Just a week after our country’s third-longest shutdown ended, most Americans are already preparing for the next. They fear that Congress will not reach any agreement on a budget by the Dec. 13 deadline — a reasonable feeling given that rank-and-file Republicans say they will refuse any budget with revenue increases.
Leading that gang, Paul Ryan’s office stated, “We should not take more from hard-working families to spend more in Washington.” Yet, this claim is an overly simplistic approach to our 3.8 million-word tax code.
Tax reform is needed, badly, and with enough nuance to make it meaningful and passable.
Our current income tax schedule is labeled as progressive — meaning that the tax rate increases as income increases. These labels typically focus on marginal tax rates, which climb from 10 percent for household incomes of $0 to $12,750, to 39.6 percent for incomes of $425,000 or more.
But the schedule isn’t as progressive as this gradation may seem; marginal rates tell only part of the story.
Each marginal rate applies only to one slice of income. For example, everyone pays only 10 percent of their first $12,750 in taxes, regardless of their gross income level. In the same way, high earners only pay 39.6 percent on the income they make in excess of $425,000.
Effective tax rates capture this variation in marginal brackets. Looking at these initially reveals a similarly, though less drasticly, progressive system. The lowest quintile of earners has an effective rate of just 2 percent, compared to 20.1 percent for the highest quintile, according to The New York Times.
However, those who bring home the most bacon — the top 400 earners — actually have a lower effective rate than the average millionaire: 19.91 percent compared to 24.6 percent. Warren Buffet puts this in strikingly human terms: “I’ll probably be the lowest paying taxpayer in the office.”
As a philosophical proponent of a progressive tax system, this is problematic. Luckily, we know what causes this difference: tax loopholes.
While there are many, the primary reason Buffet and others pay less proportionally is the capital gains loophole. That adjustment lowers the tax rate to 20 percent for the 39.6 percent bracket on income made from selling stocks, bonds or real estate. More than $0.43 of every dollar the superrich make is from selling these investments, explaining their lower effective rate.
A first step to reforming the tax code would address this problem by eliminating — or at least curbing — most of these loopholes. Legislators of all stripes should have ample reason to back such reforms.
For Democrats, this reform is an avenue to a more egalitarian society. For a developed nation, the United States is sadly unequal. Following the Palma Ratio, we rank just below Nigeria; ranking by Gini Coefficient, even China is ahead of us.
There is no doubt that our loophole system, which is largely used by the rich, contributes to this. The Center for American Progress finds that 85 percent of change in our Gini Coefficient in the last 30 years can be explained by changes in the top 1 percent’s effective tax rate.
But Republicans, who have been championing deficit reduction lately, must recognize the benefits as well. A Joint Committee on Taxation report calculated that the wealthy save $114 billion in taxes annually because of the capital gains rate.
That report also found that $116 billion in yearly revenue is lost from the home mortgage interest deduction, which is not to mention the second-home mortgage interest deduction that costs $8 billion a year. Eliminating these three loopholes, which largely benefit the wealthiest Americans, could reduce our 10-year deficit by $2.4 trillion.
But in the end, Americans will be true winners. A more equitable tax system can help spur economic growth. Nobel Prize-winning economist Joseph Stiglitz argues that these reforms would also build not only a bigger economy, but also a healthier one — one focused on business rather than finance.
More pragmatic than that, compromising on tax reform suggests some promise for the budget process. It just might save us from another shutdown.
Contact Nick Ahamed at nahamed ‘at’ stanford.edu.