The economic health of the United States is at a critical stage. We are suffering from two related crises that threaten the stability of our democracy and need our immediate and continuing attention. This is not a popular discussion topic, but one that is well overdue.
The first crisis is that our national debt has reached a dangerous level. We currently owe about $28 trillion, roughly 130% of our current Gross Domestic Product (GDP). It has never been that high before; the previous high was shortly after World War II when the debt reached 118% of GDP. Unlike then when the US government mostly owed its citizens, today the government owes a large portion of our national debt to itself, and another significant portion is held by foreign actors, especially China and Japan. That makes it a national security issue as well as an economic crisis.
To make matters worse we have no national strategy for reducing the debt. Even before the pandemic we were on track to run $1 trillion annual deficits for the foreseeable future. That is clearly unsustainable over the longer term and must be addressed sometime soon. The debt may not be a serious problem today when the dollar is the world’s reserve currency and interest rates are near zero. But that won’t last. In the future it will become a severe limitation in our ability to grow our own economy and compete in the ever increasing globalization of markets. And the fix will require fundamental structural changes in how we raise federal revenue as well as how we spend it.
Meanwhile, we are suffering an economic and social catastrophe from the coronavirus. We have close to 10 million people unemployed, some facing foreclosure or eviction, and many others who can’t provide for their own most basic needs; Americans are literally going hungry. In the near term we must make hard choices that will exacerbate the debt problem.
We need immediate and substantially increased deficit spending to shore up our social safety net as well as the nation’s economic health if we want to recover from this crisis any time soon. At the same time we need to invest in our decaying national infrastructure to remain competitive in the world economy. Further, we need to recognize that it is going to be virtually impossible to cut social spending with the current economic suffering that the working and middle class are facing, as well as the long term demands from an aging population. In fact, we will probably have to expand social spending over the coming 10 years for structural reasons beyond the current crisis.
The second national economic and political health crisis we face is economic inequality. In the near term inequality is likely more dangerous for our democracy than the size of the national debt. A large segment of the electorate already feels economically hopeless, particularly exacerbated by the impact of the Covid pandemic. It is especially politically dangerous when the working poor and middle class recognize that the wealthy are gaming the system. And it is clear to everyone today that wealthy Americans are not paying a fair share of the electorate’s collective tax obligation; instead they are exploiting loopholes in tax law not available to everyone else.
Remember when it was widely reported that Trump paid no tax as a rich private businessman? Challenged about that in the 2016 Presidential debate, he proclaimed “that makes me smart.” Though most of the wealthy don’t brag about it the way he does, they also use loopholes and tax code manipulation to legally evade a substantial share of their tax obligations.
The electorate is also becoming more and more aware that the wealthy use their economic power to actually structure tax law and policy in favor of themselves. That reality along with the economic suffering experienced by most working people breeds political unrest. We are seeing that play out today, though the source of that frustration is often masked and manifests itself in racism, xenophobia, hate crimes, and other destructive behavior that may seem unrelated to inequality.
Economic inequality, however, is not a new problem; it has been building to its present critical level for the last four decades. The current economic situation has just shined a brighter light on the extent of it.
A Little American Tax Policy History
The stage was set for the current fiscal pain, economic inequality, and associated political instability forty years ago. In 1981 the Reagan Administration introduced the “supply side” economic experiment into American government, commonly known at the time as Reaganomics. Proponents of that strategy argued that high tax rates were stifling business and economic growth. They claimed that reducing tax rates on wealthy individuals and corporations would encourage vast new capital spending, spur economic growth, and generate substantially more federal revenue than the then-current tax rates. Further, those visionaries assured us that this investment of windfall profits would energize the economy in ways that would result in wages and economic benefits increasing in a “trickle down” effect to working poor and middle class Americans; everyone would win. During the 1980 Presidential election, I am embarrassed to admit that concept made perfect sense to me. I supported it and Reagan’s election whole heartedly; unfortunately, Reagan successfully implemented that tax policy soon after his election; and then we all quickly discovered that it did not work as intended.
Prior to the 1930s the exclusive goal of federal tax policy was to raise necessary federal revenues. Beginning with the Roosevelt Administration, however, a goal of limiting income and wealth inequality became an additional key objective of federal tax policy. That administration recognized that wealth inequality was a destabilizing force in democratic governance. Thus from the 1930s to 1981 the highest federal marginal income and estate tax rates averaged about 70%. In that same time frame the corporate tax rate hovered around 50%. There is clear statistical evidence that using tax policy in that way really did provide necessary federal revenues while keeping economic inequality in check.Then the Reagan economic revolution and his tax experiment hit. That was the beginning of the end of American fiscal responsibility.
