Why an ETCO is Much Better than Just Limiting Deductions for the Wealthy

By Tom Pallow

It seems like only one element has remained from the Romney campaign, and that is because it is a good element. This element is the concept of tax reform that was explained by the campaign and many of its supporters that now is one of the two centerpieces of the soon to be future tax reform laws that must be the outgrowth of a needed compromise to the fiscal cliff that also must include medicare and healthcare reform that greatly increases price shifting to private healthcare. This concept of tax reform has been defended by brilliant economists like Martin Feldstein. This concept of tax reform is helping to move tax policy beyond the same old two arguments that have dominated tax policy over the past 100 years and were designed for a different economy. While these two arguments still need to be heard and for some very important reasons, this Romney concept has greatly helped to shift the tax policy focus toward a much more important target, a target that the two dominant tax policy arguments are not as brightly fixated. This important fixation is something that most economic analysis throughout history has shown to be one of two most important fixations. This fixation is private sector job growth and employee demand. More specifically, private sector job growth and demand in industries providing the world’s most desired goods that simultaneously bend the technology curve towards ever more sustainable products and production while not decreasing economic growth. Absolutely all of these things can be done simultaneously. They are all now being done simultaneously, but not nearly as efficiently and abundantly as they could be. This is what my work is about. The second fixation is scientific and technological advancements.

Job growth and employee demand creates lower unemployment. The simple laws of supply and demand than dictate that as demand relative to supply increases, prices will go up. In this case it means the price for labor. As a bidding war for employees and potential employees heats up, and as products get cheaper to produce and are of a higher quality, real wages will increase for all employees. Moreover, this is the only real way that real wages increase over the medium and long run, meaning a few or more years depending on a nations borrowing power until forever. Low unemployment also means much less government spending on welfare and food stamps.

Everyone knows the most important part of the Romney tax reform argument: Today’s growing US businesses that are taxed as personal income that are in the top 2% of US income earners that would then have their personal income tax rates increased under the proposed Obama tax plan are more likely to now be plowing their profits back into business expansion and new US jobs and less likely than the non- US employing wealthy to be using these monies on things that tax deductions can be taken for. (All of this argument is mathematically true by the way, at least for the most part and to a positive degree.) Therefore, if we reduce these tax deductions for the wealthy, taxes will be increased on the wealthy, but in a way where the taxes are disproportionally increased on the wealthy that are not employing in the US, relative to a disproportionally lesser increase of taxes on the wealthy who are American employers. The revenues raised from the reduction of these tax deductions can then be used to lower income tax rates for everyone or they can be used for deficit reduction, depending on your politics.

The most important feature of this Romney tax strategy is that it begins to move tax policy into the competitive and dynamic environment of the 21st century global economy. It finds a way to raise government revenues in a progressive manner by raises revenues from those who can most afford it but it also raises revenues in a manner that is less damaging to America’s most dynamic businesses and most proficient job creators. Of course we have enacted in the past countless tax credits and incentives that have had the effect of doing these same two things simultaneously before, on the federal, state, and local levels. But the Romney plan is the first to try this on a much more comprehensive and generalized manner. Remember, the biggest change economically in our lifetimes is the effective 12 fold increase in global trade that came with the weakening and fall of communism. We are never going back to the old communist world. Communism and socialism have been completely discredited as a solution for many reasons, one of them economically being that the elimination of the profit motive greatly reduces the ability to measure the value of products and commodities.

Therefore, we need to continue to move further into this new tax and economic philosophy, this form of New Keynesianism. Employee Tax Carve Outs with income tax increases on the wealthy will much more rapidly and beneficially do this. But so will some of the Romney tax plan, so both should be enacted during the upcoming tax reform laws. By getting ride of several tax deductions, but only adding a few very important tax credits in the form of US Employee Tax Credits that are used in a few very important ways (as well as against the AMT which would not cost much while saving and incentivizing many private sector job), we will make our tax code much more efficient while simplifying it. Further, because US ETCs are measured in w-2 1040 employee expenses, and even 1099 expenses if desired, they will make our tax code much easier to police. The Senator Collins ETCO will be a fantastic start! It will also allow for Republican to cross over and vote with Democrats for an income tax rate increase on the top 2% or less as part of a fiscal cliff compromise.

Romney’s tax plan and personal income tax increases on the wealthiest 2% with an ETCO would both increase government revenues while not taking away as much or virtually none needed capital from growing US businesses that would otherwise have their tax bill go up under an old fashioned income tax increase on the wealthy. ETCOs can raise far more government revenues than the Romney plan while also protecting growing US employers far more! ETCOs also create a difference in effective tax rate between the US employing wealthy and the wealthy that do not employ at all in the US. This tax rate differential acts as an incentive for the non-employing wealthy to become US employers. Moreover, he greater the difference in effective tax rate, both the more government revenues will be raised and the greater this incentive will be! Remember, only 18% of all the income that is made by all of the top 2% of income earners is the profits of any businesses that is taxed as personal income that has one or more employees in the US (1,2,3).

