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Truth, Lies, and Tax Reform

Republicans (and President Donald Trump) say they want to fix the tax code. But their proposals won't do anything like that. Here are a few ways they can do better.
Speaker of the House Paul Ryan looks on as President Donald Trump speaks about tax reform legislation in the Cabinet Room at the White House on November 2nd, 2017, in Washington, D.C.

Speaker of the House Paul Ryan looks on as President Donald Trump speaks about tax reform legislation in the Cabinet Room at the White House on November 2nd, 2017, in Washington, D.C.

If you are having nightmares about the approaching tax season, you aren't alone. Over 152 million people will file taxes this year. In Washington, the solution to anxiety about taxes is to cut them. Low taxes are the policy approach favored by the Republican Party, and even many Democrats. High taxes harm growth, impede investments, reduce incentives, and create a sluggish economy, the logic goes.

Yet, despite Republican control of Congress, President Donald Trump's efforts to lower taxes even further with a major tax reform bill were having trouble before an early morning 51–49 Senate vote on December 2nd set the stage for final approval: His party's plan raises taxes on millions of people to pay for tax cuts for the very wealthy, particularly those who make their money from owning financial assets like stocks. It's hard to see how this will help everyday workers, especially since high profits have failed to improve wage growth in the past. The old ideology about low taxes producing high growth and better outcomes looks exhausted, and a new generation of economists helped undermine it. Here's what they say about how the tax code can better serve you.

Tax Incentives Don't Help Us Save More

The early fight between Trump and Congressional Republicans over whether to tax your 401(k) contributions shows how attached we've become to the retirement savings device. Yet whether the existing 401(k) tax credits actually work is up for debate. One innovative 2014 study, led by Raj Chetty, used a change in Denmark's tax code to see how people react to incentives to save. They found that, for every $1 in increased subsidy, total savings only increased one cent. Most people didn't change anything at all, while a subgroup of wealthy people simply shifted their savings so they would pay less in taxes, without saving more overall. Similar results are likely with the Republican tax plan: Kansas cut taxes for certain kinds of pass-through businesses in 2012, which people took advantage of by reclassifying their work, according to another study by a different team of economists. Kansas didn't see more new businesses formed as a result, just people paying less in taxes.

What does work? Programs that default people into saving. The vast majority don't opt out, increasing their savings. Also, Social Security and Medicare, and other programs designed to help where markets fail. Tax incentives can't replace the role of genuine public social insurance.

And Cuts Don't Help Businesses Invest for Growth

A central plank of conservatism holds that businesses will invest more in new employees, facilities, or research and development if we reduce taxes on profits, making everyone richer. It's the core of supply-side economics, which opponents call trickle-down economics. President George W. Bush was a supply-sider, dramatically reducing taxes on dividends from 38.6 percent to 15 percent.

Senator Bernie Sanders (I-Vermont), Senate Budget Committee Chairman Mike Enzi (R-Wyoming), and Senator Chuck Grassley (R-Iowa) attend the full committee mark-up of the tax reform legislation on November 28th, 2017.

Senator Bernie Sanders (I-Vermont), Senate Budget Committee Chairman Mike Enzi (R-Wyoming), and Senator Chuck Grassley (R-Iowa) attend the full committee mark-up of the tax reform legislation on November 28th, 2017.

Today, Republicans are trying to reduce corporate taxes from 35 percent to 20 percent on the same theory. But the Bush example is telling: Danny Yagan, an economist at the University of California–Berkeley, was able to use Internal Revenue Service records to distinguish which corporations benefited from the break on dividends, and which didn't. Once you controlled for corporation type, there was zero new investment. Employees also didn't see compensation increases. Shareholders, though, saw dividends go up dramatically.

This suggests businesses invest in themselves based on others factors, like cash flow and customer demand—not capital-market returns. It also means we have to look to different things to boost businesses, like ensuring there's enough demand from customers to buy their products.

The Debt Is Good and We Shouldn't Pay It Down

One of the biggest bait-and-switches in the tax reform debate involves the national debt. Speaker of the House of Representatives Paul Ryan, during the Obama administration, argued that "the ever-rising debt will trigger an inevitable crisis and a state of decline." Now he wants to increase the debt $1.5 trillion over the next 10 years to pay for high-end tax cuts. Regardless, the argument against debt was always weak. The International Monetary Fund recently surveyed national debt loads around the globe and their findings suggest that the deficit-hawk logic is wrong for a country like the United States.

Every dollar spent paying down the debt, their team of staff economists argued in a 2015 analysis, is a dollar that could have gone to better uses, such as consumer spending or public investment. A country like the U.S., which has its own currency and faces low long-term interest rates, can maintain very large debt indefinitely. Investment in things like infrastructure and education can be more productive than lowering debt. That debt also serves as a safe investment vehicle for businesses. Countries like the U.S. shouldn't reduce their debt by paying it down like a credit card, because they aren't households. Instead, they should expand their economies until debt shrinks as a percentage of the economy, as we did in the aftermath of World War II.

Hidden Wealth Is Unfair and Inefficient—But Congress Isn't Talking About It

From the Panama Papers to Paul Manafort's alleged money laundering, there've been numerous recent investigations into the shadowy work of tax havens and other ways of hiding wealth. Economists have found the amounts involved are even more staggering than you may think. In a deeply investigated academic work, the economist Gabriel Zucman looked at balance sheets for countries across the globe and found a ton of money missing. This money is concealed in tax havens that hide wealth for all countries, "as if planet Earth were in part held by Mars," he wrote.

Zucman concluded that there is about $7.6 trillion in global hidden wealth, or about 8 percent of all household financial assets. In other words, our financial institutions have evolved not to grow wealth, but to hide it; the rich will do everything they can to hide theirs from public obligations. We should examine things like inheritance trusts and the structure of pass-through businesses, two important ways the rich keep their money away from taxation.

Nor Are They Talking About the Best Idea: Higher Taxes on the Rich Helps Workers

"Job creator" is one of the most nonsensical phrases in our economic discourse. Yet the idea that the rich "create" jobs and growth persists, and, as a result, there has been a transnational effort to reduce taxes on them, despite the groundbreaking economists Thomas Piketty and Emmanuel Saez's best efforts. The pair's 2014 paper examined how top-end incomes have skyrocketed in Western countries over the past 40 years—while everyone else's stagnated. It turns out you can draw a clear line between skyrocketing inequality across countries and the cuts to the tax rates the richest people pay on their incomes. In the 1950s, rich people in the U.S. paid over 80 percent tax on the last dollar they earned. Top rates fell worldwide in the 1970s and '80s, but they were slashed dramatically in the United Kingdom and U.S.

Some on the right celebrate this. With lower taxes, the rich have incentives to work harder and build larger businesses, increasing growth for everyone's benefit. Yet Piketty and Saez find no relationship between top marginal tax rates and growth. Instead, low rates give owners and managers a big incentive to take as much of the profits of the company for themselves as possible.

No one person makes the company; everyone is contributing to its success and should profit together. The relative power of all the actors, determined by institutional norms and market conditions, play a major role in determining who gets what rewards. High taxes on the wealthy guaranteed that arrangement ensured widely distributed prosperity decades ago, and higher taxes on the rich now would ensure that there's more left over for everyday people.

A version of this story originally appeared in the February 2018 issue of Pacific Standard. Subscribe now and get eight issues/year or purchase a single copy of the magazine.