wealth and in­come mul­ti­ply in re­cent decades as the rest of the coun­try’s share of the eco­nomic pie shrank. Since 2000, a re­cent study found, the top 1 per­cent have made those gains al­most en­tirely on in­come from cap­i­tal, es­pe­cially cor­po­rate stock – not on la­bor in­come.

Mean­while, the U.S. Trea­sury is ex­pected to run a 2017 deficit of $693 bil­lion, ac­cord­ing to the Con­gres­sional Bud­get Of­fice’s lat­est es­ti­mate, some $108 bil­lion more than in the 2016 fis­cal year. As baby boomers re­tire and health care costs rise over the next few decades, the govern­ment’s fis­cal sit­u­a­tion is ex­pected to worsen.

The ar­gu­ment in fa­vor of lower taxes on in­vestors – and on cor­po­ra­tions, another GOP pri­or­ity – is an eco­nomic one.

“We want a tax code built for growth,” Ryan said. “We want a tax code that raises wages, keeps Amer­i­can com­pa­nies in Amer­ica, gives us faster eco­nomic growth.”

Trump, Ryan, and other Repub­li­cans in Congress are wran­gling over a va­ri­ety of com­pet­ing goals for re­form. The most as­pi­ra­tional is a tec­tonic sim­pli­fi­ca­tion of the tax code that re­ally would al­low every­one to file us­ing a post­card. But more re­al­is­tic leg­isla­tive tar­gets are low­er­ing tax rates on in­di­vid­u­als and cor­po­ra­tions as well as elim­i­nat­ing the es­tate tax and al­ter­na­tive min­i­mum tax. They may also try again to kill the Af­ford­able Care Act taxes .

By tax­ing in­vestors less, some economists ar­gue, you give tax­pay­ers more of an in­cen­tive to save. The more savings in the econ­omy, the more cap­i­tal that com­pa­nies and en­trepreneurs can in­vest in ways that ex­pand the econ­omy and make work­ers more pro­duc­tive. Every­one, in­clud­ing work­ers, wins, ac­cord­ing to this the­ory.

But there are po­ten­tial neg­a­tive con­se­quences to such a pol­icy. By low­er­ing taxes on in­vestors, you shift more of the tax bur­den to well-paid work­ers. This may give highly skilled and creative peo­ple a dis­in­cen­tive to work hard or im­prove their skills so they can earn more money, while also giv­ing chil­dren of wealthy par­ents another rea­son not to work at all.

And why do peo­ple need a spe­cial tax break to mo­ti­vate them to save? Aren’t there al­ready pow­er­ful in­cen­tives to be thrifty?

Economists have an­swers to some of these ques­tions, if you trust their the­o­ret­i­cal mod­els. An of­ten-cited 1999 Fed­eral Re­serve study used dozens of al­ge­braic equa­tions to di­vine the ideally ef­fi­cient tax sys­tem. It con­cluded that the op­ti­mal tax rate on in­vest­ment in­come is “zero.” That’s con­tra­dicted, how­ever, by another the­o­ret­i­cal model, pub­lished in the Amer­i­can Eco­nomic Re­view in 2009, that found the best rate is more like 36 per­cent. Nev­er­the­less, given eco­nomic the­ory’s re­cent track record, it may be bet­ter to stick to real-world data.

There’s ev­i­dence, for ex­am­ple, that in­vestors feel in­flu­enced by taxes far more than work­ers do. If you worry about tax in­cen­tives dis­tort­ing the econ­omy, taxes on work­ers should worry you less: Peo­ple tend to keep go­ing to work ev­ery day no mat­ter what. Most economists agree that men in the prime of their ca­reers “are not par­tic­u­larly re­spon­sive to the tax rate,” said Univer­sity of Michi­gan eco­nomics pro­fes­sor Joel Slem­rod. Sim­i­larly sit­u­ated women are only “re­spon­sive at the mar­gins.”

In­vestors, by con­trast, are much more sen­si­tive – at least in the short term. It’s hap­pen­ing now: If taxes on the wealthy drop next year, as many tax plan­ners as­sume they will, then rich peo­ple have an in­cen­tive to wait un­til 2018 to rec­og­nize in­vest­ment in­come by sell­ing stocks or busi­nesses they own. And that seems to be what they’re do­ing; rev­enue to the U.S. Trea­sury dipped this year even as the econ­omy re­mains strong.

