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Taxes Could Help Reduce Inequality–But They Just Make It Worse

There are lots of ways that filing taxes could be better for people who aren’t multimillionaires. We just don’t seem interested in them.

Taxes Could Help Reduce Inequality–But They Just Make It Worse
[Top photo: Martin Cormier via ]

If there were a way to eliminate tax loopholes for the superwealthy and corporations while simultaneously reducing income inequality, you would think it’d be more popular. But tax reform is not high up on the list of exciting reforms that might create a more equitable society.

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But there is at least one group of people who are focused about the debate on comprehensive tax reform that’s gearing up this year: the lobbyists who will be paid handsomely to swing things their clients’ way. The poor and middle classes, however, don’t have any lobbyists, which may explain why taxes and public spending in the U.S. are making inequality worse rather than reducing it.

If the poor and middle classes did have lobbyists, what ideas might get pushed through as part of comprehensive tax reform that would reduce inequality?

Bill Gates, speaking at the American Enterprise Institute last year, had one idea: “Don’t tax my income, tax my consumption.” His rationale? Income is easy to hide, but consumption isn’t. It’s not hard to see where he’s coming from—it’s never been easier to set up an offshore bank account, and companies as well as wealthy individuals are using them in numbers we’re only beginning to understand.

By taxing consumption instead of income, the argument goes, you could capture a share of the price of every yacht, luxury sports car, $2,000 leather bag, $800 pair of shoes, and whatever else the uber-wealthy choose to buy in your country. You could even expand the consumption tax to include services, which isn’t usually the case for existing sales taxes mostly at the state level. Were that so, you could collect sales taxes from hedge fund manager fees, attorney fees, plastic surgeries, landscaping, housekeeping, and other services that are more likely to be consumed the higher up you go on the income ladder.

So is that the solution to a more equitable tax code? Should we eventually stop taxing income entirely—at the corporate as well as personal level–and shift toward taxing only consumption? Rebecca Wilkins isn’t convinced. A career tax attorney, Wilkins is the executive director of the FACT Coalition.

“The basic problem with a consumption tax is that it’s inherently regressive,” she says. “It’s almost impossible to do a progressive consumption tax. The reason for that is that lower-income people tend to spend all their money just to get by, to pay the rent or a mortgage payment, groceries, utilities, food, whatever. The more income you have, the less of your income you actually consume, so the wealthy consume only a fraction of their income, and instead, they invest the rest of it.” 

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One key fact that Wilkins also points out is that taxes in the U.S. are not as easy on the poor and middle classes as you might guess, despite the fact that they have less money to tax. According to the latest Who Pays? report from the Institute on Taxation and Economic Policy, which documents the shares of income paid in taxes to state and local governments for all 50 states, “virtually every state’s tax system is fundamentally unfair, taking a much greater share of income from middle- and low-income families than from wealthy families.” Combine regressive state and local tax regimes with a barely progressive federal tax regime, and you find that most Americans pay around 20% of their income in taxes.

It wasn’t always that way, even as recently as a decade ago. “The Bush tax cuts really put a big dent in what used to be a much more progressive tax code that can actually help address inequality,” Wilkins says, highlighting in particular the Bush-era reductions in capital gains and dividends tax rates.

So maybe we should find ways to raise more taxes on income from capital—capital gains, dividends, estate taxes, and others—as a way to make the taxes progressive again? After all, the wealthier you are, the greater your share of income comes from capital as opposed to wages or salary. As Warren Buffett famously likes to say, because most of his income comes from investments and not a salary, he pays a lower tax rate than his secretary.

But it’s harder than you think, says Eugene Steuerle, Richard B. Fisher chair and institute fellow at the Urban Institute. “Measuring income from capital is hard to do,” Steuerle says. For one thing, “capital income taxation is on a realization basis rather than an accrual basis. If you don’t ever sell your stock that has capital gains, you could never pay taxes on it.”

Steuerle has been at this for a long time; you can read more of his reflections and ideas to reform public spending in his book Dead Men Ruling. Among his long list of achievements, he led the 1984 Treasury Department study that led to the Tax Reform Act of 1986, passed by a Democratic House of Representatives led by Tip O’Neill and signed by President Ronald Reagan. It was considered a landmark achievement by all sides, lowering marginal tax rates for all, while simplifying the code, eliminating special-interest loopholes, raising the corporate tax rate, and raising the capital gains tax rate—in effect, making the tax code more progressive. 

Yes, that’s right, Ronald Reagan signed a bill that, as former Senator Bill Bradley wrote in a 2009 op-ed, “resulted in the wealthy contributing a higher percentage of income-tax revenues than they had before the reform.”

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“The notion of progressivity is as old a philosophy as there is in government,” Steuerle says. “I don’t think it’s going to go away. The question of how you do it is a much tougher issue.” 

“Yes, the tax code can be an important tool to reduce economic inequality,” says Nicholas Galasso, the research and policy advisor at Oxfam who was the primary author of the now-famous report concluding that the 85 wealthiest people in the world have the same amount of wealth as the bottom half of humanity. But he doesn’t view a shift toward a more progressive tax regime that reduces inequality to be very likely. 

“I think that the anger around rising inequality in the U.S. concerns how our rule system is blatantly rigged in favor of economic elites to the detriment to everyone else,” Galasso says. “This is the case regarding tax, but it’s also evident in many other areas too.”

Making the tax code more progressive may need to start by first tackling a different problem entirely—a PR problem. People might feel different about their taxes if they had more of an understanding of what they were actually paying for. (Obama tried this with his “you didn’t build that” speech, however, and it didn’t work very well.)

While traveling last year, Wilkins picked up an in-flight magazine and found an article series on Minnesota. One article was on all the high-tech firms that were there, especially medical device firms like Medtronic; one was on the Twin Cities and what a great place it was to live, and how highly educated the workforce was, the string of city parks, and a joint partnership between the University of Minnesota and the medical device makers. “And never did they draw the connection that taxes pay for those things; taxes pay for the university system and the public parks; and the infrastructure and public health and clean water and more,” Wilkins recalled. 

“Taxes make the environment possible that makes Medtronic successful,” she concluded. “I just thought it was a really interesting juxtaposition because right then Medtronic was in the news for exploring an inversion to avoid paying corporate taxes in the U.S.”

About the author

Oscar Perry Abello is a New York-based journalist writing about social justice and equity in cities, communities, finance and the economy.

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