By Tom Pallow of Third Way Progressives, 1/17/11, firstname.lastname@example.org & 202-903-1133
Our tax reform plan is the only plan that would simultaneously increase private sector job growth and government revenues. To read specifically why this is so go down to the paper in the Weekly Blog section of our website ThirdWayProgressives.org and read the paper entitled, “Why the Deficit Commission and Senator Warner are Wrong on Tax Policy and Our Tax Plan is Right.” This paper also addresses President Obama’s tax proposals, and on our website you can read about our entire tax reform, industrial policy, and budget plans and ideas.
The most important thing to keep in mind is that our tax plan does by far the best job of addressing America’s two most prominent needs. Every poll on the subject shows, and by large margins, that Americans are most concerned about lowering our unemployment rate and lowering our federal deficit. Given this desire to reduce our deficit, axiomatically it follows that most of the jobs that we create must come from the private sector.
Our overall tax plan would raise $1.25 trillion over 10 years versus $925 billion over 10 years for the Deficit Commission’s tax plan and $700 billion over 10 years for President Obama’s tax plan. Further, if these tax plans were dynamically scored, our plan would greatly increase its revenue generation when compared to the other two plans. This is because our plan would also create through tax credits for US employee expenses an effective tax cut for the employers of 98% of Americans who work for a business that has its profits taxed as personal income. Our C Corporation tax plan would, in a revenue neutral way, also greatly incentivize US private sector job creation, and our FICA tax plan would raise $336 billion over 10 years while doing the same. Our capital gains tax plan would raise 63% more federal revenues than President Obama’s capital gains plan while lowering the capital gains tax rates on venture capital investments, stocks bought at IPO or secondary offering, bonds bought at first issue, and the underwriting of the above investments. These investments are the four primary investments that drive private sector job growth through the financial markets. Plus, within our capital gains plan, in order to receive a lower tax rate, these four investments would have to have at least 5% of their current business, or future investment, being US employee expenses that would qualify for our US Employee Tax Credits under our personal income tax plan, and they would also have to be expanding in the US relative to most of the revenue raised from the financial offering. Therefore this policy too would go a long way in creating private sector jobs in the US, and it would create a great basis for reforming the Carried Interest tax rule. Again, for more on these tax plans visit ThirdWayProgressives.org in the Weekly Blog section.
So if you visit ThirdWayProgressives.org it will become obvious to you that our tax plan would do the best job, and by far, of both increasing private sector jobs and lowering our federal deficit. The ability to quickly achieve these two goals will set Democrats up for victory in 2012. However, sticking with President Obama’s current tax plan (FICA tax cuts for one year, followed by personal income tax increases on all of the top 2% of income earners in 2013) will not bring Democrats or Americans success in 2012, nor will the Deficit Commission’s tax plan, nor would the Wyden-Coats Tax Bill alone. Let us walk through why all this is so.
Let us suppose that our government passed the tax cuts in our tax plan immediately, at least the US Employee Tax Credits in the personal income tax portion of our plan and the tax cuts in our capital gains tax plan. These tax cuts in our plan would stay indefinitely, and we would work to bring them even lower over time. Therefore, both political parties in the US would stand for lower tax rates for American job creators. These tax cuts would go a long way in creating private sector jobs in the US. One of the reasons this is so is because these tax cuts would create absolute certainty for US employers that their income tax rates and tax rates for capital formation in the US would never go up. Added economic confidence would arise with this absolute certainty. These tax cuts would only cost about $122 billion over 10 years. However, in 2013 our plan would push personal income tax rates on the top 2% of income earners up to 39.6% and 36% at the same income bracket levels that President Obama has proposed, and the top long term capital gains rate would go up to 25% in 2013 under our plan.
