Tuesday, September 28, 2010

On paper transactions

I'll grant Alan Reynolds this much in his Great Inequality Debate with Linda McQuaig and Neil Brooks: he's absolutely right to recognize that the issue goes far beyond labour income. But I'm not sure he recognizes the implications of his argument for ignoring the higher nominal income gaps that have developed over the past few decades:
(M)ost growth of top 1% incomes since the 1986 tax reform has been the result of shifting income from corporate tax forms to individual tax forms (by using Subchapter S corporations, partnerships and LLCs) when individual tax rates fell in 1987 and 2003. There were also unusually large increases in reported capital gains and dividends after those tax rates were cut in 1997 and 2003.
CBO estimates are extremely sensitive to what Piketty and Saez (in an article with ­Anthony Atkinson of Oxford University) refer to as “the ­response of reported income to changes in tax law.” When tax rates on capital gains were reduced in 1997 and 2003, taxable capital gains reported by the top 1% soared for four years. When the dividend tax was cut to 15% in 2003, ­dividends reported by the top 1% ­quintupled in four years.
Now, the former point seems to me to offer a compelling refutation of the claim that lowered tax rates do anything to increase productivity or generate any other positive economic outcome. Instead, according to Reynolds' own analysis, the link between lower income tax rates and higher income is the result of wealthy individuals shuffling the same activities from "corporate tax forms" to "individual tax forms".

That would seem to offer reason to establish a baseline relationship between the two so that there's no particular value in shifting back and forth to game the tax laws in place at any given time. But I have my doubts that Reynolds would want to see that kind of system put in place, since his tax-cutting ilk seem to prefer attacking only one form of taxes at a time rather than acknowledging the long-term implications of a race to the bottom in both corporate and personal taxes.

What about the issue of compliance, though? It's easy enough to point out that if the wealthy have been abusing the tax system in a way that allows them to leave taxes unpaid, the answer out of both budgetary common sense and principles of fairness is to step up enforcement, not to lower tax rates in hopes that they'll be more willing to pay what they owe voluntarily.

But again, it's also worth asking whether there's any indication that high tax rates actually affect the economy as Reynolds and company accept and preach as an article of faith. And if Reynolds is right in suggesting that the only real difference caused by higher tax rates is in reporting and transaction structure rather than economic activity, then it's hard to buy any argument that there isn't room to raise taxes on the wealthy if needed to balance the U.S.' federal budget.

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