Since 1980 Republicans have implemented the supply side economic model three times when they enjoyed political control (the Reagan, George W. Bush, and Trump administrations). It has never delivered the promised results, in fact just the opposite. What it has done is dramatically increase the wealth of those already wealthy, substantially increase the national debt, and effectively stagnate economic growth for working poor and middle class Americans.
Some reference statistics illustrate the point that supply side economics is a failure in our American economy, at least at the tax rates in effect prior to the Reagan Administration:
- In 1980, before Reagan, the top 1% of Americans earned about 10% of total national income; the bottom 50% earned about 20%. Today the numbers are almost reversed; the top 1% earn 20% of national income while the bottom 50% earn about 12%.
- The shift in the wealth share enjoyed by Americans is even more dramatic. Today the top 1% of Americans have around 40% of total national wealth, but staggeringly, the bottom 90% have only about 25%.
- At the same time the debt to GDP ratio went from 32% in 1980 to 106% in 2019, the year before the pandemic. It is predicted to exceed 130% this year and continue to grow even after the current health and economic crises are over, unless fundamental structural changes are made.
- The 33 years starting in 1948, the first year after the economic shock of industrial reconversion and assimilation of returning military personnel into the labor force after World War II, and ending in 1980, the average annual GDP growth was 3.8%; the next 39 years, starting in 1981, the first year of Reagan’s “supply side economics”, and ending in 2019, the average annual GDP growth rate has been 2.6%.
- And remember the higher GDP growth prior to 1981 was while we suffered under those “business stifling” high tax rates. Does that economic performance seem like supply side economics has been a success? Why would Republicans keep promoting its virtues? Could it be as simple as those wealthy and corporate constituents tend to give large donations for the opportunity to exercise influence over the “right” tax legislation and policies?
In addition to reduced marginal tax rates the Reagan era introduced a Republican laissez-faire approach to economics and federal governance in general. That persists today and has had additional profound negative effects. It fostered a breakdown in the sense of national responsibility corporations and the wealthy feel toward collective social justice. Suddenly it was acceptable to use the tax code to shift federal tax obligations away from themselves and toward working poor and middle class Americans. That led to the creation of an entire new tax evasion industry (they call it tax avoidance, but it’s evasion just the same) starting in 1981. The major accounting firms immediately began developing imaginative financial vehicles for their corporate and wealthy clients with the sole purpose of legally evading their tax obligations. Tax shelters, shell corporations, and off-shore tax havens became the norm. That’s still the modus operandi and is substantially why we are in the economic mess we are today.
Here are Some Things to Keep in Mind:
Only about 60% of federal income is actually taxed. Much of that is by design to benefit the wealthiest Americans virtually exclusively, through investment vehicles and soft enforcement of existing tax law;
Employees pay a 6.2% Social Security tax on their earnings, plus a matching employer contribution of 6.2% in lieu of wages. Self employed people pay the entire 12.4%. That is a very regressive flat tax on the poorest of the working class. But to increase the regressiveness, those with current incomes of more than $142,800 don’t have to pay on additional income above that amount; that specifically shelters the financially comfortable and wealthy from having to pay for Social Security in proportion to their earnings;
Employees also pay a 1.45% Medicare tax plus an equivalent employer match in lieu of wages; self employed individuals pay the entire 2.9%. This payroll tax is used to offset some of the cost of healthcare for people 65 years of age and older; it also provides certain basic health services for people with disabilities;
Even the employer paid portion of Social Security and Medicare taxes are designed such that they favor the wealthy. The employer portion of the tax is a deductible expense against capital earnings by business owners and corporate shareholders;
Generally, private healthcare insurance, through an employer in lieu of wages or individual policies, covers those younger than 65. That is probably the most regressive and inequitable tax of all because it is such a large portion of working Americans’ income. And sadly, it is usually not even called a tax or treated as such in national economic statistics since it is mostly paid to private insurance companies;
State and local taxes tend to be almost universally regressive. They disproportionately impact the economic health of the poorest and lowest middle class working people. For example: state and local sales taxes are generally levied on goods that working people need and buy most; but not on services (i.e., entertainment, legal services, housekeeping and other personal services); those are purchased and used much more by wealthy people;
Pure investment income is taxed at a much lower rate than wage income, and in some financial instruments not at all; Likewise, corporate and business income is generally taxed at a lower rate than wage income; since the vast majority of such income is earned by wealthy individuals they enjoy a lower tax rate than working people;
After-tax undistributed corporate profits are not taxed to the shareholders in the year in which they are earned. With efficient tax manipulation and estate planning they may in fact never be taxed;
Most American multinational corporations use foreign tax havens and other tax code manipulation to “launder” significant portions of their profits to evade US taxation.