Further, and very importantly, because our tax cuts for job and capital formation in the US are set in stone, the vast majority of American voters will have no fear in 2012 of voting for Democrats who will raise taxes on the top 2% of income earners in 2013. This is because Americans will no longer fear that raising taxes on the top 2% will slow job growth and the economy by raising taxes on the 50% of business income that is taxed as personal income that exist within that top 2%. In fact, the opposite would happen! Voters will understand that the higher tax rates are on those who do not hire in the US, and the lower tax rates are for those who do, the more hiring will take place in the US! Most importantly, the math always works in our favor in these areas. If one were to analyse all of the income that is produced by the top 2% of income earners in the US, one would see that only about 18% of all of that income is the profits of any business that is taxed as personal income that has one or more employees in the US (1,2,&3). Regarding capital gains, only 3% to 12% of financial market capital gains come from the four investments that would receive a tax cut under our plan (4&5).
Therefore come 2012, our Democratic Party base, the vast majority of independents, and even some Republicans will vote for Democrats to raise personal income taxes on the top 2% of income earners and on the top capital gains tax bracket in 2013. This policy would energize our base, but more importantly it would put the credit markets at ease both now and in the future that we are doing the right thing regarding our deficit and debt. This is because, not only would our economy be growing faster, but our tax plan raises more federal revenues than President Obama’s and the Deficit Commission’s tax plans. Also, the above scenario could occur without ever having to change the filibuster rule.
There are several problems with President Obama’s current tax plan. Firstly, the FICA and business tax cuts in the President’s plan will only be in place for 2011, so while the unemployment rate should be going down in 2011, it might be going back up and it will still likely to be very high in the election year of 2012. Our plan would not have this problem, especially if our FICA tax plan were passed into law. Secondly, most economists predict that in 2012, 2013, and 2014 the unemployment rate will still be quite high (above 8%), and there is a worrisome probability that it will be raising in 2012. This will mean that most voters outside of our base will be fearful in 2012 of increasing taxes on the top 2%, and therefore on 50% of business income that is taxed as personal income. Of course, our plan would not present this problem. Thirdly, because tax rates on 50% of non-C Corporation business income is set to go up in just two years, keeping the tax rates low on businesses over the next two years will not have the same tax certainty, confidence induced, bang for the buck, regarding job growth that the tax cuts in our plan would have. This is because businesses try to make most decisions looking more than two years into the future. Fourthly, because most economists predict that the unemployment rate will still be high in 2012, and therefore Americans will be hesitant to raise taxes on the top 2% in 2012, the credit markets over the next two years will find it hard to believe that we will actually reduce our deficit in the future. Hence, in order to achieve the same degree of credit market confidence that would occur under our tax plan, total federal government spending would have to be cut much deeper than it would under our tax plan. Also, our overall tax plan raises 80% more federal revenues than the President’s tax plan and as much as four to five times more when dynamically scored.
The main problem with the Deficit Commission’s tax plan is that it would create a net shift in income and consumer spending from the poor and middle class to the wealthy. That is, the Deficit Commission’s tax plan regarding personal income taxes is to create a direct exchange for tax payers by eliminating all tax deductions in exchange for lowering all tax rates. The problem with this exchange is that the top 5% of income earners in the US pay about 60% of all federal personal income taxes, however, the top 5% is only responsible for about 22% of all federal tax deductions. So this exchange would create a direct shift in income to the top 5% of income earners from the bottom 95%. Since the top 5% of earners has an average savings rate of about 30%, while the bottom 95% only saves an average of about 3% of their income, this would mean that the overall economy would suddenly have a chunk of consumer demand pulled from it. Therefore, with a large slice of consumer spending pulled from it, the Deficit Commission’s tax plan would slow the economy and job growth. With a slower economy, less tax revenue as anticipated would be collected by governments in the US. Also, the Deficit Commission’s tax plan would alienate and depress our Democratic Party voting base because it would create a shift in income from the poor and middle class to the wealthy.
