Major corporations are rich with cash right now. The stock market is hitting new highs. And the wealthiest of the wealthy have become even wealthier.
It is time to have a rational discussion about the tax rate on capital gains and dividends.
There’s a crisis in government finances. Interest payments on our current national are $250 billion annually. This level is equivalent to about $4,000 for each of approximately 60 million taxpaying households in the U.S.
While households currently pay $4,000 on average to support past spending, this amount will likely rise.
First, there’s no plan yet to move federal spending in line with revenue. The level of debt is expected to continue to rise much faster than increases in prices, wages and our ability to pay.
Second, the average cost of borrowing by the federal government is currently well below 2 percent. Over the next five years, as we very slowly recover from the Great Recession and as unemployment moves toward 5 percent, we can expect interest rates to double or triple. When they do, and we finally begin to run a balanced budget, the average federal interest burden per household will probably well exceed $10,000.
At that point, interest on our debt will emerge as the largest budget item, assuming the government share of health-care costs or our looming Social Security crisis does not explode first.
There’s nothing we can do about past excesses. These were premised on the belief that we can grow so fantastically that our debt can be paid easily by our children. Our desire to have fewer children, our complacency as the sole economic superpower, and our belief that wealth will continue to come easily have frustrated economic growth. Add to that challenges from global warming and our failure to manage entitlements.
While our children can point the finger at past generations, there’s little sense blaming each other. We are responsible for this mess. We should not spend beyond our means unless we leave great legacies in infrastructure and a bright future.
Finger pointing is designed to form coalitions that lobby for others to pay for past excesses. Some argue the rich must pay more taxes. Perhaps they are correct.
Others point to the 47 percent of households that pay no federal income tax. This group correctly notes that the top 10 percent of households already pay more than 70 percent of taxes. They make a good point, too.
A more productive exercise is to recognize that we all will have to pay more. Perhaps the tax rate should go up a few points across the board. The most effective reform, though, is to ask our tax code to stop doling out advantages to various constituencies.
One place to start, right after the home mortgage interest deduction, is the capital gains and dividends tax. Currently, these rates are less than half the marginal rate for the ordinary income of upper middle class households.
There is some rationale for a lower capital gains and dividends tax rate. Corporations that cannot afford huge tax-avoidance legal departments pay a corporate income tax of more than 35 percent before deductions. The shareholders of these corporations then pay taxes twice — at the corporate level, then at the household level. However, the effective corporate tax rate, after deductions, is between 10 and 15 percent.
This effective corporate tax rate of less than 15 percent is argued to compensate for the costs incurred when companies use their limited liability bankruptcy protection. Even so, the combined effective tax rate for corporate earnings of less than 30 percent is below the marginal tax rate of most investors’ earned income.
Let’s begin by lowering the corporate tax rate to 10 or 15 percent, as they have in Canada. After all, corporate taxes only raise about 10 percent of federal revenue. And, we should be rid of corporate tax preferences that are gamed in myriad ways by clever lawyers. We would find, as Ireland found and Canada will too, that a lower corporate tax rate and simpler tax regime will attract businesses and jobs.
We should treat all income as income, regardless of source. The fear some have that a rise in our historically low dividends tax rates will discourage investment will be balanced by decreased corporate taxation. Meanwhile, employment will grow and the system will be more fair.
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. Follow his tweets at @ColinRead2040.