Bell Curve The Law Talking Guy Raised by Republicans U.S. West
Well, he's kind of had it in for me ever since I accidentally ran over his dog. Actually, replace "accidentally" with "repeatedly," and replace "dog" with "son."

Wednesday, April 05, 2006

Restoring the Incentive to Work

Bush's tax cuts are fully implemented this year, including reducing the income tax on dividends to 15% (capital gains also top out at 15% now). Thus, a wealthy person who works pays 35% on the marginal dollar, but only 15% for returns on investments. This will lead to pernicious side effects.

To begin with, more and more wealthy people will use various tax devices to recharacterize income from wages to investment. A boon for tax lawyers, to be sure, and a reduction in transparency for accounting purposes. This sort of strategy benefits those who can afford tax lawyers above all. It will also result in a decline in revenue for the federal government, resulting in reduced services (thus higher out of pocket costs) for the rest of us.

Second, this incentive structure discourages work at the high end. For example, doctors now have a strong incentive to retire and invest rather than continue working. Republicans have always claimed that high taxation discourages work, which is normally a phony argument for tax cuts. All things being equal, a person earning $500,000/year will not say "no" to more money, even if taxed at a high rate. But now the Bush/Republican policies have made working much more expensive than investing -- all things are not equal.

Third, a scheme that pushes investing and dividends over work will provide an additional incentive to speculation in the stock market, day trading, and other unproductive activities.

Fourth, this devalues labor overall. Why should hard working people be taxed higher than the idle rich? Why should the tax code favor investment, and thereby punish working? The view that capital is much more important than labor (much more deserving of being honored) is a very right-wing Republican view, one that Democrats certainly should not endorse.

How would it affect our economy if all income taxes from wages were set at a flat rate of 10% with a $20,000 standard deduction, but investment and dividend income were taxed at the current progressive rates applied to income (e.g., marginal rate of 35%)? This would make labor cheaper and dramatically increase consumer spending, which is supposedly responsible for 2/3 the economic activity in the country. Wouldn't consumer spending drive investment as surely as low tax rates, but with the added bonus of immmediately raising living standards for the vast majority (the real goal, I should hope, of any economic policy)? I resent the fact that I pay much higher taxes now than a trust fund babe.

Honoring labor in the tax code is not a quaint idea, but may be the way for liberals to re-connect with the working classes who have been distracted by the social conservative agenda into voting for lower taxes for their bosses, paid for by less government service (higher cost of secondary education, worse K-12 schools, worse roads = more wear and tear on vehicles, closure of hospitals, etc.). Thoughts? Anybody willing to buck the Standard Economic Orthodoxy that says that cutting taxes on investment is the only option for economic growth?

23 comments:

Dr. Strangelove said...

LTG makes some very good points. Here are my thoughts on his (I am keeping to the numbering he introduced.)

1. How does one characterize "wages" as "investment"? I did my taxes last night, and I am fairly certain TurboTax did not give me the option of shaving some income off my W-2 forms and calling it "investment." Unless I am mistaken, the opaque world LTG refers to is the mythical land of accounting where one-man corporations and living trusts roam free. This is not where most of us reside. It's hard to define "income" for people when it's all shifting zeroes and never gets spent on anything tangible--and so rich people get to define it however they like. But then, we all knew the rules never did apply to the rich anyhow. (My point is that I agree with LTG, and I think he is touching on part of a larger problem. It may be that we need a wealth tax for some people too...?)

2. Ah yes, the old Republican argument that to get people to work harder, the poor need the spur of poverty while the rich need the spur of wealth (some famous economist said it that way... Galbraith, maybe?) There is a counter-argument, however, that most of us who invest money have already paid taxes on that money, because we earned it in wages--so it feels like you are kind of taxing us again.

3. "Day trading" as an "unproductive activity"... no doubt you have similar feelings about arbitrage in general! I agree--but some feel another way to look at lowering taxes on investment is that it would encourage saving, which is desirable. How different is it, really, to put your earnings in the bank or in a mutual fund? Doesn't it all end up in the hands of the big corporations anyhow?