As for the Wyden-Coats Tax Reform Bill, this is a tax plan that only applies to the C Corporation tax code and it is assumed to be revenue neutral when statically scored. The plan would create a tax exchange for C Corporations in the US by eliminating existing tax loopholes and deductions in exchange for lowering the statutory C Corporation tax rates. This tax reform plan would be a little more than marginally helpful for US economic growth, and thus when dynamically scored it would actually increase revenues to the federal government. Smaller, more dynamic, and faster growing American C Corporations that generally hire a disproportional high number of new employees in our economy would have their tax rates go down under the Wyden-Coats plan. This would increase their capital and thereby allow them to employ even more in the US and thus increase economic growth. Effective tax rates would go down for these smaller C Corps because it is generally the larger C Corps that typically receive the most current tax deductions and loopholes while the smaller yet faster growing C Corps generally pay closer to the top statutory tax rate of 35% that would then be cut by lowering the deductions and loopholes. This would create a stimulative effect for the economy. Moreover, making the tax code simpler for businesses reduces their compliance costs which is also positive for growth.
However, on closer examination it can be seen why a Wyden-Coats style tax reform would not be the panacea that many claim it would be. Many overestimate the value of a Wyden-Coats style tax reform plan because of a misunderstanding of some of the “averages” in this area of tax data. The “average” effective tax rate that American C Corporations pay is about 17% in the US, even though the top statutory rate is 35%, and this is because of the many deductions and loopholes. The problem with this particular “average” is that a very large C Corporation with many employees and a profit of $1 billion a year is counted equally in this average with a small C Corp with few or even no employees and a profit of $100,000 a year. The problem with using such an average with this tax reform plan is that the majority of the tax deductions and loopholes that will be eliminated for C Corporations are made available only to America’s largest C Corporations and not it’s smallest. Therefore, with this tax trade off, many of America’s largest and best employee paying businesses will suddenly have their effective tax rates go substantially up, and generally only smaller C Corps, a surprising number of which in recent years have no employees at all, will tend to have their effective tax rates go down. Hence, the cost of capital would go up for the employers of the vast majority of Americans who work for a C Corporation, which is about 50% of our private sector economy and it has historically been the economies highest paying sector for average employees. This tax increase in itself would have the effect of slowing economic growth. Furthermore, some of these tax deductions and loopholes exist for justifiable reasons that create economic efficiencies. Most importantly from our perspective, we might be raising taxes on America’s highest wage paying employers while lower taxes on our economies lowest wage paying employers. Of course our C Corporation tax reform plan would create the opposite reality. While a Wyden-Coats style tax reform would still create an overall positive effect for the American economy and it is well worth enacting, due to this “averaging” misunderstanding by some and the fact that many of the deductions and loopholes will always be seen as worth keeping, such a tax reform will only be a good start.
The best way to address our C Corporation tax code would be to get rid of all the most egregious and economically inefficient tax deductions and loopholes and replace them with a somewhat lowered statutory rate. But, so that effective tax rates do not go up on many of Americans best paying businesses, institute a US Employee Tax Credit like that in our C Corporation tax plan that can be found at ThirdWayProgressives.org. Such a policy would be revenue neutral when statically scored, but when dynamically measured it would raise more federal tax revenues than the Wyden-Coats Bill. But most importantly, it would create an incentive for all C Corporations both foreign and domestic to hire in the US. It would most reward those US and foreign C Corporations that pay their US employees in the most generous ways, and it would lower tax rates on those who pay above average in the US. Remember, there is no expenditure that has a greater multiplier effect in the economy than a high paying, steady, private sector job! Of course the worst paying US and foreign C Corporations would have their effective tax rates go up. Our C Corporation tax plan would also create much tax parity with our personal income tax plan which raises much new federal tax revenues. The Wyden-Coats Bill is not intended to raise tax revenues, but neither is it intended to raise taxes on so much of the American economy and slow it down.
Again, because our overall tax reform plan raises more federal revenues than the Deficit Commission’s or President Obama’s tax plan, $1.25 trillion over 10 years versus $925 billion and $700 billion over 10 years respectively (and again, remember, these numbers are not dynamically scored), less will be needed to be cut from the federal budget in order to balance our federal budget. Nonetheless, our federal spending will need to be reduced and some spending will need to be shifted to other areas.
