Politics & Policy

Untaxing the Rich

Candidate Donald Trump gives a speech on taxes at Trump Tower, September 2015. (Photo: Andrew Burton/Getty Images)
A misguided Republican obsession

EDITORS’ NOTE: This article is adapted from one that appears in the October 15, 2017, print issue of National Review.

Even during this unusual presidency, some features of our national politics have not changed at all. Republicans are preparing to cut taxes in basically the same fashion they would cut them under any president of their party. Democrats are resisting by using their standard lines, among which “It’s a tax cut for the rich!” has pride of place. The Republicans know their retorts by heart, too; they have 40 years of practice. For anyone disoriented by the political events of the last two years, it’s all very reassuring.

Conservatives could stand to be a little less reflexive about these issues, though. The Democrats have a point that is worth taking seriously.

That point is not that Republican tax policy is motivated by a slavish devotion to the interests of rich people. The supply-side economic theory that has underlain Republican economic thinking for more than a generation offers an economic argument for seeking to bring down their taxes, and even for seeking that goal especially. The theory places great emphasis on the way taxes reduce incentives to work, save, and invest. The highest tax rates — the ones that apply to the highest earners — have the biggest disincentivizing effect.

The way our income taxes are structured provides a subtler reason for concentrating on the top rate they impose. If you cut the lowest tax rate — the 10 percent rate that applies to the first $9,500 of a single person’s taxable income — you’re not just giving people in that tax bracket a very slightly stronger incentive to work. You’re also cutting taxes for everyone in the higher tax brackets, from the middle class to Elon Musk, because their first $9,500 will be taxed less too. Nonetheless, their incentives to earn more will not change at all. The federal government will still be taxing the next dollar Musk earns at the top tax rate.

Most of the revenue that the 10 percent tax rate raises for the federal government does not come from people who are actually in that tax bracket. That’s true, as well, of the 15 percent tax rate. It’s true of all of the tax rates except for the very highest one, the 39.6 percent tax rate. That’s the only tax rate that applies to the next dollar earned by everyone who pays it. Cutting it therefore offers more bang for the buck than cutting any other rate.

That’s the economic case for cutting taxes for rich people. There’s also a moral case. Most conservatives do not object in principle to a “progressive” tax code that takes a larger percentage from people who have more income. Even the flat tax and the “fair tax” (a proposed national sales tax) have this feature, because they have exemptions large enough to let people afford the necessities of life with untaxed income. But how progressive the tax code should be is a dividing line between Left and Right.

When liberals say that “tax fairness” requires raising taxes on the rich, and definitely not cutting them, conservatives wonder what’s so fair about a system in which (the top) 1 percent of households pays more taxes to the federal government than (the bottom) 60 percent does. The top 0.1 percent pays more than the bottom 40 percent, too. These numbers come from the Tax Policy Center, which is not a conservative group; and they include employees’ payroll taxes, not just income taxes. Any tax cut that reduces tax liabilities in a reasonably proportionate way will, conservatives say, cut taxes more for rich people than for middle-class or poor people. That’s just because rich people bear so much of the tax burden.

When conservatives use numbers such as these, though, they skip over two considerations. The first is that high earners pay a large percentage of all tax dollars in part because they make a large percentage of all income. Looking at the percentage of each group’s income that goes to taxes is more informative. The second is that while federal taxes are progressive, state and local taxes are regressive.

Combine taxes at all levels of government, and the lowest-earning fifth of households pays around 15 percent of its income in taxes. The middle fifth pays around 23 percent. The top fifth pays 33 percent. Within that top fifth, the top 1 percent pays roughly 38 percent.*

Our tax system is, overall, progressive. But while conservatives may reasonably wish for a significantly smaller government that would allow these numbers to come down, the rates do not rise with a steepness that should shock the conscience. A household making $2 million a year, roughly the average for the top 1 percent, pays 15 percent more of its income to the government than a household making $65,000 a year, the average for the middle fifth. This disproportion is not the kind of injustice that a major political party should make it one of its main items of business to correct. (Moreover, these percentages somewhat overstate the progressivity of the tax system. Arguably they should include employers’ payroll taxes, which are a hidden tax on employee wages.)

How skewed to the rich are Republican tax proposals? Here, again, Left and Right tend to use different measurements. If you’re trying to make Republicans look especially plutocratic, the way to do it is to ask how many dollars rich people will save as a percentage of a total tax cut. In 2016, House Republicans endorsed a plan that had as its main features replacing today’s income-tax rates with three rates of 12, 25, and 33 percent; reducing the tax rates on capital gains and dividends; eliminating the estate tax and the alternative minimum tax; increasing the standard deduction; and cutting the corporate tax rate to 20 percent. The Tax Policy Center found that the top 1 percent would get 99.6 percent of this tax cut in dollar terms.**

The Tax Foundation, a conservative group, highlights a more neutral measure of how a proposed tax policy affects different groups: the percentage by which it changes their after-tax income. These figures aren’t quite as eye-popping, but they still show a marked tilt toward high earners. The Tax Foundation finds that the middle fifth of tax filers would see a 0.2 percent increase in their after-tax income as a direct result of the House Republican plan. The top fifth would see a 1 percent increase. And the top 1 percent would see a 5.3 percent increase in their (already very high) incomes.

