Tax Cuts for the Rich: A 40-Year Mistake

Last month, we found out something that was not especially surprising but extremely concerning. A study by economists Emmanuel Saez and Gabriel Zucman showed the richest 400 Americans now pay a lower effective tax rate than the bottom 50 percent of Americans. In short, the richest people in our country now face less taxation than the working class. Despite the recent calls for the rich to “pay their fair share” and the supposedly progressive taxation policy in the U.S., Trump’s 2017 tax cuts finally allowed the wealthiest people to pay the least into our society. However, the recent tax cut was just the completion of a decades-long pattern.

Tax cuts for the rich have been commonplace for around 40 years. The pattern started with President Ronald Reagan’s emphatic support for trickle-down economics. During Reagan’s tenure, he passed two tax cuts that drastically cut tax rates for the richest Americans. His popularization of tax cuts for the rich continued for decades. Although there were marginal tax increases in the 90s, they did not reverse the fortunes of the wealthy, and George W. Bush’s tax plan lowered their taxes even further. The rate of taxation for the highest bracket fell from 70 percent in 1980 to 39.6 percent during the Obama administration. The tax bill that Trump signed in 2017 lowered that top rate down to 37 percent. For good measure, Trump’s plan also doubled the exemption for the estate tax, meaning that a tax that exclusively affects the richest people—the top one percent of income earners pay over 70 percent of the estate tax—has been handicapped. These factors explain why 52.2 percent of the benefits of Trump’s tax plan go to the richest 10 percent of Americans.

The rich also benefit from deriving income from other sources. Capital gains, a major source of income for the rich, are taxed at a severely lower rate. The top rate is only 20 percent. Taking advantage of legal structures like LLCs or hiring tax attorneys to find loopholes in the tax code also allows the richest people to further reduce their tax burden.

Tax cuts for the rich have been pushed by the Republican party and the conservative movement for several reasons. A prevalent one is the moral case: you should not “punish success.” The truth is, taxes on the rich are not a punishment, and the reverse is true. If wealthier people are not taxed at a higher rate, the tax system punishes the middle class. To pay for basic expenses—food, shelter, clothing—everyone needs to set aside a certain amount of money. For people with less money, the amount they need to spend is a high proportion of their income; for people with lots of money, the amount they need to spend is a low proportion. Truly discretionary income is lower for people with less money to begin with—you don’t have a lot of extra money lying around if you are working paycheck-to-paycheck. If our tax system instituted a flat tax for all people, it would mean people with lower income have a greater share of their discretionary income taken away than rich people. A flat tax harms the poor and middle class much more than the rich, and progressive taxation with different tax brackets derives from this observation. As income ascends higher and higher into the tens of millions or hundreds of millions per year, so too does taxation need to rise. Otherwise, the system favors the rich and punishes the working and middle classes. High taxes on the rich are a necessity for fairness.

Another argument against taxing the rich is that wealthy people are job creators. They allegedly derived their fortunes from building businesses that employed thousands. The complaint here is that levying higher taxes on them is unfair: they did a good thing. However, this representation is not accurate for the wealthy in America. For people making over $10 million per year, around half of their income is from capital gains. Another 20 percent is from dividends and interest. Starting or growing a business is simply not how the uber-wealthy become uber-wealthy. Even when business growth is involved, the so-called “job creators” do not employ people out of the goodness of their heart. Employees are simply a necessity for firms; they are hired because there is no alternative. If it were possible to completely automate production or fire all the employees of a business, employers would certainly do so to decrease costs and maximize profit. If not, that employer would be replaced with someone who would. These jobs are not a gift and they are by no means charity; there should not be tax exemptions as if they were those things.

Opponents of taxes also cite economic reasons. Their claims rely on supply-side economic theory and the idea of the Laffer Curve. The theory goes that high taxes actually inhibit economic growth by removing the incentives to work more, produce more, or invest more. As you raise taxes more and more, you will eventually reach a point where you harm the economy and have less wealth to tax. From then on, raising tax rates decreases tax revenues. The diagram below illustrates this trend.