However, letting the Republicans cut federal spending to a growth rate below the rate of inflation would be a mistake. Cutting spending to this level would pull demand out of the economy and therefore slow the economy. In regards to reducing our federal deficit it is just as important that we grow the private sector by sifting government spending into more productive uses. One thing our federal government needs to do to achieve high paying private sector growth is begin a public/private R&D matching program like what was done in California in the 1990’s with regard to hybrid and electric cars, with an agreement that production will be done in the US. This program could be done along with matching funds from the states. This program would help build our manufacturing infrastructure. This program, along with our environmental tax plan that would reward manufacturers for using “best practices” (This plan can also be found at ThirdWayProgressives.org), would bend over time our applied science in manufacturing towards more environmentally sustainable production, and it would greatly increase high paying jobs and our manufacturing base in the US! Under the new House rules the moneys for such a program would need to come from existing programs, but such a shift would be well worth it.
Another part of our economy that still needs assistance is the residential real-estate market. Most economists covering this area predict that 2011 will be the worst foreclosure year in American history. There are millions of Americans who are upside-down on their homes. Many of them have mortgages that have arms that are about to expire or they are making less than they once were. Given that interest rates are at record lows, there are millions of more Americans that are barely upside-down or have high loan to values that could save large amounts of money that would then increase consumer demand in the economy if they could only refinance.
Our federal government could fix this problem at NO COST with the following program that could also double as a way of reforming Fannie Mae and Freddie Mac: The federal government could underwrite second position mortgage loans for the portion of total loans made over 80% loan to value for each property. This can be done through Fannie and Freddie, and perhaps other lenders. The government would only guarantee the portion of Fannie’s and Freddie’s portfolio that consisted of these second position loans. These second position loans would be amortized over 40 and even 50 years, and the program should encourage lenders to sell each attached first position loan as 40 year amortized loans. With the government borrowing from the Fed at very low interest rates, and with these loans being amortized over 40 years and more, millions of Americans could have their mortgage payments drop and many would avoid foreclosure. Through this program, all existing loans will be completely paid off and consumer demand in our economy would rise. Both factors would add great confidence to our economy.
The mandate of this program could be that it be run in a revenue neutral or non-profit manor. There would only exist risk to the federal government if the lending guidelines were extremely lacked, even beyond what took place throughout the 2000’s, or if the price of residential real estate in the US 40 or 50 years from now was somehow only worth a little more than what it is today or less. Given the average increase in residential real estate of 8% in the US over the last 100 years, we should not be fearful of this second risk. If we cannot manage the first risk, we should all turn in our democracy cards and ask to be British colonies again. Therefore, this is a program that we can extend after this real estate crisis as one of our most important tools for creating affordable housing. Further, by the federal government only insuring that part of the portfolios of Fannie and Freddie that are these second position loans, we would be going a long way to reforming Fannie and Freddie, while maintaining in a sound and responsible way the government’s ability to increase low income housing.
Another shift in federal spending that would be beneficial would be to actually cut the salaries of non-military federal workers, but then take that savings and hire more federal workers and replenish our infrastructure. The hiring of new federal and infrastructure workers would have the effect of lowering the unemployment rate and thereby saving money on the cost of unemployment insurance. Economic efficiencies would also be developed with the new infrastructure. This is also a practice the states could engage in. As for direct federal spending cuts, the easiest and most efficient way to “cut” federal spending while we are still essentially in a recession would be to extend the age at which those under age 55 can start to receive social security.
However, the hardest issue for us to address over time regarding federal spending will be healthcare. This problem can best be understood by exposing a fundamental misunderstanding that nearly all policy makers in the US hold regarding healthcares role in our society today. Policy makers tend to mistakenly believe that the high rates of inflation in recent decades in the healthcare field in the US has caused the healthcare portion of our overall GDP to become much larger than it was only decades ago. However, this relationship is backwards. In reality it is the expansion of healthcare as a portion of our overall GDP that is causing inflation in healthcare to be high. Remember, areas of the economy that are growing faster than the rest of the economy as a whole will nearly always have inflation rates that are above the national average.
