Taxes and Concentration of Wealth


The concentration of wealth plays a role in economic growth and employment, crime rates, and just about every aspect of American society. The primary tools government uses to manipulate the concentration of wealth are tax and healthcare policies. In this article, we focus on how recent tax policy is reshaping the concentration of wealth.

Policies that distribute wealth and power more broadly are sometimes called “socialist” by those who argue against them. Similarly, policies that concentrate wealth and power too much are sometimes called “oppressive” or “fascist”. Both of these names are misleading. In a capitalist democracy, a wide range of policy decisions can set the stage for incentives and fair business; we’re still working to find the best balance.

Capital gains income tax:

Under President Bush’s tax cuts, investors are now paying 15% tax on income from capital gains. Meanwhile, income from work is taxed about twice as much, depending on your marginal rate. The tax code is effectively encouraging income from capital gains by giving back half the tax on that type of income. It’s not clear to me that the government should be in the business of encouraging one type of income over another, but if we do then we should be encouraging income from work. Investors may argue that they have already earned this money and paid taxes on it so it should not be taxed again. This is true; remember that you only pay tax on the new income. The original amount you invested is not considered income and is not taxed again.

Estate taxes:

Estate taxes were created along with child labor laws, voting rights for women, and the establishment of an income tax during the Progressive Era (1900-1918). President Bush is eliminating the estate tax, and has proposed to make this tax cut permanent in the coming term. The question of whether we should we maintain estate taxes or eliminate them is a subjective question. Rather than make this point myself, let me defer to the words of President Franklin Roosevelt: “Great accumulations of wealth cannot be justified on the basis of personal and family security. In the last analysis such accumulations amount to the perpetuation of great and undesirable concentration of control in a relatively few individuals over the employment and welfare of many, many others. Such inherited economic power is as inconsistent with the ideals of this generation as inherited political power was inconsistent with the ideals of the generation which established our Government.” President Bush’s agenda for estate taxes is to reduce the estate tax over time to nothing, and in the next 4 years, his agenda is to make this permanent. If this happens, families of vast wealth will effectively be an elite class, removed from the rest of Americans by the virtue of birthright.

Dividend income tax:

Bush’s economic agenda for the next 4 years also includes eliminating the tax on dividend income (http://www.gop.com/GOPAgenda/AgendaPage.aspx?id=2). If this is passed, those who receive dividend payments will not pay any taxes on that income, giving them an after-tax raise of more than 50% (35% tax leaves 65%. Going from 65 to 100 is a 53.8% gain). That personal income will no-longer be contributing to the government revenues, and the shortfall will accumulate against us all in the form of budget deficit. If stopping the double-taxation of dividends is the goal, the correct way to deal with it would be to make dividend payments a deductible expense just like any other cost of doing business.

These recent tax cuts have been very effective in getting money back into the hands of Americans, but have put us into growing debt. The budget deficit is important because the national debt must someday be paid down, with interest. This is one of the most important factors that determines the value of the US dollar and international confidence in American investments. With extensive history and other nations as examples, we clearly see that as the debt gets bigger, we will experience inflation, not be able to buy as many foreign goods, and see less international interest in our stock markets. The U.S. budget deficit in 2004 will hit a record $445 billion, according to the White House. Not only would this be a record deficit, but also an unprecedented fall from record surplus.

Federal Budget Surplus or Deficit

Data source: http://www.cbo.gov/showdoc.cfm?index=1821&sequence=0

Instead, if income from all sources is simply taxed as income, then tax policy will be much more fair and government revenues will be higher. On this point, the Democratic agenda to roll back such specific portions of the recent tax cuts seems right. The timing, however, is sensitive: increasing taxes during economic recession can make problems worse.

In any event, the Federal Reserve (not tax policy) is the primary mechanism for managing economic recession. If the federal government uses changes in the tax code to manipulate the economic cycles, then it is acting as a backseat driver to the Federal Reserve. In addition to the complication this adds for the FED in determining the funds rate, it also makes it much harder for citizens and businesses to plan and prepare taxes.

The concentration of wealth threatens our nation. The poverty rate was 12.5% of all Americans in 2003. The numbers are even worse for children: 17.6% of Americans under the age of 18 are living in poverty (http://www.census.gov/hhes/income/income03/prs04asc.html). I hope you will agree that these numbers are too big. These Americans often disappear in our society and are not very well represented in politics: they may not apply for jobs or vote, they often do not have health insurance, they often do not pay taxes on the money they do earn; they hide from the system because the system demands taxes that they can’t afford to pay. Tax policy is exacerbating this problem and should be made fair in the ways I described above. Once the downward spiral of joblessness and poverty can be broken, the upward spiral of employment and fulfillment can begin. Increasing the workforce and reducing structural poverty is clearly in the interest of America.

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