In other words, govern­ments should tax work­ers more be­cause they can get away with it. How­ever un­fair it might be, the dis­par­ity doesn’t af­fect eco­nomic be­hav­ior as much.

There’s a big flaw, though, in the ar­gu­ment that lower taxes on the rich stim­u­late longert­erm in­vest­ment, and thus jobs, fa­mously la­beled as “trick­le­down eco­nomics.” While tax rates might af­fect the tim­ing of some in­vestor de­ci­sions in the medium term, it’s much harder to see how they af­fect long-term be­hav­ior. No mat­ter the tax rate, in­vestors ul­ti­mately look for op­por­tu­ni­ties to get richer.

Democrats, in­clud­ing for­mer Pres­i­dent Barack Obama, have pro­posed higher taxes on in­vest­ment in­come. For ex­am­ple, the so-called Buf­fett Rule would have im­posed a min­i­mum rate of 30 per­cent on all tax­pay­ers with in­come of $1 mil­lion or more, no mat­ter where the money came from. That didn’t pass, but Congress did bump up the rate on cap­i­tal gains and div­i­dends from 15 per­cent to 20 per­cent. And it im­posed the net in­vest­ment in­come tax, or NIIT, a 3.8 per­cent levy on wealthy in­vestors, to help fund the Af­ford­able Care Act.

Ef­forts to kill the NIIT stalled in the Se­nate along with bids to re­peal the ACA, but some House Repub­li­cans aren’t giv­ing up.

Mean­while, the bot­tom 99 per­cent has been sav­ing less and less – a fac­tor contributing to grow­ing in­equal­ity along with stag­nant mid­dle-class wages and ris­ing debt lev­els.

While re­tail­ers com­plain there’s not enough con­sumer spend­ing, tril­lions of dol­lars are sit­ting in in­vest­ment ac­counts. Banks have a glut of de­posits, stock mar­ket val­u­a­tions are high, cor­po­ra­tions are flush with cash, and prom­i­nent in­vestors have more money than they know what to do with. Buf­fett’s cash pile is just shy of $100 bil­lion. The me­dian U.S. worker from age 55 to 64, how­ever, has just $15,000 saved in re­tire­ment ac­counts, ac­cord­ing to a re­cent study by New School for So­cial Re­search’s Schwartz Cen­ter for Eco­nomic Pol­icy Anal­y­sis.

Never mind the ar­gu­ments over what’s best for the econ­omy, though. There’s that ul­ti­mate Amer­i­can ques­tion about tax­a­tion we’re for­get­ting: What’s fair?

It’s not right, some con­ser­va­tives ar­gue, to tax in­vest­ments at all. It’s “dou­ble tax­a­tion” to take a bite out of money flow­ing from as­sets that were taxed when first earned. (Tech­ni­cally, it’s div­i­dends and gains that are taxed, not the orig­i­nal amount that’s saved, but the IRS makes no pro­vi­sion for in­fla­tion.)

Tax­ing work­ers more than in­vestors is fair, con­ser­va­tives also ar­gue, be­cause in­vestors and work­ers are re­ally the same peo­ple at dif­fer­ent stages of their lives. When you’re young, you save and pay high tax rates on your wages. When you’re old, you get to en­joy the lightly taxed pro­ceeds of that in­vested in­come.

The wrench in these ar­gu­ments is the mas­sive jump in in­her­ited Amer­i­can wealth driven by ris­ing in­come in­equal­ity and loose tax laws. In prac­tice, the per­son who ac­cu­mu­lates as­sets is of­ten not the per­son who spends them. Af­flu­ent re­tirees are in­creas­ingly re­luc­tant to even touch their nest eggs. A huge and dis­pro­por­tion­ate share of the na­tion’s largest for­tunes is in the hands of peo­ple in their 80s and 90s. And the es­tate tax is tar­geted for elim­i­na­tion by the White House.

As a re­sult, an un­prece­dented amount of wealth may soon be in­her­ited. The gen­er­a­tion on the re­ceiv­ing end of this fa­mil­ial largesse will get a tax break ev­ery time they cash in on the fruits of oth­ers’ la­bor.

Yes, many of these lucky heirs and heiresses go to work any­way, or con­trib­ute in other ways. Still, it’s hard to ar­gue that pro­duc­tive mem­bers of so­ci­ety – peo­ple like our ER doc­tor – should pay twice as much in taxes as peo­ple who sit around play­ing video games. But that’s the choice that un­der­lies Amer­ica’s tax code – and one that will fig­ure in the de­bate over how, or whether, to re­write it.

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