4. The "Standard Economic Orthodoxy" says, of course, that to tax investment/savings progressively would asphyxiate the markets. But it is quite a leap to go from there to claim that cutting taxes on the rich would help the economy--as though somehow their tax money currently fell into a black hole and could therefore be withheld for free.

Many people like to say that the government is a poor investor of our money... but is it? The government buys roads, schools, police, and fire protection--we buy yachts and designer jeans (well, the rich do.) The truth is that government investment in common, public goods is vital, and a strong program of public investment--like the kind Pat Brown did as governor of California--is the best way to help the economy.

As for Bush's tax cuts, Edna. St. Vincent Millay expressed it best:

"My candle burns at both ends;
It will not last the night;
But ah, my foes, and oh, my friends ­
It gives a lovely light!"

Anonymous said...

One easy way, off the top of my head, to characterize wages as investment income is for a CEO to receive a big chunk of stock, perhaps a special class of stock, at the time of his job offer, and then receive payments in terms of dividends (very high). Nobody bothered with this sort of thing while dividends were taxed like wages.

Would restoring taxes on investment to levels in the go-go 1990s really hurt investment? Did it hurt investment in the 1990s? What if, by doing so, you could open up more consumer spending. Wouldn't that also spur the economy AND immediately benefit standards of living?

 

// posted by LTG

Anonymous said...

"Labor is prior to, and independent of, capital. Capital is only the fruit of labor, and could never have existed if Labor had not first existed. Labor is superior to capital, and deserves much the higher consideration." - Abraham Lincoln   

// posted by Raised By Republicans

Anonymous said...

My prefernce would be for a tax system that didn't penalize working people at the expense of investors but one that didn't penalize investors either. What we should be taxing is consumption of luxury goods. So we should be taxing the daylights out of SUVs and such. We should consider having a more agressively progressive tax rate on property too (i.e. increasing marginal tax rates based on the value of the property). Second homes should be taxed like crazy. I'm not a tax specialist so my proposed approach may not get the goal I'm advocating but you can get the idea.

What we want is an economy where people who can work do work and people who have lots of extra money put it back into investments rather than cashing it out and spending it on toys. Investment isn't the worst thing we could encourage. Consumption is. 

// posted by Raised By Republicans

Anonymous said...

Why tax consumption? I thought consumption drove economic growth. It seems that you want people to save that money, so that it can be invested. Why attack luxury goods? Doesn't that distort the market in odd ways? I mean, why is spending money on SUVs (which drives good paying manufacturing jobs) worse than spending money on smaller cars (which produce much less profit for the car industry)? My thought experiment was that if we had to penalize one group, penalize investors rather than employees. But the better policy would be to tax all income (including, IMHO, inherited money - i.e., money you didn't do a goddamn thing for) at exactly the same rate.

I agree with one thing: tax second homes. We have a great housing shortage, and speculation in housing, as well as rich folks purchasing various pieds-a-terre, has been driving up prices. Housing differs from most other goods in that its supply is very inelastic. Land is finite; zoning regulations reduce flexibility as well. In CA, prop 13 makes things even worse, by giving a massive disincentive to selling one's home: the law is that an existing million dollar home might be taxed at 1979 rates ($1,000 a year or less(!)) but if you sold it and bought another million dollar home, taxes would rocket up to $15-$20K/year. So in CA, houses that would be ordinarily torn down and redeveloped into more affordable condos just remain as unaffordable small houses.
 

// posted by LTG

Anonymous said...

I tend to agree with LTG and I feel his pain in terms of the tax burden. As a single person with no deduction, I am left to shovel as much as I can into a retirement plan so that I can be taxed later rather than sooner. This means I must have faith in markets and compound interest. Either that, or I have to hope that by the time I retire, the tax rules might have changed.