This 18% of income is extremely important. It comprises the immediately available capital for what are generally America’s fastest growing and most dynamic businesses, that are also generally of the greatest importance to America’s economic future. Businesses that are taxed as personal income are responsible for generally 60% to 90% of all new private sector jobs, and closer to 90% when coming out of a recession. Such businesses that are in the top 2% of incomes are America’s most successful, so they are responsible for as much as and often near to 55% of the above, close to 90% of new jobs. They also typically become America’s most prolific exporters in the following business cycle a decade latter. Therefore we should not be reducing their immediately available capital, even for needed government revenues. One common misconception about growing businesses is that they are not adversely affected by high tax rates and quarterly income taxes because they can write off as a tax deduction the profits they quickly plow into their expansions. But very few businesses ever expand this way. Most often they need to save for a few years before they can then make their next big expansion. This expansion savings would be reduced without ETCOs. If you need to know more about ETCOs visit the website, ThirdWayProgressives.org and go to the Weekly Blog section.

Romney’s tax plan should be enacted to some degree. But in reality, both for political reasons but even more so for economic reasons, relatively little tax revenues will be able to be raised by reducing tax deductions for the wealthy. Most itemized tax deductions are already very limited for the wealthy. Moreover, the most costly to the federal government itemized deduction for the wealthy is the charitable deduction. It would not make political, economic, social, or moral sense to limit charitable deductions in any way, perhaps with the exception of reducing for the wealthy the value of non-cash donations. For the wealthy, medical expense deductions could also be cut to some degree, as could mortgage payments for second homes for those with extremely high incomes, as well as could be cut the home business deduction for the wealthy regarding actual living spaces. Savings deductions are already greatly restricted for the wealthy, but were they do exist they should be cut. Of course all US employers would be able to use US Employee Tax Credits to create an ETCO against all of these reduced tax deductions, thus creating a way to further widen the effective tax rate differences between wealthy people who employ in the US and those would do not. You get this, we create a greater incentive, we get more private sector jobs and government revenues; see this qualityism thing is really pretty easy!

However, with charitable deductions consisting of such a large portion of all tax deductions taken by the wealthy and with the great need for these charitable deductions to stay in place, and given how few and little all other itemized deductions can be reduce further for the wealthy, not many new government revenues are going to be raised by the Romney plan. However, raising revenues with this plan would be much more efficient and job growth incentivizing than would be an equally sized personal income tax increase on the wealthy without an ETCO. Once again, this new tax strategy that works to promote private sector economic growth will, due to its ability to do so, generate far more economic growth and therefore also more tax revenues than will an old fashioned tax increase that does not have an ETCO and therefore has no concern for how it will adversely affect private sector economic growth. Because the new style of taxation will created an atmosphere that is much more supportive of job and economic growth while the old style will have the effect of slowing growth, the new style of taxation in the short, medium, and long run will raise far more government revenues than would the old style.

However, anyone reading this paper and understanding the virtues of this new, endogenous growth tax philosophy must by now be thinking, there has got to be a more efficient and proficient method for raising taxes on the wealthy but in a way that promotes job and economic growth. There is, and because problems are most often solved by being as direct as possible, what you are really questioning is: Is there a much more efficient and proficient way of raising effective tax rates on wealthy non-employers while lowering effective tax rates on all employers in the US and in our states that chose to participate with their income taxes. Of course the answer is ETCOs, and done best by using US and state Employee Tax Credits.

Remembering the virtues of low unemployment and the fact that few tax and economic entities are more accurately measured and regulated than W-2 employee expenses, it becomes easy to see the virtues of ETCOs, especially while using ETCs. For example, with Romney’s plan, effective taxes will be kept low on wealthy non-US employers who currently are not saving and buying things that would trigger tax deductions. These wealthy would be rewarding equally with many of America’s most proficient new job providers. Further, under Romney’s plan, if any of these most proficient job providers are currently taking the itemized deductions that will be cut, their effective tax rates will be going up. But of course we know how to fix this with ETCOs. One of the few concepts that all economists agree on this that monetary incentives matter, so let’s incentivize one of the two most important thing that increase real wages, private sector employment demand. This is what ETCO’s and ETCs do. This is also why, when dynamically scored, which is more often closer to reality then most static scores, a tax increase with an ETCO will raise four to five times the government revenues than would an equal sized tax increase without an ETCO!

Furthermore, the Romney’s plan will raise relatively little revenue while ETCOs and ETCs allow governments to raise very large amounts of tax revenues without slowing economic growth and prosperity. Remember, the larger the differential in effective tax rates between the employing wealthy and the non-employing wealthy, the larger the amount of tax revenues will be raised and the greater the incentive will be for the non-employing wealthy and all those who want to be wealthy in the future to find ways to become wealthy by employing fellow Americans. Our federal government needs a great amount of new tax revenues. We cannot continue to monetize our debt without eventually experiencing massive inflation, and if our debt continues to increase we will someday in our lifetimes enter a debt trap of not being able to keep up with our interest payments. On the ThirdWayProgressives.org website, in the summary that is in the Weekly Blog section, is a batch of data about how high income tax rates have historically averaged since WWII. Rates have averaged quite higher than they are today for the top 1%, 2%, 5%, and even 10% of incomes. Look, we need tax revenues, and we need to find our tax revenues were they are least often spent in the economy, and because of much higher savings rates those high incomes are where that exists.

