How to tax the rich in this political climate
Feb 1, 2012

How to tax the rich in this political climate

There is a lot of agreement that the rich pay too little of their wealth, that inequality has sharply risen over the last three decades benefiting the rich tremendously, and that the rich in America now enjoy a privileged status made possibly by their influence in politics. That GOP frontrunner Mitt Romney has been revealed to pay only 14% in taxes has undoubtedly been very damaging to him, and Obama invited Warren Buffet's secretary to this years state of the union to hammer in the point that he pays less than her in taxes.

However, there are better ways and worse ways to go about making the rich pair their "fare share", as Obama likes to say. By far the simplest ways to raise taxes are merely to raise the top marginal tax rates. Conversely, as George Bush Jr. recognized, the fastest way to lower the taxes is to reduce the marginal tax rates as was done in the Bush Tax Cuts. But is this the best way?

The reason that Mitt Romney and Warren Buffet pay so little in taxes is because the tax code has an enormous number of loopholes such as the the issue of using capital gains taxes, not income taxes, on carried interest. In fact, as the Economist notes, the entire complicated mess of a tax code is inundated with ways that allow companies and individuals to lower their net effective tax rates. Further, because of all these facets, it is very distorting on the economy as people put their money into vehicles for the single purpose of reducing their tax rates and not because they are necessarily the optimally efficient market outcome.

When the tax code is as convoluted as it is, raising marginal tax rates are not even particularly effective. The predominant effect of raising them is to have people shift their income and investments into one of the many loopholes available to avoid the tax rates. Net revenue will increase, but nowhere as near as one might expect and there will be significant distortions. So not only is it better to fix the tax code as a way to raise revenues, it is also better to do this as a means to be able to more effectively change marginal tax rates later.

There remains, however, one enormous stumbling block: that Congress is broken. In a functioning legislature, it would be possible for technocrats to set aside their partisan differences and engage in a genuine look through the tax code. Non-partisan, non-vested experts (such as the CBO or academics) could analyze the code and advise on the most effective loopholes and deductions that would balance the need for increased efficiency and revenue. One could even imagine the partisans agreeing to a new revenue number and then aim to come up with the most effective way to come up with that new number through changes of that tax code. Simplifying the tax code has always been a Republican idea, and if it is done so that it increases the progressivity of our tax system then Democrats can come on board.

Such a suggestion is impossible in today's politics. Even the most basic things like appointing government personnel can't get through Senate filibuster. There isn't intelligent, reasoned, or technocratic debate over the details going on in the House or the Senate. It is a raucous, hyperpartisan, polarization to extremes that cannot come together for even the most basic and obvious of answers. Throughout all of this, is the omnipresent influence from the vested interests. For any line in the tax code that politicians try to change that affects a vested interest, the lobbyists will be present, the phone calls to politicians will be made with promises to extend or cut back on campaign funding, and ultimately that line will be ignored. Lines that affect the rest of us, without the backing of the vested interests, will survive or fail based on the outcome of the hyper partisan situation.

This is not the kind of political climate for an intelligent modification of the details of the tax code. It is just not possible, regardless of whether we think this is the best way or not. Instead, the only thing left is to play the game as Obama is playing it. Soundbite up a 30 second proposal on raising tax rates on the rich, push it through the media as a populist measure, and run an entire Presidential campaign on the topic. It might work. It might get won this way, and Obama's side of the hyperpartisan game may win out by gaining enough support to win an election and then force the issue. It won't be the most effective victory, but it will raise revenue from the rich and that is a win.

The ironic thing is that Democrats have to do literally nothing to make this happen. The Bush Tax Cuts are set to expire on Jan 1st 2013. If the entire legislative process just shuts down, the rates go up. And the people are overwhelmingly on Obama's side on this issue which is a winning issue politically for him and, just possibly, will allow him to win the election. So we have a very effective path forward for the second rate option of just raising the marginal tax rates. And we have almost no possible path forward for adjusting the tax code to accomplish the same revenue increases more effectively.

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Anyong said...

Loop Holes are deliberately made to sheild the's a great way to garner votes and money support the next time round.

Anonymous said...

The tax code isn't for the rich, it's for the peasants ... as it has always been and no amount of debate or legislation will ever change that.

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