What To Do?
As I mentioned in the beginning of this paper we must face the need to fundamentally restructure how we raise national revenue as well as how we spend it. The emphasis of this paper is mostly on restructuring national fiscal policy to raise needed federal revenue for a balanced budget while reversing economic inequality growth through intelligent application of tax policy. There are many things we need to consider in restructuring our economy. Following I will offer several appropriate changes that make sense and seem necessary to me:
I need to deal up-front with the most fundamental and politically controversial element of fiscal restructuring which I think is critical for our long term survival and leadership in the world community. That is the need to rebalance our spending between military and non-military needs. Our current annual military budget ($732B) is higher than the next 12 highest spending countries combined. That includes China ($261B) and Russia ($65B), two of our most antagonistic military competitors. I accept the argument as probably reasonable, that our military spending should be higher than other countries because of our historical position of leadership in the world community, but 4 times China’s and 11 times Russia’s?
National security spending is a large element of our economy; we can’t simply ignore its impact on fiscal priorities and tax policy. It is clear to me that less, but more efficient, military spending is a necessary and achievable part of getting our fiscal house in order. I have not done the research on specifically how to reduce military spending. And I am not proposing to undermine our military preparedness or make us less secure; but we need to focus on future military needs and not on preparation for fighting wars of the past; in short we need to spend more intelligently. My goal here is just to stake out placeholders for further consideration.
To that end, I suggest that we need to restructure military spending to substantially shift our national security investment away from major military hardware systems and toward diplomacy, intelligence assets, cyber security and offensive capabilities, artificial intelligence systems, and special operations military forces. That emphasis is likely to be much more economically efficient than our current hardware-focused footprint. And it is more likely to better meet our twenty-first century security needs. It’s time to face the reality that future military conflicts are more likely to be localized “hot spots” than major wars capturing and occupying territory. But even if a major conflict were to erupt, it would be fought mostly with intelligent systems, missiles, and specialists, not with aircraft carriers, manned warplanes, and other hardware intensive systems. We also need to recognize that we cannot afford to be the world’s police force, which historically since World War II has not won us many friends anyway.
Domestic Fiscal and Tax Policy
In the broadest terms, it is critical to both rational fiscal and tax policy that we reinstate a significantly simplified progressive federal tax system that includes limiting economic inequality as one of its cornerstone objectives. Among other things, that means we must tax income uniformly across the wealth spectrum regardless of how it is derived. That won’t be politically easy. The wealthy with their economic power and access to politicians have a disproportionately strong influence over tax policy. Regardless, that is critical to success and we must find the national will and a way to do it.
With restructuring military spending, and within the above context, there are a number of steps we could take to solve our current unsustainable fiscal condition and reform the US tax code to be more just. Our goal should be to eventually balance the federal budget, arrest and then reduce economic inequality, while saving our democracy in the process. Following are a few things in some combination that we should consider doing:
A. Personal Taxes
- Tax all personal income at the federal level on a more progressive basis as well as uniformly regardless of the source, whether wage based or capital investment based. If all income were uniformly taxed regardless of source but no other changed were made, even using today’s personal income tax rates, we could virtually balance the annual federal budget;
- Eliminate the cap on Social Security taxation above a fixed earnings limit. There is no rational economic or fiscal reason for cutting off continuing taxation on incomes above a specific threshold, currently $142,800;
- Make all income Social Security taxable both from wages and investment income. Why should only wage earners have to pay Social Security taxes while earnings that come from investments are untaxed?
- Similarly, index Social Security benefits to need, do not tax, and gradually phase them out at higher levels of wealth and income;
- Use the additional SS savings and revenue generated by taxation of all income and needs indexing to (a) establish Social Security on a long term financially sustainable path, and (b) lower SS tax rates across the board. Reduced rates will significantly benefit working and middle class Americans whose income is earned almost exclusively from wages;
- Replace Medicare/Medicaid with universal healthcare insurance for all Americans with costs heavily subsidized or free for at least the lower half of income earners. Sustainability of Medicare is already even more in financial crisis than Social Security. We have to do something soon or it will collapse. Why not do the right thing?