All of this is because we live in a nation where less than 2% of our GDP can produce enough food that we throw away almost a third of it, we are the world’s largest agricultural exporter, and obesity is a major problem. We also live in a nation where, because of high tech mechanization and cheap labor in the underdeveloped world, we can produce physical goods so cheaply that the addition of self storage units in order to hold people’s extra things has been one of the fastest growing sectors of the US economy over the last two business cycles. Therefore, if you live in a very advanced society like we do, where food and physical goods can be produced so cheaply that there exists almost too much of both for most people, that societies GDP will naturally shift to the areas of the economy that everyone never has enough of. One of those areas is how long we live. So it is the natural progression of a society as it becomes ever more advanced to have a larger and larger portion of its GDP move to healthcare, along with other things like recreation and tourism. Hence, we cannot reject this inevitable increase in the healthcare economy. We must embrace and facilitate its technological advancements, and become its world’s largest exporter. This would also be a good area to institute our R&D matching program through business incubators, hospitals, and universities.
That said, we must make certain that healthcare costs do not bankrupt our federal government and make our most important industries uncompetitive. To this end, Democrats must insist on keeping our new healthcare law that provides all Americans with preventative medicine and some level of health insurance. In order to keep the cost of Medicare, Medicaid, and the new healthcare plan down, Democrats should have a policy of, “Mend it, dont’t end it,” when it comes to the new healthcare law. Democrats should allow Republicans to end the 1099 rule (Our tax plan can best help pay for this), allow them to greatly increase tort reform throughout the plan, and to force uniformity throughout the states that would eliminate the inefficiency of consumers not being able to purchase health insurance across state lines. These changes should be allowed with Republicans than allowing the bill to be funded. More reforms can come if needed with future funding. Through the same type of efforts healthcare costs can be moved away from businesses and more on to consumers and the government. But no matter what, Democrats should always insist that all Americans have some level of health insurance.
Education reform is also a very important ingredient for our economic renaissance. Recent efforts should continue in this area along with developing more coordination with America’s colleges and universities regarding our R&D matching and profit sharing program.
Yet the most important thing for Democrats and Americans to remember during this period of deficit reduction is that we cannot cut the growth in federal spending below the rate of inflation. Any larger amount of reduction would pull demand out of our economy and therefore slow our economy. The key to deficit reduction for our country is to find new ways to increase federal revenues that actually incentivize and grow our private sector. If you read the paper, “Why the Deficit Commission and Senator Warner are Wrong on Tax Policy and Our Tax Plan is Right” which can be found below this blog posting you will learn how the Deficit Commission’s and President Obama’s tax plans will have the effect of depressing our private sector and our overall economy, while our tax plan is the only plan that would actually stimulate private sector growth. At the same time our plan would raise more federal revenues than the Deficit Commission’s and President Obama’s tax plans, $1.25 trillion over 10 years versus $925 billion and $700 billion over 10 years respectively, and again, these numbers are not dynamically scored.
Because our tax reform plan can raise more federal revenues than any other tax plan, and because our tax plan and budget priorities would increase economic growth so much, our nation will be in the strong position we need to achieve in order to acquire a successful trade and foreign policy. For example, from our new found position of economic and fiscal strength, where we did not need to borrow so much from nations like China, China would soon learn that they need a relationship with us more than we need one with them. It is this position of strength that will insure a positive and just result for us and the rest of the world regarding trade and currency issues with China. This economic and fiscal strength will also give us the ability and time to win our wars in the Middle East, as well as depress all other despotic dictators throughout the world who oppose economic freedom and democracy.
- Emmanual Saez and Thomas Piketty, “The Evolution of the Top Incomes: A Historical and International Perspective,” National Bureau of Economic Research, working paper no. 11955, January 2006.
- The World Top Incomes Database, Facudo Alvaredo, Tony Atkinson, Thomas Piketty, January 2011.
- US Census Bureau, Statistics of US Businesses: 2008 : All industries US.
- “Recent Changes in US Family Finances” Federal Reserve Bulletin.
- Jay R Ritter, University of Florida, “Initial Public Offerings”