The president’s agenda could end up costing American workers more than they receive in benefits.
The president's agenda could end up costing American workers more than they receive in benefits.
I n pushing his Build Back Better agenda, President Biden has touted redistributive taxes as a means of lifting the middle class. However, the Democrats’ $1.75 trillion budget proposal (scaled back from $3.5 trillion) could end up costing American workers more than they receive in benefits. Increased inflation, taxes, and debt that would result from the proposal would eat away at transfers to the middle class.
What matters to the households is not how much they receive but what they can buy — doubling your income is worthless if everything is twice as expensive. The proposed transfers will be eroded by the higher prices caused by Biden’s policies that provide a triple threat to price hikes by raising demand, cutting supply, and accommodating loose monetary policy. Inflation has come in repeatedly above expectations this year, eroding the benefits of wage increases. Rising prices are the result of the fiscal over-response to COVID, which caused an economic phenomenon unique in modern history: an increase in disposable incomes during a recession. While demand was boosted, supply was cut and firms were weighed down by policies that kept workers out of the labor force.
The Build Back Better plan would exacerbate this supply-demand imbalance by injecting more money into the economy while simultaneously keeping workers out of the labor force. By one estimate, the proposal would cost 9 million jobs over the next decade — at a time when firms are struggling to hire workers. Meanwhile, historically accommodative monetary policy would fan the flames of inflation.
The triple threat to prices already has them increasing 5.4 percent year over year. The price hikes are likely to persist for the middle class, as imputed rents in the CPI often lag housing prices, which are booming. Moreover, the poor spend a greater fraction of their incomes on consumption than the rich and generally consume items that are more sensitive to price increases — which makes inflation an asymmetric tax on the poor.
Back-of-the-envelope calculations indicate that inflation could erode the benefits to low- and middle-income Americans in the reconciliation package. Consider the child tax credit (CTC), which adds roughly 2.9 percent to the median household income of $69,700 for couples with two children. This would be inflated away if price growth exceeded nominal wage gains by 2.9 percent, currently a real possibility.
As a broader illustration, if $1.75 trillion were paid equally over 10 years to the approximately 121 million households in the U.S., each household would receive $1,450, a 2.1 percent increase in the median income. Inflation could very well outpace wage growth by as much.
Furthermore, economic evidence is clear that even much smaller price increases erase middle-class gains because the Biden transfers are mostly in-kind in nature, e.g. schooling or health care. In-kind transfers provide less in benefits than the dollar amount spent by the government, because recipients are forced to spend on certain items. For example, Medicaid, a big-ticket item in the new plan, has been found to be valued at only 20 to 50 cents on every dollar spent.
Even if the reconciliation package ends up delivering benefits, the middle class will likely end up shouldering a large share of the proposed taxes to fund it. Though the bill includes primarily taxes on the wealthy, there is always a difference between those who actually suffer from a tax and those who mail the checks to the IRS. For example, higher sales taxes sent by companies to the IRS are often passed on to consumers through price increases.
Biden’s taxes will be paid by those unable to avoid them, namely workers and consumers, not investors. Investor capital is highly mobile, as evidenced by small differences in risk-adjusted after-tax returns to capital across nations and industries. Investors switch from more-taxed to less-taxed activities, thereby equalizing returns, analogous to highway lanes running equally fast due to switching from slow to fast lanes. This mobility is true for the proposed wealth taxes on mobile capital but does not apply to property taxes, the main existing wealth tax. Property taxes collect money because you have to live somewhere; meanwhile, you can invest anywhere.
As labor is less mobile than capital, it often suffers from taxes imposed on investors. Workers earning below Biden’s $400,000 cutoff per year, while not sending checks to the IRS, will pay for the capital taxes through lower wages and employment. Evidence suggests that corporate tax cuts increase investment and wages. The Council of Economic Advisers summarized this evidence in 2017 and used it to correctly predict the effects of the Trump tax cuts.
On top of these costs, the Biden package will require taxes on future generations to service higher debt payments. Investors are too few and mobile to pay for the new debt in future taxes, so the middle class will, as they already do in socialist countries through higher sales and payroll taxes. This intergenerational transfer is on top of the massive one conducted through COVID policy that cut economic activity of the young in the name of preserving largely old-age health.
While the White House continues to claim its spending bill will help American workers with surprisingly strange economic rhetoric, simple economic analysis suggests otherwise. Higher inflation, lower output, and a more burdensome debt load will all fall largely on the middle class.
Tomas J. Philipson is a professor at the University of Chicago. He served as a member and acting chairman of President Trump’s Council of Economic Advisers from 2017 to 2020. Jon Hartley is an economics Ph.D. student at Stanford University and a visiting fellow at the Foundation for Research on Equal Opportunity. He served as a senior policy adviser to the Congressional Joint Economic Committee.