The Great Tax Debate
For the first time since 2010, taxes are a top-priority issue in American politics. During a recent campaign video, President Obama called on Congress to renew income tax cuts for filers earning less than $250,000 a year.
Not only does this announcement relight a debate that was only postponed two years ago, but it turns taxes into a divisive election issue. This means that along with income taxes, the other major taxes in the United States on corporations, payrolls, and capital gains could be in play for reform. Whichever party wins in November is poised to go on the offensive and determine the long-term future of American tax policy.
Income and Capital Gains Tax
The individual income tax is at the heart of the current argument. It is split into six brackets, ranging from 10 percent on the first $8,700 of income to 35 percent on money earned over the lofty threshold of $388,350. Obama is targeting the pinnacle bracket. Under his plan, it would rise to 39.5 percent, while the tax levels on the lower brackets would remain where they are. Republicans in Congress also support cutting the lower brackets, but they would keep the highest rate at 35.
Raw numbers aside, though, the central question in this debate is about the tax burden. No matter what one bracket pays, it will always pay more or less money relative to the others, and according to Hauser’s Law, tax revenues will never be higher than 21 percent of gross domestic product. President Obama would shift the burden towards America’s richest earners, the so-called “1 percent,” who he believes can spare the most income to pay down the debt.
Fiscal conservatives, however, don’t believe that the rich should be the only ones closing the gap.
“I think taxes ought to be lower for everyone,” said Mike Stenhouse, CEO of the Rhode Island Center for Freedom and Prosperity in an interview with the Brown Politics Memo. “It’s a partnership. You need all components.”
While the top bracket of income tax has fallen from over 90 percent in the 1960s to its current level of 35 percent, the portion of revenue it provides is rising, a figure which reflects both the progressive nature of the US tax system and growing income inequality.
Whenever taxes are paid, though, they are also evaded.
The US capital gains tax on property and investments is where accusations of dodging most often start to surface. The tax rate on a short-term capital gain — say, a stock or piece of real estate held for under a year that rises in value — is the same as regular income tax. For capital held for longer than a year, though, the rate is cut nearly in half. Furthermore, a capital loss, which occurs when property loses value, can nullify payment on the gains and be carried through multiple years to protect against taxation. This particular tactic has gained notoriety by helping some of America’s wealthiest taxpayers guard their money from the Internal Revenue Service.
“The top 1 percent pay the lion’s share of all taxes,” noted Mark Blyth, a professor of international political economy at Brown University, “but they also avoid paying the lion’s share.”
In a recent disclosure, the IRS revealed that in 2009, 122 of the 400 highest earners in the country paid 15 percent or less in taxes. Republican presidential candidate Mitt Romney earned $21.7 million in 2010, but paid only 13.9 percent in taxes. This is troubling news for an administration strapped for tax revenue and with limited prospects for legislative action. Only if the Democrats win spectacularly this November will they have the political capital to tackle this problem, and even then they will face stiff resistance.
“The more money you have as an individual,” Blyth observed somberly, “the more you can avoid paying taxes.”
Corporate Taxes and Payroll Taxes
Not to be forgotten are these last two cornerstones of the US tax system, which contributed 9 and 40 percent respectively of US federal revenues in 2010. While neither are directly involved in the current debate, the winning party this November could gain the momentum to reform one, if not both, in the upcoming congressional term.
The corporate tax in the United States is one of the steepest in the world, with a combined state and federal rate of 39.2 percent at the top bracket. As a result, many of the largest American companies, including Internet juggernaut Google, report their earnings through subsidiaries in low-tax countries such as Ireland, the Netherlands, and Bermuda. This costs the US nearly $60 billion per year in avoided payments.
The obvious solution of lowering the corporate tax rate, though, may not work. Blyth believes the problem is institutional, on a worldwide scale.
“Show me a corporation that doesn’t try to minimize its taxes,” he said. “This is a global phenomenon. It says that the [US] tax rate is meaningless.”
No matter how low the US sets its corporate tax rates, they could never feasibly be low enough to compete with tax shelters abroad. With this in mind, a reform of the corporate tax system would have to be a global procedure, carried out through an international organization such as the G20. Only through a multilateral reconciliation of tax rates could the problem of tax sheltering be properly taken care of.
Supporters of tax reform, however, might try to tackle the payroll tax first, which is a more domestic issue. The second-largest source of government revenue after the income tax, the US payroll tax provides money for Social Security and Medicare. While it is a relatively low tax, only 13.3 percent split between employers and their employees, the programs it funds are in trouble.
A report by the Trustees of Social Security and Medicare predicts that the nation’s two largest entitlement programs will be out of money within 21 years. The Social Security trust fund is set to run dry by 2033, and Medicare will be out even sooner, by 2024. Some will not consider changing the payroll tax without first addressing these larger problems.
“I think reform is necessary,” stated Stenhouse, “before we talk about raising or lowering taxes.”
With Romney’s selection of House Budget Committee chairman Paul Ryan (R-WI) as his running mate, the subject of welfare reform could become a central, perhaps even decisive, election issue. No matter how the election turns out, though, the futures of payroll taxes and entitlement programs are inseparably linked. A repair of one will lead to radical change in the other.
Prospects for Large-Scale Overhaul
With the combined pull of income taxes, capital gains taxes, and payroll taxes, some families can end up paying almost half their yearly earnings to the government. Out of this fiscal drain arose the idea of a comprehensive bill that would streamline individual taxes in the United States. Deductions would be minimized, rates would be lowered, and paying would be simpler for all Americans. But what are the realistic chances of such a reform passing?
On the positive side, it has been supported by members of both major political parties. President Obama is on the record calling for tax simplification, as is Rhode Island’s own Republican candidate for Congress, Brendan Doherty. In an age of division and Congressional contrariness, bipartisan support is a step in the right direction.
On the other hand, though, simplification could arouse the activism of the wealthy, some of whom rely on deductions and tax shifting to reduce what they pay. Their clout could easily snuff out a promising reform bill.
“I don’t think there’s any possibility of reform,” asserted Blyth. “People would defend their privilege.”
Given the uncertain outlook for total tax overhaul, the future of taxes in the United States could be decided much sooner, perhaps even by this upcoming election. Americans, then, must be careful with their votes this November — it might determine what ends up on their tax forms next April.
photo by Peter Souza