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The political conversation about taxes

By       Message Seymour Patterson     Permalink
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Presidential candidate Ted Cruz may not be as bombastic as presidential candidate Donald Trump, but his ideas are no less concerning. For all his faults, at times Trump gets it right as when he rails against automakers moving some of their operations to Mexico: Mexican joblessness will be ameliorated by this action, while America's job market gets hobbled. Americans are understanding people! They forgive presidential candidates on the campaign trail their rhetorical excesses. Among these excesses are promises about tax cuts to spur robust economic growth. They assert this ignoring the empirical evidence to the contrary as there appears to be no correlation between low tax rates and rapid economic growth. For instance, when marginal tax rates were high in the post-WW II era, more than 90 percent, economic growth averaged 4 percent. However, when marginal tax rates were lowered to the neighborhood of 35 percent, economic growth averaged 2 percent. This is not difficult to calculate--data on tax rates and economic growth are available from the government, so if you doubt this positive relationship between tax rates and economic growth rates you can compute it yourself. No need to rely on the self-serving narrative of the political class.

It is not clear why Cruz believes tax cuts for the rich "would create economic growth not seen in 30 years." (See ThinkProgress.org) Cruz would have a flat 10 percent rate on individuals and a 16 percent rate on business. He is proposing to convert the mildly progressive tax system into a regressive one where people's tax bite falls with income. The current top marginal tax rate on individuals earning over $415,050 is 39.6 percent. On the other hand, the bottom (lowest) tax rate is 10 percent. The top corporate rate 39.1 percent--arguably the highest among developed countries. Apart from the fact that there is no empirical evidence Cruz's plan would lead to faster economic growth, such a tax cut will have two effects. First, it will give the rich a tax break of 29.6 percent. Nothing for people in the 10 percent income tax bracket would change. Second, an instantaneous effect of the cut will be growth the income inequality gap. According to Bloomberg, the gap between CEO compensation is about 500 times the income of nonsupervisory employees. Wages have remained relatively flat: One has to assume labor productivity has not risen, but CEO productivity jumped by a factor of 500. Further some people have argued that the unearned income should avoid taxation because of double taxation. But such a move would exacerbate the inequality gap. The inequality gap was not always so daunting: in the 1950s, the ratio between workers' pay and CEOs' was 20 to 1. Since then, this ratio has ballooned 1000 percent. "Today Fortune 500 CEOs make 204 times regular workers on average, Bloomberg found. The ratio is up from 120-to-1 in 2000, 42-to-1 in 1980 and 20-to-1 in 1950."

Moreover, income inequality can lead to social unrest: strikes and demonstrations for higher worker compensation like a $15 minimum wage. Recently around the country service workers, low-wage workers, with the support of the Service Employees International Union organized huge protests in favor of raising the minimum wage $15.

Bernie Sanders was considerably more ambitious with his tax plans for the country were he to become president. First, he wants to make substantial changes to the estate tax laws. In terms of the estate tax, the bulleted quotes below show: Start of quote, Sanders' bill does the following:

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" Lowers the estate tax exemption level from $5.4 million to $3.5 million for individuals and from about $11 million to $7 million for couples.

" Increases the marginal tax rate to 45 percent on estates between $3.5 million to $10 million, 50 percent on estates between $10 million and $50 million, and 55 percent on estates over $50 million.

" Creates a new billionaire surtax of 10 percent that would only impact 530 billionaires who are worth a combined $2.6 trillion.

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" Ends loopholes allowing billionaire families to set up dynasty trusts to avoid taxes.

" Closes loopholes used by the wealthy to avoid estate taxes.

" Protects family farms and conservation easements.

Positive reaction to Sanders bill was widespread:

In addition to addressing the estate tax, Sanders had no compunctions about returning to the 90 marginal tax rates of bygone years. Altogether, along with advocating free education and healthcare, Sanders' approach would help to close the income inequality gap.

Large cuts in taxes to benefit the rich defies economic logic and seems to be part of the doctrine of trickle down economics. This is what a flat tax does presidential candidate on the right advocate to jolt the economy to faster rates of growth. However, if the present value of a prospective investment opportunity's net payoff is positive, i.e. profitable, why would an astute, discerning rich person need an incentive in the form of a tax cut to take up that investment? If the present value of an investment opportunity is negative, then the tax rate does not matter, unless as when the companies pay no tax and receives tax subsidies from the government.

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Implicit in the flat tax progressive tax debate is trickle-down versus trickle-up basis for economic growth. Historically, the evidence appears to be on the side of trickle up--minimum wage earners are more likely to spend their minimum wage increases and help economic growth than the rich who presumably have all the consumer goods they want. A 90 percent marginal tax might removes the incentive of the rich to hide their money in secret offshore accounts. Instead, they might try to avoid the tax by expensing wages (paying their employees more) and investing in their plants (expansion, innovation, etc) to grow their business domestically. Further, historical evidence on low taxes versus high taxes seems to support the former.

 

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Seymour Patterson received a Ph.D. in economics from the University of Oklahoma in 1980. He has taught courses and done research in international economics and economic development. He has been the recipient of two Fulbright awards--the first in (more...)
 

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