Much of the rhetoric is this national election comes down to tax policy. While taxes are often discussed in campaigns, the huge and growing public debt, the stubborn Great Recession, and our worsening income distribution has brought tax policy to the forefront.
Economists span the spectrum from liberalism to conservatism. When it comes to tax policy, they speak in a remarkably united voice. Politicians often detest economists’ prescriptions because they are designed with the long term in mind, while politics is decidedly short term.
Policies designed to spur economic growth and efficiency will yield dividends to us all. But, these dividends seem less obvious than their various costs. Taxpayers are troubled when economists recommend we give up some deductions of dubious economic rationale but rather the result of political pandering.
Economists’ policies are designed for efficiency. Economists see tax policy as a tide that will raise all ships, not raise some by sinking others. We view tax policy not as a tool for class warfare, from either the perspective of the 1 percent or the 99 percent.
I begin with recommendations designed to make the economy more efficient.
We can take our first cue from Canada, a nation with a more coherent economic policy than ours. Their corporate tax rate is now 15 percent, which is on the low side, but certainly not the lowest of prosperous and globally competitive nations. Their rationale is that the lower tax rate allows Canadians to consume products at a lower cost. Meanwhile, the nation is more globally competitive and export-oriented. A reduction in the corporate tax rate acts like an export tariff reduction. Economists universally agree that such tariffs make no sense at all.
If the profits of corporations are reduced, that tax revenue is better recovered by taxing those who command a share of profits through dividends and capital gains. In fact, by reducing the corporate tax and increasing dividends and corporate capital gains taxes, we can spur our export industry and domestic consumption without increasing the after-tax income of the wealthy. We simply tax these earnings at a later stage. Meanwhile, the economy grows. That is a no-brainer, but it smacks in the face of what some deem to be fair. There, we cut off our nose to spite our face. Canada does not, though.
The second set of policies are deductions for households and preferences for corporations. Most economists would vastly reduce deductions. If tax revenue neutrality is a goal, this could reduce the overall tax rate.
Especially confusing to economists is the deduction for mortgage interest, as much as every homeowner likes it. Consider the plight of the median income household, which earned $50,502 in 2011. That income allows a family to support about $15,000 in mortgage interest payments each year, according to FHA guidelines. With a $15,000 mortgage interest deduction, perhaps another $10,000 in New York state and local income, property and school taxes, and the personal exemptions for a family of four, the household will pay a marginal tax rate of 10 percent. In effect, their mortgage interest and state and local taxes are subsidized at a rate of 10 percent.
The household will receive $1,500 in reduced taxes for the mortgage interest deduction.
Households with a higher annual income of $100,000 that own the same home will be in the 25 percent tax bracket and will receive a 25 percent subsidy, or a $2,500 refund. The subsidy rises to about 33 percent for a household earning a quarter million dollars per year, and rises only a little beyond that.
In other words, the percentage and absolute home ownership subsidy increases with wealth. Home ownership deduction reform will have little effect on low-income households or on the price of modest homes, but may reduce the value of higher-end homes and the higher income homeowners who currently enjoy the largest subsidies.
Romney addresses the deductions issue by recommending they be phased out for higher income earners. Obama has not articulated a deductions reform policy.
The policies I have outlined can all be designed to be revenue neutral. In fact, by increasing the efficiency of the tax code, they contribute to growth, enhance revenue and reduce the deficit. If we wish to reduce the deficit and debt still further, we can look for places within the spectrum of incomes to increase tax revenue without significantly decreasing consumption or job creation.
Even billionaires like Warren Buffett or Michael Bloomberg recognize that our system can afford perhaps a ten percentage point increase in the tax rate for those making a million dollars per year without affecting the rate of job creation. Obama has embraced Buffett’s prescription while Romney remains wed to the conservative status quo.
At the same time, we should provide incentives for those who reinvest their incomes in new plants and equipment and generate new jobs. We have the tools to differentiate between the incomes of job creators and the incomes of passive investors and speculators. We can use those tools to preserve and enhance efficiency while we increase tax revenue and reduce our nation’s debt, even if neither candidate has proposed we become more creative with our tax policy. All we need is some political pragmatism and courage.
Colin Read contributors to Bloomberg.com and has published eight books with MacMillan Palgrave Press. He chairs the Department of Finance and Economics at SUNY Plattsburgh.