Washington Wednesday - Bills to pay

NICK EICHER, HOST: It’s Wednesday the 22nd of September, 2021.

Glad to have you along for today’s edition of The World and Everything in It. Good morning, I’m Nick Eicher.

MARY REICHARD, HOST: And I’m Mary Reichard.

First up today: The potential multi-trillion-dollar tax hikes to fund the Democrats’ massive spending plan.

Democrats are still working to craft and pass a bill based on President Biden’s $3.5 trillion spending proposal. And last week, they unveiled a plan to pay for it partially with more than 40 separate tax hikes—adding up to about $2 trillion.

EICHER: Democrat party leaders still have work to do to win over two moderate Senate Democrats who have strong reservations about the size of the spending package.

But if they do manage to push a bill across the finish line, what impact might those trillions in tax increases have on the U.S. economy?

REICHARD: Joining us now to help answer that question and others is Jeff Haymond with Cedarville University in Ohio. He is the Dean of the School of Business Administration and Professor of Economics.

Professor, good morning!

JEFF HAYMOND, GUEST: Good morning.

REICHARD: Well, among the proposed increases, the plan would raise the top marginal income tax rate to 39.6 percent. That’s up from 37 percent. It would also impose a new 3 percent surtax on people making more than $5 million.

Now, for our listeners who are not in that income category, is there any reason they should care?

HAYMOND: Sure, I mean it one level, we've got to consider both sides of the equation here. We have to be aware that this is to fund a large increase in government expenditure. And at one level, that's going to take additional resources that could have been used in the private sector. So we can never forget that aspect of it. As the government gets bigger, necessarily the private sector gets smaller.

Then for the actual taxes itself, I mean, we know that everyone responds to incentives. An old saying is if you want more of something, subsidize it. If you want less of something, you tax it. So at one level, they realize that this would discourage the incentive to do the behavior that's being taxed. But on the other hand, they assume that for rich people, somehow they're just going to keep going out and making the same level of income and we know that rich people have a lot of options that maybe poor people do not have. So we can count on some change in behavior: how much it will be in the future, change in behavior in terms of production or change in compensation in the way they receive compensation. All that's going to be an adaptation to the new institutional rules of higher tax rates. We should not be foolish enough to think that people are going to willingly just say, I'm going to do everything at 39.6 percent as I was going to do at 37 percent.

And one final thing I just want to highlight. It is not simply the federal tax level that matters. It matters the sum of the federal, the state, and the local taxes as well. So if you're a California resident, with a high tax rate of 13 percent, you've got to add that on top of that, and in many cases, the localities are going to have it on top of that. In some cases, we have high net worth individuals already paying north of 60 percent of their income in taxes. So every little bit pushes you further away where people decide, hey, it's just not worth it for us to do the grind that leads to these kinds of financial results. We’re just giving it all back to the government.

REICHARD: Let’s talk about capital gains rates. What about the proposal in that area? Would that affect whom and what would it mean?

HAYMOND: Well capital gains is one of those interesting tax rates because that's the tax that's paid on the appreciation of assets, such that if you buy some investment property—say for $100,000—and then you hold it for, say, 20 years and it now sells for $200,000, you will make a $100,000 gain that you have to pay taxes on.

Now, one of the reasons why we typically have a lower taxable rate for capital gains is because they do not currently index capital gains for inflation. And if you had an investment property, for instance, over 20 years, much of that gain may be what we would call phantom gain purely due to inflation. And so to tax it at ordinary income tax rates, when you actually didn't make any money in real purchasing power terms, is kind of a hard sell to the people that held on that asset for a long time. So historically we've tried to keep it at lower rates.

One of the things that has been apparent is when we raise capital gains tax rates, we're gonna get lower revenue than if we actually lower than in every major capital gains tax regime before, such that the argument is why would you want to do that if it's actually going to cause lower revenue. And so famously when Mr. Obama was asked that during his initial campaign, he said, I would do that as a matter of fairness. So that's core to kind of one of the Democratic ideals is they believe even if it results in lower tax revenue to the American Treasury, it's good to do because that would be more equitable in other word.