B. Corporate Taxation
- Eliminate the tax evasion benefit of shell corporations and off-shore tax havens for multinational corporations. The data to do that already is collected and IRS access exists;
- Tax American multinationals on worldwide income net of taxes paid to other countries;
- Tax foreign multinationals at the US corporate rate on income they earn on sales in the United States;
- Tax individual shareholders’ at personal tax rates on corporate income earned by closely held corporations (those not publicly traded) or where the only or primary reason for incorporation is to reduce tax liability. This will eliminate the ability for wealthy individuals and members of professional groups (i.e. law firms, engineering and architectural firms, doctors, other professionals) to evade fair taxation through use of the corporate structure.
Note: Items 1, 2, and 3 are entirely achievable within existing international trade treaties. They are just not being enforced. That also has the potential of raising tens or hundreds of billions of dollars in tax revenue that is currently being evaded by tax loopholes and lax enforcement. It will also likely have a trade stabilizing benefit of causing other countries to implement more uniform corporate taxation across the international community of nations;
Additional Loose Ends
If we implement all or most of the tax reforms I outline above we may still not achieve long term fiscal stability and reasonable economic equality. To do that we likely will need to deal with additional cost and revenue drivers:
— High quality healthcare costs must be addressed. The United States currently spends about twice as much per-capita on healthcare as other developed countries do; at the same time those countries already provide universal healthcare and have better life expectancy and health outcomes than we do. That should tell us market-based healthcare does not deliver the cost efficiency or quality we need and ought to expect. A non-partisan but comprehensive national analysis of the best economic balance between public and private services to provide quality healthcare should be initiated. It must consult with all legitimate stakeholders and the resulting recommendations must be implemented by the federal government. Universal healthcare is a necessary American right. We must implement it if we want to claim to be a liberal democracy in the twenty-first century;
— When all the dust settles and political posturing shakes out we are likely to need to tax the undistributed corporate earnings of publicly traded companies to the shareholders as income from those corporations in the year in which it is earned. That will be a very heavy political lift and a most controversial provision of any revised tax code, probably as much as universal healthcare. It will be derided by conservatives as a wealth tax; not quite, but it will be very unpopular among the wealthy.
I have two arguments in favor of that provision:
- First, from the models that I have seen we can never get to any reasonable level of economic equality (say like we had in the 1950s or 1960s) if we allow the wealthy to simply reinvest their wealth indefinitely without any intermediate taxation. That is particularly true if we continue to endorse a very low estate tax policy. We have to consider significant taxation of one or the other.
- Secondly, if we want to talk about a wealth tax, the poor and working class people already pay a wealth tax on virtually their entire capital investment – their homes. We call it property taxes. And while the wealthy also pay similar taxes on their real property, unlike working class people it represents a very small percentage of their total wealth. If we want to call it a wealth tax so be it. But it seems only fair that the wealthy should pay tax on the largest share of their wealth just as poor and working class people already do.
— The IRS and Justice Department mission should be substantially strengthened with additional personnel and other necessary resources to implement robust tax investigation and compliance enforcement. Since the beginning of the Reagan Administration the IRS has been starved of resources. Predictably, investigation and enforcement have continually declined year after year. As IRS enforcement declines, more evasion occurs. We need to reverse that trend so that the electorate can become more confident that the tax system is treating everyone equally and fairly.
— I have not discussed anywhere in this paper the economic cost of our lack of investment in pre-K childhood development, inadequacies of our education and justice systems, disparity among races, or white public institutional bias in preserving inequality. These all have real but hard-to quantify economic impact. We can legislate and regulate to correct some elements of them. But others require a fundamental shift in American society’s appreciation and respect for each other. We can’t fix that in fiscal or tax policy. The increasing diversity of color and culture in America over time is probably the only solution for some of that.
This is a strategic concept paper. It is not intended to be a prescriptive solution to our fiscal crisis or a formula for how we must reform our tax code. It is my best effort to consider where we are, how we got here, and the kinds of things we need to consider to get to a better place. It is offered to prompt rational discussion on the subject and offer ideas on how we might reform our systems to strengthen our democracy and serve the American electorate more equitably than is being done today. If it meets even part of that goal I will be ecstatic.