Ever Wonder What Good Tax Policy Looks Like?

Not that this will come as a surprise to you, but it’s pretty much the complete opposite of what George Bush, CNBC talking heads, and other misguided journalists with more mouth than brains say it is.  Here’s a taste from Gene Sperling’s comment/article in yesterday’s Financial Times:

How to reform a winner-takes-all economy

By Gene Sperling

Published: January 30 2006 20:51 | Last updated: January 30 2006 20:51

Two of President George W. Bush’s economic goals in his State of the Union address on Tuesday will be to convince anxious American workers that they should not lose faith in an open, global economy and that they should support tax reform that moves the

US

closer to eliminating all taxation on investment. What must be recognised, however, is the growing degree to which these two policy goals are in conflict. While the president is essentially right to stress that we cannot turn our back on open markets and globalisation, his rhetoric and policy framework ignore the increasing winner-takes-all and loser-loses-all tendencies in the

US

economy.

Last year, the wealth of the richest 400 Americans climbed to nearly double the 1982 level as a share of

US

gross domestic product; but we also saw those suffering losses taking steeper falls. Jacob Hacker of

Yale

University

has found that when

US

families suffer a drop in income, they face 40 per cent declines on average. At the same time, Lawrence Katz, the Harvard economist, has documented the increasing polarisation in the

US

labour market as earnings grow at the high end while opportunities for middle-class jobs dry up.

Such extreme gains and losses are often due to significant differences in education or skill but as Robert Shiller, the Yale economist, has written, the unpredictability, speed and vastness of global markets have also enhanced the role of luck, or slight timing advantages, in determining who falls into the winners’ or losers’ circles.

Consider twin brothers with equivalent education and work histories, who each took good jobs six years ago – one, fortunately, with Google, the other, less fortunately, with Lucent. Since the investment community was still betting on Lucent in early 2000 and Google was just getting established, it is hard to say that skill led one worker to $2m in stock options and the other to a pink slip and a job retraining programme.

Even though such differential outcomes can seem unfair to many, this is a price we gladly pay for a free market economy. Our progressive tax system has been part of the way the

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has balanced the desire for a free economy with the values of equity. Yet, eliminating taxation on investment income exacerbates – not moderates – winner-takes-all outcomes. Consider our brothers. If the one at Lucent finds a new, $60,000 a year job, he could pay about 25 per cent in federal taxes (including payroll taxes). Yet, under Mr Bush’s tax policy, if his twin at Google can find a solid 6 per cent return investing his $2m, he can make at least $120,000 a year while paying a lower 15 per cent tax rate. If we move closer to Mr Bush’s vision of zero taxes on dividends, capital gains and inheritances, the Google twin could watch his gains accumulate tax-free year after year and then pass on his wealth to an heir, tax free.

Moving the

US

tax code in this direction is wrongheaded on both economic growth and value grounds. Progressive taxation is critical to

marshall

the resources to ensure that those who end up at Lucent or

Delphi

have the support and education to get second and third chances in the global economy. Without a greater cushion against falls in the global economy, workers may opt to take less risk on their future, just as entrepreneurs would risk less if they thought a single bankruptcy would land them in debtors’ prison.

Furthermore, a tax system that eases the Googler’s tax-free wealth accumulation but forces his brother to pay higher taxes on income earned through labour betrays American values that honour the hard work of the middle class over policies that perpetuate an economic elite. A better tax reform plan would prevent the most privileged Americans from paying lower taxes on their investment than typical families pay on their wages, while encouraging savings and wealth creation for struggling workers. We could start by ending our current system of giving those in the highest tax brackets more than twice the tax deduction of typical workers and creating a flat tax incentive for savings – a 30 per cent credit for everyone. More important, we should provide automatic matching credits for moderate income workers to save – essentially creating a universal 401(k) plan for retirement savings accounts for all Americans.

So if the president really wants to build support for greater openness in the economy, he needs to focus on tax reform that expands the winners’ circle, not reform that expands the current winners’ fortunes.

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