In this particular rate, they're talking about raising it from 20 to 25 percent and what that does is have a n effect on the margin, as economists would like to say. Some investments, if you know you're going to have to pay a bigger tax bill if you sell to switch your investment from one to another, you're less likely to to make that switch. What that tends to do is it freezes capital in lower productivity investments. And so that harms economic growth over the longer term.

So, in general, economists tend to frown on capital gains tax rates being a source of revenue especially in light of the empirical evidence that it just seems to usually lead to actually lower tax revenue.

REICHARD: Let’s talk about raising taxes on big corporations. Republicans in their 2017 tax cut slashed the corporate rate to 21 percent—way down from 35 percent. But they also introduced new taxes on big companies’ overseas earnings. In the end, that amounted to a projected $330 billion tax cut.

Democrats now want to push the corporate tax rate back up to 26.5 percent. You’ve explained how taxes affect everyone across the board, so should working class Americans oppose raising taxes on huge corporations?

HAYMOND: They should. And, really, for multiple reasons. I'm going to hit the standard one you'll hear most of the time and then I'm going to hit one you probably don't hear which is, I think, even more important. So the most frequent criticism of corporate taxes is, look, corporations are just a legal fiction. And those profits that you're going to tax would have otherwise went to shareholders or workers or employees—all of which are in many respects just ordinary Americans, because every ordinary American has a pension fund, has got corporations—if they're public—in their pension funds and so forth. So you don't ever tax corporations. Real people are taxed. So what we're saying is we're going to tax real people, which will include employees and the shareholders, as well as the purchasers of that company's product. So, there's no escaping the fact that individuals are going to be hit by that.

Let me give you a different reason to be against corporate tax rates. Economists usually say, if you want to be efficient, if you really want a certain amount of tax revenue, tax it once and tax it at the source. Why should we have double taxation? Because, remember, when we distribute profits to shareholders in the forms of dividends, they're gonna have to pay taxes on the dividends. If you're taxing it twice, you're having a really high tax rate, which is another reason again, why corporate tax rates have been lowered historically. It's in recognition of the dual taxation that's occurring there.
What we have is this leads to a higher level of political corruption in our economy. If you raise the corporate tax rate, you have a lot of opportunities for very large corporations to hire very expensive K Street lobbyists, who will be able to get special favors as we see throughout already the the Democratic spending bill, by the way, in green energy and otherwise, such that you tend to see a tremendous misallocation of capital. Most shareholders that are getting their dividend are not going to be politically powerful enough to to influence the political process. But big corporations, yeah, they have a heavy influence. And politicians tend to like it that way.

REICHARD: Final question. Taken as a whole, professor, what kind of impact would the Democrats’ planned tax increase have on the economy? And would the promised benefits balance that out?

HAYMOND: Well, there's always a benefit or you wouldn't get this public policy. But the question is, is it a broad social benefit? Or is it a benefit to special interests that are pushing those products? And of course, the latter is the answer. The constituency of the Democratic party that wanted them to do this is very much in favor of that. I think net on net, this is going to be harmful to the economy. When you increase regulatory state, when you increase the taxation state, you typically get a lower performing economy. I tend to believe, for instance, in the Trump years before the the virus, it was not so much his tax cuts—although I think that helped—but Mr. Trump's deregulatory agenda, which unleashed what we saw with some very robust economic growth. I think that effort was hamstrung by Mr. Trump's trade policies which were on net negative. Mr. Biden has kept all of those negative trade policies. And yet, now we're going to insert, you've got the bad policies on trade that Mr. Trump had and you're going to add to it a higher regulatory state, which that party is calling for, and you're now going to have a smaller private sector with a robust expansion of the public sector. So all those things are on net, in my mind, negative. But clearly, they're going to benefit the people that receive that largesse.

REICHARD: Professor Jeff Haymond with Cedarville University has been our guest. Professor, thanks so much!

HAYMOND: You’re welcome.

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