With President Biden’s popularity at all-time lows, the administration seems increasingly desperate to boost approval ratings. However, the pursuit of a “tax-the-rich” policy agenda could turn costly for most Americans while hurting the Democrats’ chances in next year’s mid-term elections.
President Biden’s newly unveiled US$1.75 trillion budget plan – only half of the original US$3.5 trillion price tag - includes new climate investments, spending on healthcare, pre-kindergarten, home care and housing subsidies.
To pay for the President’s social spending and climate package, Democrats were flirting with a tax on unrealised capital gains of billionaires or those with incomes of more than US$100 million each year. That proposal would have likely been challenged in the courts and been incredibly difficult, if not impossible to implement. Interestingly enough, President Biden’s initial proposals earlier this year to close death tax loopholes would have overcome legal challenges and been much easier to implement.
Instead, the president’s newest proposal – totaling US$2 trillion in tax increases – raises taxes on earnings. The plan includes a 15 per cent minimum tax on the reported profits of large corporations, and a 1 per cent tax on corporate stock buy-backs.
This would be on top of individual income tax increases which would include a 5-percentage point increase to the top marginal tax rate - a surtax - on incomes exceeding US$10 million a year, and an additional 3 percentage points on incomes above US$25 million. These changes would raise the US top marginal income tax rate, including Medicare taxes, to nearly 49 per cent for the highest earners.
The good news is that the new plan comes in at a significantly lower price tag. The bad news: the proposed tax hikes will significantly hurt the working rich – employers – and their employees. This is because higher taxes on business profits discourage new investments and firm growth.
By punishing business expansion while failing to close loopholes that benefit the ultra-rich, President Biden’s tax plans will lower economic growth and worsen inequality.
Tax The Rich!
At this year’s Met Gala – a fundraising event for the Metropolitan Museum of Art – democrat politician Alexandria Ocasio-Cortez wore a dress emblazoned with the slogan, “Tax the Rich.” “Tax the rich” may seem like a good slogan to boost a politician’s approval ratings. However, tax the rich proposals[i] haven’t always been very popular even in America’s bluest states – Illinois[ii] and California[iii]. In 2020, state legislatures that sought to impose higher taxes on their wealthiest residents by ballot measures failed[iv] convincingly.
Bi-partisan backlash for the Afghanistan withdrawal, the immigration crisis at the southern border, and, with most Americans already disapproving[v] of the job the President is doing, the push for higher taxes has so far failed to convince key members[vi] of the President’s own party to support his agenda.
Moreover, if implemented, Biden’s current tax proposals would lower retained earnings used to finance business expansion plans. For liquidity-constrained business owners especially, the business tax hikes will reduce risk-taking, innovation, and job creation.
Research[vii] shows that firm owners bear roughly 40 per cent of tax hikes and employees bear 30-35 per cent of the burden. Increasing the tax liability raises the cost of capital, deters the formation of new establishments, and reduces labour demand. The reduction in labour demand will lead to lower wages and discourage labour supply.
For the wealthiest individuals, the benefit of tax avoidance will increase. They can choose to keep their income below US$10 million each year, spread the sale of large assets over several years, borrow against their assets, choose to transfer large fortunes to their heirs, contribute large sums to tax-advantaged retirement vehicles, or simply shift income to people who aren’t subject to the higher tax rates.
How Government Spends Could Save The Day
Another crucial mistake would be to ignore that government spending priorities matter. Some programmes such as infrastructure, healthcare, child tax credits, investments in workforce training programmes and apprenticeships can increase labour productivity. Other spending such as unconditional subsidies for food and housing[viii] could work against the national objective of getting Americans back to work.
Unfortunately, some investments that would likely yield the highest returns suffered the largest cuts in Biden’s slimmed down[ix] budget plan. These include a US$254 billion cut to the child tax and earned income tax credits, US$262 billion cut to higher education and workforce investments, and US$123 billion cut to clean energy investments.
The jury is still out on the impact that the new spending will have on the economy. But as many experts predicted earlier in the year, Biden’s US$1.9 trillion stimulus divided Congress and pushed prices higher faster, resulting in less of the necessary investments to support American workers. Main Street has lost big once again[x].
Data from the Bureau of Labor Statistics show that although nominal average hourly wages for civilian workers increased by 4.6 per cent over the past 12 months, inflation-adjusted earnings fell by 0.4 per cent during the same period. That means that most Americans – especially those at the lower end of the income distribution – are feeling the inflation pinch.
With inflation running hot and roughly 5 million Americans still missing from work – mostly due to reduced labour supply - Democrats are squandering their chances to hold on[xi] to their narrow majority in the 2022 mid-term elections. And the latest poll numbers should remind the president - a 48-year veteran of DC politics - that winning for an incumbent is all about the economy.
The most serious forecasts[xii] have revised down their outlook for US economic growth this year and next. But while the near term remains somewhat positive, the US economy faces more headwinds than tailwinds over the medium to long term. Climate risks, America’s aging population, the large decrease in international migration, and, of course, geopolitical risks are all factors that could act to drag down economic growth.
Incumbents who preside over relatively worse economic outcomes are punished at the polls, regardless of election-year performance. A failure to “Build Back Better” would hurt Democrats and likely sink Biden’s chances for a second term.
The Latest In The “Build Back Better” Proposal
Biden’s economic agenda is full of holes. In the past month, the tax proposals have multiplied. They range from tax cuts to tax hikes and then again tax cuts for the wealthy.
The latest tax proposal in the “Build Back Better” agenda: raising the cap on state and local tax deductions from US$10,000 to US$80,000.
Previously, individuals could deduct unlimited amounts of state and local taxes from their federal taxable income. The SALT deduction was a bigger benefit to the rich. The deduction also reduced the incentive to move to states that offer a better price for government services.
The state and local tax (SALT) deduction cap was introduced as part of the Tax Cuts & Jobs Act as a means to partially fund reductions in federal income tax rates.
Raising the cap on state and local tax deductions will disproportionately benefit the richest Americans in coastal states, explaining why it is so unpopular among both Republicans and Democrats. Democrat senator Bernie Sanders who called the proposal “beyond unacceptable” is working on his own proposal to raise the cap but only for households earning less than US$500,000 each year.
Raising the cap on state and local tax deductions will amount to a US$142 billion tax cut for Americans who earn more than US$1 million over the next five years, with more than half of the benefit accruing to residents of California, New York, New Jersey and Illinois – Democrat-led states. These are states where public finances are strained and the quality of government services has declined due to corruption and bad governance, despite frequent tax increases.
Raising the cap on state and local tax deductions would curb tax competition so that politicians in those states can continue to raise taxes to fund wasteful projects without losing wealthy taxpayers and important political contributors to low tax states. Eliminating the cap on SALT deductions will likely discourage reforms that would deliver higher public sector efficiency in poorly performing US states.
Dr Orphe Divounguy
Orphe Divounguy is a Senior Economist at Zillow Group Inc. Divounguy is the former Chief Economist at the Illinois Policy Institute. Divounguy is also the founder of the Quantitative Research Group and the co-host of the Everyday Economics podcast. Divounguy’s columns and articles cover fiscal policy, labor economics, and quantitative methods for programme and policy evaluation. Contact: firstname.lastname@example.org. The views presented here do not necessarily reflect the views of his employers.