Our tax code needs an overhaul
The biggest winners from President Joe Biden’s $1.9 trillion coronavirus relief package, proportionately, will be the lowest- and second-lowestearning quintiles of U.S. households. The bill provides them with 2021 income increases of 20% and 9% over what they would otherwise have had, respectively. It’s a start on the giant task of reversing recent decades of upward redistribution of income; the next steps are to make permanent certain key provisions of this bill, such as an expanded earned-income tax credit — and then to take on the U.S. tax code.
Traditionally, the objective of tax reform has been to broaden the base of taxable income, both business and individual, by reducing loopholes, then apply a lower marginal rate to collect the same amount of revenue. This formula no longer applies to a society in which the federal government’s revenue base has been both hollowed out and rendered unduly favorable to the rich by repeated Republican tax cuts. In 2019, the government collected just 16.3% of gross domestic product while spending 21%. The latest tax cuts, enacted under President Donald Trump in 2017, and expiring for individuals in 2026, cost $1.5 trillion and conferred the biggest benefits on the top two quintiles of the income scale.
For the sake of both fiscal responsibility and equity, Mr. Biden and Democrats in Congress must start work on a postTrump tax reform agenda. Rather than revenue-neutrality, the goal should be to eliminate further loopholes that favor the wealthy, then apply somewhat higher marginal rates to that expanded base.
Probably the highest priority for such a reform agenda would be to reduce or eliminate the favorable treatment of dividends and capital gains, currently taxed at a top rate of 23.8%, relative to ordinary earned income, subject to a 37% top rate. That differential cost the Treasury $167.5 billion in fiscal 2021, according to the Tax Policy Center. The law that enables heirs to inherit large sums without paying tax on unrealized capital gains cost the Treasury $43.8 billion, while compounding and perpetuating wealth inequality.
The Trump tax law also created a brand-new 20% deduction for “qualified business income” that mostly favored upper-income individuals and cost $47.4 billion in fiscal 2021. The Trump bill also reduced the corporate tax rate to 21%, correcting a competitive disadvantage for U.S. firms relative to competitor nations — and probably overcorrecting. The rate could go up modestly and still remain near the 26.5% average of industrial nations (adjusted for GDP). The Congressional Budget Office says a 1 percentage point increase would raise $100 billion over 10 years.
It would be hard to write a tax bill as sweeping as Mr. Trump’s without making any improvements, and the measure did, by reducing the value of the mortgage interest deduction and the deduction for state and local taxes paid. The mortgage interest deduction, especially, encourages suburban sprawl without meaningfully improving homeownership opportunities for lower-income people; 95% of its remaining benefits, $29.5 billion in fiscal 2021, go to the top 25% of households, according to the Tax Policy Center.
Eliminating or further reducing these two provisions might sting upper-middle-class suburbanites, who have tended to vote Democratic lately; meanwhile, Republicans will seek to exploit any revenue-raising reform as liberal “tax and spend.” Yet an efficient, equality-promoting tax policy might be a political winner for Democrats: Stiffer taxation of the rich polls well. It would be necessary and appropriate even if it didn’t.