Proponents of this theory argue that lowering taxes will lead to more work, production, investment, and a better economy; they also claim you will increase tax revenue by lowering taxes. The issue, however, is that the American economy is almost certainly not on the right side of the Laffer Curve. Reagan and George W. Bush’s tax cuts both came in the midst of or right after a recession, so the revenue increases that eventually came from them are more attributable to the trends of the business cycle—not the tax policy. I agree that temporary tax cuts are an effective policy for combating recession, but supply-side theory says these cuts should be permanent and that they will increase tax revenue. Unfortunately for trickle-down economists, tax revenues were comparatively lower after the Reagan and Bush tax cuts. Before Reagan’s cuts, roughly 18 percent of U.S. GDP was taken as taxes; that level fell to 16.5 percent and never went back to 18 percent until 1997. Bush’s cuts again lowered the percentage of GDP collected from almost 20 percent to 15 percent. Tax revenue has never reached 20 percent again. Out of all of this data, we can see that the changes in nominal tax revenue were due to the regular cycle of the economy; if taxes were not cut, revenue would have been even higher. When Clinton raised taxes, revenue actually grew. If we were on the right side of the Laffer Curve (which was the justification for Bush’s cuts a decade later), revenue would have fallen. Circling back to the modern day, Trump’s tax cuts have failed to explode tax revenues, and the Federal government is now receiving less money adjusted for inflation. The American economy, therefore, does not have a problem of high taxes on the Laffer Curve.

Nor do high taxes on the rich necessarily lead to a poor economy. Income tax rates in the 1950s and 60s reached over 90 percent, and the economy was in many ways the strongest in American history. Although rates that high are unnecessary, postwar America proves that, on a conceptual level, high taxes on the rich and a good economy can coexist.

Letting the uber-wealthy off from paying their deserved taxes is a huge factor causing income inequality, which then contributes to many different issues. Housing prices have risen incredibly, in part because four out of five new apartments constructed are luxury apartments made for the increasing number of wealthy people. Similar inflation is now seen in many markets, making the cost of living unaffordable for more people. More broadly, income inequality hurts economic growth. With ever-increasing income inequality, the economy is hollowed out. Working people have less and less money, which means less spending in the economy and less growth. Letting billionaires have mass riches to pour into elections is no boon to democracy, either. The existence of people who can, on a whim, drop tens of millions of dollars into a campaign threatens the fairness of elections. The idea of one-person, one-vote kind of disappears when you can change the fortunes of a candidate with your money.

These issues don’t even take into account the trillions of debt the government has accumulated due to its defunding. Reagan’s fiscal policy led the Federal debt to triple from around $900 billion to over $2.8 trillion. Bush’s administration oversaw a doubling of the debt from $5.8 to $11.9 trillion. H.W. Bush, Clinton, and Obama also saw large increases in the total debt, in part because they never undid tax cuts for the rich. After four decades of tax cuts for the rich, we have added $21 trillion in debt for the current grand total of $22 trillion; deficits continue to grow out of control with no end in sight. Tax reductions for the wealthy compound the issues of income inequality and debt, so something needs to be done to reverse them.

First and foremost, tax cuts for the rich have to be undone. Raising the top marginal rate back to 70 percent might not be the best solution, but creating new, higher tax brackets that extend into higher incomes is necessary. The highest tax rate should not kick in at $500,000. Congress should create tax brackets for money made past $1, $2, $10, or more million made in one year and assign higher rates than just 37 percent for them. Even if we went to the extreme and created a 70 percent bracket for money made past $10 million, the effects on the earner would be negligible. They would still be making millions of dollars, and they need to make $10 million before they even start receiving the high tax. For people with this much income, taxation does not decrease their quality of life, and only the money they make after the first $10 million receives the 70 percent rate. Again, 70 percent might not even be needed; top rates in the 40s or 50s could still raise huge revenue sources for lifting people out of poverty, fighting climate change, funding affordable housing, paying for college tuition, decreasing the deficit—anything other than padding out the investment account of some rich guy.

Secondly, a wealth tax is desperately needed in this country. There are hundreds of billionaires in America, and most of their money will never be spent. Even Bill Gates, who has donated literal billions, still has around $90 billion lying around. It is simply impossible for most billionaires to ever spend all that money. Taxing the wealth of billionaires will have no tangible consequences for them, but putting just a tiny fraction of those billions into social services will help millions of working families. It also will remove the loophole of capital gains being taxed obscenely low and make those 400 richest Americans pay a higher tax rate than the working class. A wealth tax will restore fairness in the tax code.

For four decades, we have seen tax cuts for the rich fail to live up to their promises. At the same time, we have seen massive spikes in income inequality and public debt. I am not suggesting that taxing the rich will be a cure-all for society’s ills. What is true, however, is that undoing tax cuts for the rich will both fund our government and provide resources for the working class. We need to acknowledge that trickle-down economics has crashed. It’s time for a new policy: make the rich pay their fair share.

Katharine Sciackitano is a first-year Economics major in the College of Arts and Sciences. She is currently the Deputy Editor for Economics of the Agora.

Photo courtesy Joyce N. Boghosian, Creative Commons