Issues: Tax Equity

Our tax system can and should help us build a just society. To do that, it needs to raise enough revenue to meet our current needs and invest for the future. Just as important, it needs to raise that revenue fairly, asking the most of those with the most ability to pay.

We are a long way from that goal.

Taxes and the growth of income inequality

Americans continue to live with the impact of the Bush tax cuts, which went disproportionately to the very wealthy. Instead of counteracting the growth of income inequality, tax policy under the Bush administration actually contributed to it. The combination of a less progressive tax system and an increasing imbalance of power between workers and corporations have led to a widening gap between the rich and the rest of us. An in-depth study by the nonpartisan Congressional Budget Office found that growth in after-tax incomes since 1979 has been overwhelmingly skewed to the wealthiest 1 percent of the population.

Inflation-adjusted income for the top 1 percent grew by 275 percent over a generation. For the broad middle class (the middle 60 percent of the income distribution), income grew by only 37 percent. And for the bottom 20 percent, income grew just 18 percent. As a result, the distribution of income in our country is more unequal today than at any time since the 1920s.

In international comparisons, the United States stands out for our extreme levels of inequality. Data compiled by the Organization for Economic Cooperation and Development (which takes in most of the developed world) show us to have the most unequal distribution of income of any major industrialized country. This inequality hurts our economy, corrodes our society and weakens our democracy. It hurts our economy because middle-class consumer spending is the engine that drives our economic growth. Squeeze the middle class and concentrate income among 1 percent of the population, and growth suffers. It corrodes our society by creating a privileged elite, disconnected from the vast majority and contributing to a sense that we are not all in this together, that hard work and playing by the rules will not be rewarded. It weakens our democracy by concentrating political power along with income and wealth, as the 1 percent uses its financial resources to shape the outcome of electoral contests and influence the course of legislation.

This, in turn, fuels cynicism and disengagement among voters.

Why we need progressive taxation

A progressive tax system reduces inequality by levying higher rates on those with higher incomes. Our tax system, though, has become less progressive over the decades. In the 1950s, the corporate income tax (which falls primarily on the wealthy) accounted for more than a quarter of federal revenues. By 2010, it was less than a tenth. Over the same period payroll taxes – which are paid by workers, and because they are capped, hit those with lower incomes the hardest – have grown from roughly 10 percent of federal revenues to 40 percent.

Even progressive forms of taxation, such as the federal income tax, have become less progressive over the years. In 1996, the top 1 percent of taxpayers paid an average effective federal income tax rate of 28.9 percent. By 2008 (the latest year for which figures are available), that rate had fallen to 23.3 percent. (These rates reflect actual taxes paid, after all deductions and credits, expressed as a percentage of adjusted gross income.) The richest 1 percent have benefited from a lower top tax rate – currently 35 percent on income over $379,150, down from a top rate of 39.6 percent before the Bush tax cuts.

Many of the very richest Americans are benefiting even more from the preferential treatment our tax code gives income from owning capital, as opposed to income from work.

Most Americans get the bulk of their income from wages and salaries (or, in the case of retirees, their pensions, savings and Social Security). In contrast, at the top of the income distribution – among those with incomes of $1 million or more – wages and salaries account for only about a quarter of total income. Most of the income of the very rich takes the form of dividends and capital gains. Under Bush, the top tax rate on most capital gains was reduced to 15 percent (from 20 percent, which was itself a reduction from 28 percent), and the top tax rate on qualified dividends was reduced to 15 percent from 39.6 percent. To give a sense of the staggering sums involved, if the 400 richest U.S. taxpayers had paid the top rate that applies to regular wages and salaries on their capital gains in 2007, it would have generated an additional $18 billion in federal revenues.

Corporations ride free

A shocking number of profitable corporations pay little or no federal corporate income tax. The group Citizens for Tax Justice has identified 78 profitable corporations that paid no federal income tax in at least one of the last three years – and 30 that actually enjoyed a negative income tax rate (meaning that other taxpayers paid them) over the three-year period. Even worse, some of the loopholes that corporations use to avoid taxes – such as the ability to defer U.S. taxes on foreign profits – also cost American jobs.

Corporate tax dodging extends to the state and local level. Another recent study of Fortune 500 companies by Citizens for Tax Justice identified 68 corporations that paid no state corporate income tax at all in at least one of the last three years. Even so, states continue to compete to provide additional business tax breaks at the expense of working families and to the detriment of public services. In Michigan, for example, the Republican governor and state legislature have raised taxes on the working poor (through a cut in the state’s Earned Income Tax Credit) and retirees (by taxing their pensions) – not to fund education and other services, but to further reduce business taxes.

Toward a fairer tax system

The combined result of these bad policies has been a shift of the tax burden onto working families at both the federal and state levels. At the same time, “deficit hawks” are pushing for devastating cuts in domestic spending, on everything from food assistance to medical research to education to Social Security. Whether through an unfair tax burden or harmful cuts in vital programs, we are being asked to pay for a party we aren’t invited to. With an unprecedented amount of income concentrated in the top 1 percent, we should instead be looking to raise revenues through a more progressive system of taxation.

Restoring equity to our tax system should start by allowing the Bush tax cuts for the wealthy to expire this year. The Bush tax cuts were bad policy all around: Not only did they help turn a budget surplus into a deficit, but they also tilted our system away from fairness and accelerated the growth of inequality. If these changes are made permanent, their already high cost will explode to roughly $5 trillion over the next decade – more than twice the cost over the first decade. Who would benefit from that mind-boggling sum? Overwhelmingly, it would be the wealthy. In 2010, almost 40 percent of the benefits of the various Bush-era tax changes went to the top 1 percent (incomes of over $645,000), and more than half to the top 10 percent (incomes of over $170,000).

We support further action to end the privileged treatment of dividends and capital gains income. One  particularly outrageous abuse is the treatment of so-called “carried interest.” This allows hedge fund managers to claim that their compensation is actually capital gains – taxed, under the Bush tax code, at a maximum rate of 15 percent.

The single most progressive tax in our country is the federal estate tax – and for that reason, it is a favorite target of the Right. Wealth – and the power that goes with it – is even more concentrated than income. The estate tax, part of our tax code since 1916, focuses on inherited wealth and does not touch the vast majority of taxpayers.

Under Bush, it was sharply reduced and then eliminated entirely in 2010. A congressional compromise at the end of 2010 reinstated it for 2011, but with an extremely high exemption ($5 million) and a historically low rate (35 percent) – a cut from its already low 2009 level. We support extending and increasing the tax on inherited wealth.

The corporate tax code should be reformed to eliminate loopholes that allow profitable corporations to dodge federal taxes – particularly loopholes that encourage the movement of operations offshore. We are strongly opposed to a repatriation amnesty, in which companies are offered an opportunity to bring offshore profits back to the U.S. tax-free. When a similar tax amnesty was last offered, in 2004, the benefits were pocketed by shareholders and were not used to increase domestic employment. In fact, many corporate recipients went on to reduce their U.S. workforces. Another amnesty would send precisely the wrong signal to corporate America, encouraging them to shift still more work out of the country.

To provide additional revenue to meet our country’s needs, we support the creation of a small tax on financial transactions, similar to those already in existence in the United Kingdom and under consideration by the European Union. Not only would this tax raise needed revenue from large financial institutions and wealthy investors, it would serve as a disincentive for the kind of out-of-control speculation that fueled the financial crisis of 2008-2009.