The numbers would be a little more equal if you made two adjustments. People tend to rise economically as they spend decades working. A tax cut for high earners will therefore benefit more people over a generation than it does at any point in time. Also, higher-earning households are so in part because they tend to have more workers. So a higher proportion of two-earner couples than of all households will benefit from a cut in the top tax rates. But the difference between how well the tax cut treats the $500,000-a-year and the $50,000-a-year household is too large for such issues to make a big difference. Republican tax plans really do provide a bigger payoff for the rich than for the middle class or the poor.

At least, a bigger direct payoff. The growth in after-tax incomes would be larger for every group if the Republican plans resulted in higher economic growth. Which brings us back to the supply-side case for tax cuts, and especially for tax cuts on large incomes.

The problem with that case is that it assumes a strongly positive effect of tax cuts on economic growth that does not appear to exist. Bill Clinton raised tax rates and the economy sprinted ahead. George W. Bush cut them and the economy limped. Barack Obama’s second term featured higher tax rates than his first one, and a better economy. This evidence does not prove that tax cuts are harmful. It is consistent with the possibility that tax cuts have a mildly positive effect that other factors can defeat. It is not consistent with the idea that it makes an enormous difference whether the top tax rate is closer to 30 or to 40 percent.

The supply-side argument itself implies that cutting tax rates has diminishing returns. Reducing the top tax rate from 70 to 50 percent, as the initial Reagan tax cuts did, meant that making an additional pre-tax dollar netted someone in the top bracket 50 cents instead of 30. The incentive to make that dollar was 67 percent higher. The House Republican plan, by cutting the top rate from 40 to 33 percent, would increase the incentive by just 12 percent.

The likely returns for the economy from cutting the top income-tax rates are modest.

Some changes to tax policy may do real good for the economy. The mortgage-interest deduction directs resources toward building larger homes at the expense of other goods; scaling it back would raise national income. Cutting the corporate tax rate and letting businesses write off the cost of investments the year they are made would promote investment and therefore growth. While economists debate who pays the corporate tax, changes to it are probably worth making even if rich people will reap a disproportionate share of the direct benefits.

But the likely returns for the economy from cutting the top income-tax rates are modest. Neither the economic nor the moral arguments for doing so are compelling. Why then are Republicans so devoted to this cause? The influence of large donors to political campaigns could have something to do with it, as is often alleged. But I suspect something else is at work. Compound interest has been said to be the most powerful force in the universe. Intellectual inertia must surely be ranked among the rivals for that title.

– Ramesh Ponnuru is a senior editor of National Review.

* Author’s calculation, based on combining the Tax Policy Center’s federal numbers with state-and-local figures available at https://itep.org/whopays/#Introduction.

READ MORE:

An Anti-Growth Tax Cut

An Opportunity for Pro-Growth and Pro-Family Tax Reform

The Tax-Reform Challenge

** The TPC has estimated that the recently released Republican “framework” for tax reform would be skewed to the rich, as well, but not as much so. Its estimate has been challenged, however, because it filled in details of the framework that have not yet been decided.

Ramesh Ponnuru — Ramesh Ponnuru is a senior editor for National Review, a columnist for Bloomberg View, a visiting fellow at the American Enterprise Institute, and a senior fellow at the National Review Institute.

Most Popular

Culture

Courage: The Greatest of Virtues

EDITOR’S NOTE: The following is Jonah Goldberg’s weekly “news”letter, the G-File. Subscribe here to get the G-File delivered to your inbox on Fridays. Dear Reader (Or Listener), As the reporter assigned the job of writing the article about all of Sidney Blumenthal’s friends and supporters told his ... Read More
Immigration

My American Dream

This morning, at 8 a.m., I did something I’ve wanted to do for as long as I can remember: I became an American. I first applied for a visa in early 2011, and since then I have slowly worked my way through the system — first as a visa-holder, then as a permanent resident (green card), and, finally, as a ... Read More
U.S.

The Gun-Control Debate Could Break America

Last night, the nation witnessed what looked a lot like an extended version of the famous “two minutes hate” from George Orwell’s novel 1984. During a CNN town hall on gun control, a furious crowd of Americans jeered at two conservatives, Marco Rubio and Dana Loesch, who stood in defense of the Second ... Read More