I think you have to distinguish somehow between small investors and "Wall Streeters". Most Americans are small time investors trying to save up for retirement or a house payment. And there are more investors among the middle class now than ever before. It isn't just money for money's sake. So you really have to be careful how you treat taxes on these investors. I also think that you have to make exemptions for certain investment instraments.

Consdier that we now have the first generation of 401Kers retiring. 401Ks are investment instraments that will be heavily taxed and that are untested in the market. I say make 401Ks tax free, or at least lower the rate on them. Why tax them 30% at the time of withdraw? Since pensions are drying up, wouldn't it be better for the goverment, and perhaps cheaper to allow me to save for my retirment tax free than depending on an overstretched government pension system that is now picking up the legacy costs for every struggling company in the country? This way, I can better supplement what is left of social security when I retire at 75.;-)

If you want to spur savings, RBR, I would say that you give favorable interest rates on CDs and savings accounts, sort of like ING Orange is trying to do. (In the interest of full disclosure, I hold an account with them.) Then create a progressive tax system to deal with the interest. Say your start taxing on holdings over $20-30K and then tax in a progressive way as was proposed above. Investment is another form of income for may middle class Americans, and usually comes from after-tax dollars, and shouldn't treated differently than income.

I think LTG objects to what looks like a tax shelter through investment. It is one thing to invest in national infrastructure, quite another to hide income in the Caymans. I think LTG is focused on the big investors who benefit from a favorable tax code. There is no doubt in anyone's mind that the current tax system benefits investors (of substantial means) and big business. It isn't just about who can afford the tax attorney. Its the laws themselves. I think we need to have a flat, soild 15% rate on big businesses, like in the good old days. No exemptions. When oil companies and big pharma can rake in 20% margins and claim they need that for research and exploration, there is something seriously wrong. Frontline did a very interesting episode called "Tax Me If You Can" which you can download and watch for free. In iterviews IRS officials said that 1: middle class and poorer Americans get audited more often than higher income Americans 2: Big Business used to pay around 15% of the taxes coming into the treasury, now they pay a mere 5%-7%. Someone has to make up the difference and that someone is us, middle class America.

The current tax system has so many exemptions and loopholes that it isn't progressive any longer. And Congress needs to qit tinkering with it as a backdoor way of shutting up special interests.

 

// posted by UNwest

Anonymous said...

Given the limits on contributions, I concur 100% with UNWest that 401Ks should not be taxed at all on withdrawal. $15K/year is not about fatcats getting rich, but a modest way to help retirement. Perhaps we could go further and say that, after age 65, the personal exemption increases to $40,000?

Just imagine how tax policy could be benefitting ordinary Americans if we weren't so incredibly busy building a tax system that puts the highest burdens on the middle class to fund tax breaks for the rich and big business. 

// posted by LTG

Anonymous said...

I just think that an investment based economy is better than a consumption based one. Right now we have enormous tax incentives to turn all our profits (whether from work or investments) into luxury items like big screen TVs, tricked out H2s and BMWs etc. There are countries in the world where tax incentives are such that capital is constantly re-invested, not extracted by the elite to finance their ever grander life styles. 

// posted by Raised By Republicans

Anonymous said...

Well, RBR, that is what tax cuts and low interest rates do. The problem is that "investing" seems to be limited in peoples' minds to stocks,bonds, and real estate. I see investing as that stuff plus savings accounts, CDs. Poor, workign class people, try to use low risk investments like CDs and savings accounts as well as home equity. But when there is no incentive to save, on only the small investors get punished with taxes, then you have an economy based on rewarding upper class investors at the expense of the smaller investors. Can you say "Ponzie scheme"?.

So I reiterate my point- reward smaller investors since they are the ones really holding up the house of cards (just like small business are the biggest employers) and take it out of the wealther investors. I resent the fact that the government sees fit to tax every dollar I touch but lets the wealthy get off with hardly a notice. And then, to make it all worse, rather than turning my dollars into some benefit for my community, they use it to go fight unnecessary wars. 

// posted by USWest

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