For those who are rightfully concerned to some degree that further income tax rate increases with ETCOs will not raise as much government revenues as myself and others are projecting due to Laffer Curve related concerns, let me quickly explain why ETCOs alter the Laffer Curve. You see, the Laffer Curve is a great mathematical measure of a market that exists in our economy where supply meets demand. The demand comes from those who have incomes above about $12,000 who also have the prevailing attitude that, “Government takes far more from me than what it gives to me, therefore, whatever I can do to cheat it I will!” The supply in this market comes from accountants or people who pose as accountants who help them cheat. Like with any market, the higher the price, the more sophisticated the service and the greater the demand is likely met. ETCOs alter the Laffer Curve because, people who are high or very high income earners who work for others or do not employ enough to benefit from ETCOs, tend to have spent more time being educated and trained via monies that are government provided, whereas employing entrepreneurs with these high incomes tend to have spent less time being trained and educated via government funds and more time when the did indeed, build it on their own. This is a generalization about our economy that is simply true and that will likely always be true. Just think about the well off doctors, lawyers, engineers, and then employing entrepreneurs that you know. Therefore with ETCOs, we will be lowering income tax rates on many high income earners who already are inclined to believe that they are not now getting a good deal from government, while we are raising income taxes on the wealthy who are more inclined to believe they are. Moreover, by reducing tax deductions for the wealthy and increasing income tax rates on the wealthy with ETCOs, we will be simplifying our tax code and making it easier to police those people who more often believe that they are getting a bad deal from government. Once again, ETCOs, especially when measured through US Employee Tax Credits are measured by w-2 and w-4 expenses, or whatever is legislated, which makes this particular tax credit extremely easy to policy.

This new, endogenous growth tax philosophy agrees with the primary goals of the two old tax policy arguments, that redistribution of incomes must occur so that consumer demand is kept up with the rest of the economy, and that taxes on employers must be kept low so that their cost of capital will be kept low. But this new philosophy believes that increasing the demand for employees and increasing scientific and technological outputs are at least equally as important. Most importantly, unlike the two old arguments, our new tax policy in no way trades a primary goal for another primary goal. Our tax and industrial policies achieve all four primary goals simultaneously.

I have not explained ETCO’s in this paper. But if you visit ThirdWayProgressives.org in the Weekly Blog section you will find a 12 page summary of our ETCO tax plan. This summary explains how ETCOs can greatly increase the efficiency and effectiveness of capital gains, C Corporation, FICA, environmental, and estate taxes. Also in the Weekly Blog section you can read about our industrial policy proposals which affect the other half of what creates prosperity for all in the economy, scientific and technological advancements.

One very important thing, if you are reading about ETCOs, and you find it hard to imagine how a particular tax concept could be formulated into workable tax law, please, please, please, do not assume that it cannot be done! I have been working on these ideas since right after the 1988 election, for more than 24 years now. Believe me, if you have a question, I will have a workable answer! So please feel very free to contact me personally if you have any questions. Anything less would be laziness and letting the American people down.

With Congresses having an approval rating somewhere in the teens, and for a few years now, the American people have felt let down for a long time. Further, dont’t for a second believe that because Democrats won in this election, the American people like what Democrats have to offer! They hate Democrats and Republicans nearly equally. Most people who voted for Romney were voting against Obama, and most people who were voting for Obama were voting against Romney. Moreover, once again the fastest growing group of voters was independents. Since 2002 nearly all polls put in the 60’s and 70’s the percent of American’s who think that America is on the wrong track. The numbers for this question have been more often worse for Obama than they were for Bush, even though they have been very bad for both. We now exist in a very competitive and dynamic global economy, and if we do not adapt through our tax and industrial policy we will all suffer greatly. If President Obama and Democrats do not do anything to make the economy better, Democrats will lose big in 2014 and 2016. We can not rely in the future on hurricanes right before elections and sub-par Republican presidential campaigns. Further, do not assume that economies naturally and automatically come out of recession. With our federal and state government fiscal positions, with weak consumer demand, with the competitive nature of our global economy, and with the economic slow downs in Europe and Asia, America could easily experience a “lost” economic decade as Japan did in the 1990’s and even beyond.

Mediocrity is not in America’s nature and we will not stand for it. Since our beginning we have more than any other nation been the world’s leader. During this time we have been the first to do more things than any other people. Let’s be the first to bring on a much more efficient and effective tax and industrial policy system, one that would be much more prosperous, egalitarian, and environmentally sustainable than any other in the past and by far. It will work this way for us as well as for the rest of the world as it greatly helps to increase the number and quality of democracies. It is time that we do what America does best again!

1. 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.
2. The World Top Incomes Database, Facudo Alvaredo, Tony Atkinson, Thomas Piketty, January 2011.
3. US Census Bureau, Statistics of US Businesses: 2008 : All industries US.