November 08, 2012
Setting the Table for Tax Negotiations
The looming “fiscal cliff” presents an opportunity for a new grand bargain: make taxes flatter, but make spending more progressive.
In July 2011, President Obama and Speaker John A. Boehner came close to striking a deal. It did not work out. During the presidential election campaign, each party retreated to its starting position, with the president pushing for tax increases on those making more than $250,000, and Republicans advocating spending cuts. So what now?
With only a few weeks before we reach that so-called fiscal cliff – automatic spending cuts and tax increases – the most likely solution is a temporary fix that, at best, would make a down payment on future changes.
But the negotiations also provide an opportunity to prepare the electorate for a broader discussion of tax and fiscal policy that should take place over the next two years.
There are reasons to be optimistic. A tax overhaul is more likely to happen in a president’s second term, as he has more leeway to pressure his own party to compromise. Max Baucus, a Democrat and chairman of the Senate Finance Committee, and Dave Camp, a Republican and chairman of the House Ways and Means Committee, have worked together to hold a series of joint hearings in anticipation of possible legislative action.
To be sure, the opportunity set for change in the tax law is limited by each party’s core principles. For Democrats, preserving a safety net for the most vulnerable is a priority. For Republicans, cutting spending and keeping tax rates low are seen as critical to economic growth.
Is there a way forward? One approach to consider is flatter taxes (a less progressive rate structure on a broader base) and more progressive spending. As Eric M. Zolt, a law professor at the University of California, Los Angeles, explains in a draft paper, we need to stop thinking about taxing the rich “as the only, or perhaps even the primary, way to increase social spending programs.”
Instead, he suggests, we may need less progressive taxes, or even regressive taxes, to finance more progressive spending programs. Mr. Zolt notes that outside the United States, “this is hardly a new insight.”
The Nordic and Western European countries for the most part refrain from heavily taxing the rich. They instead support progressive spending programs with policies like consumption taxes that are more regressive than those in the United States.
It would be difficult for President Obama to reverse course completely and not increase the portion of the tax burden that falls on the rich. But we do not have to raise tax revenue by raising rates. Broadening the base is the wiser choice.
Here is what one version might look like. The tax side of the equation focuses on the tax base. Keep ordinary income rates where they are now, and drop the corporate rate to 25 percent. Increase the capital gains rate to 20 percent, which Wall Street already expects, or 25 percent. Adjust or create limits on some of the tax breaks that provide benefits without regard to income, like the home mortgage interest deduction and the exclusion of employer-financed health care insurance premiums.
The spending side of the equation could address inequality. Through spending, not taxes, focus on bringing the bottom up, not knocking the top down. Aim government spending toward the poor and most vulnerable. Focus on programs that improve economic mobility, like job training and support for technical education.
Right now, government spending is only mildly progressive. Social Security and Medicare are mostly intergenerational transfers, not redistributive across income groups. Government subsidies for housing, retirement saving, health care and student loans could be better designed to help the poor and lower middle class. Too much of our government spending amounts to a cross-subsidization program, as federal tax revenue is used to subsidize each state’s favorite industry.
Would this approach of flatter taxes and more progressive spending work politically? Maybe. Each side gets something.
For liberals, concentrating spending cuts on the wealthy and preserving programs for the poor protects the most vulnerable, improves the overall progressivity of the tax-and-transfer system, and better reduces inequality compared to raising the top tax rate. Conservatives would applaud no increase in tax rates, only a small increase in tax revenue, and a somewhat smaller government.
The key is for both sides to embrace economic mobility as a litmus test for spending programs. Take education, for example. Subsidizing school lunches for needy elementary school children makes sense; it is hard to learn when you are hungry. Subsidizing technical training in community colleges makes sense; we should make sure that our citizens can fill the jobs that exist here and now, and in the future.
By contrast, providing federal student loans for law school tuition is puzzling. Outside of the top 20 or so law schools, going to law school is hardly a certain step up the economic ladder.
New York City’s continued success as a global financial capital depends in part on how we, as a country, deal with inequality. Our comfort level with inequality depends on whether financial success is earned by merit rather than political connections or the happenstance of birth. Economic mobility over generations is the best measure of how much inequality we should embrace, and by that measure we are behind all developed countries except Britain.
Wall Street philanthropists understand that merit and economic mobility are part of the social compact that makes their wealth deserved. Hedge fund managers dominate the boards of many charter schools, which they support as a method of improving economic mobility while sidestepping the institutional dysfunction of local politics.
And they would certainly support flatter taxes.
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