A demonstrator holds a sign at a rally in opposition to the Republican tax bill held in Lower Manhattan
This article appears in the Summer 2018 issue of The American Prospect magazine. Subscribe here.
The immediate aim for progressives on taxes is clear: show all the ways in which the 2017 Republican Tax Act favors the interests of the wealthy and short-changes average Americans, who will ultimately end up paying the cost.
But the long game on taxes is a lot less obvious. We need policies that foster a more widely shared prosperity, correcting for the trend toward increased economic inequality instead of aggravating it. We need stable financing for programs that the public continues to demand. And we need to reduce the risks of climate change by promoting the shift away from carbon fuels. Working out an effective and persuasive strategy to achieve those aims poses an extraordinary challenge.
How we got progressive taxation in the first place may hold some lessons for us now. In their book Taxing the Rich: A History of Fiscal Fairness in the United States and Europe, Kenneth Scheve and David Stasavage distinguish between two types of arguments for progressivity. The more familiar argument is that a person’s ability to pay increases with income and that a graduated tax is fair because it tends to equalize the sacrifice asked of rich and poor. The less familiar argument—but the one that Scheve and Stasavage point to as crucial to the rise of progressive taxation in the 20th century—is compensatory: Higher taxes on the rich compensate for other advantages the rich enjoy from government policy.
Progressive taxation in the United States emerged in two steps, each of which had its own compensatory argument. In the late 1800s and early 1900s, support for a constitutional amendment to allow a federal income tax came predominantly from the South and the West, where Populists and Democrats saw an income tax as a way of compensating for the advantages that protective tariffs created for industrial and financial interests concentrated in the Northeast. But rates only went as high as 7 percent in the income tax passed by Congress after the ratification of the 16th Amendment in 1913.
It was during the two world wars that marginal rates on top incomes rose to much higher levels—up to 94 percent during World War II—justified by an even more powerful compensatory argument. With millions of men being conscripted to fight, it was only fair to demand greater sacrifice in taxes from those who stayed home and often prospered from the war economy. The “conscription of income,” some called it. During the Cold War, while the draft was still in effect, Congress maintained highly progressive rates. And because economic growth was strong in the postwar years, conservatives got little traction arguing that progressive taxes hindered economic growth, until the stagflation of the 1970s paved the way for the tax cuts of the Reagan era.
The late 20th-century decline in progressive taxation wasn’t peculiar to the United States. Governments in the advanced economies cut the top marginal income tax rate from an average of 60 percent in the early 1970s to 38 percent by 2000, according to Scheve and Stasavage. Their explanation is that without wars involving mass mobilization, the compensatory argument for sharply progressive taxes became harder to make. Let’s leave aside the adequacy of that historical analysis (which leaves out differences in political influence and fails to explain the decline in corporate taxes that occurred in the same period). The political question now, in an era of runaway top incomes, is whether liberals can effectively make a different compensatory argument, justifying progressive taxes as a means of compensating for decades of government policy that has unduly favored powerful corporations and people at the top.
That seems to me the right argument to make, but I also see another lesson for the long game on taxes from recent European and American history. And that lesson, while not contradicting the first one, goes in a different direction. If we want secure public financing, we need to put relatively less emphasis on income taxes altogether.
The European countries with substantial public services and generous social insurance programs don’t rely heavily on progressive taxes on income. They typically achieve greater economic equality and security on the spending side, while collecting revenue through regressive taxes on consumption, primarily the value-added tax (VAT), as well as payroll taxes. Because it is built into everyday prices, the VAT provokes relatively little conflict. And because it is rebated for exports, it has advantages in international trade. That’s one of the ways the Europeans reconcile incentives for economic growth with protections for economic security.
The United States desperately needs the kind of stable financing for public goods and services that a tax like the VAT provides. Since the end of the Reagan era, tax policy has seesawed back and forth. In 1993, Bill Clinton raised top marginal rates back up a bit, but George W. Bush cut them back down a decade later. Then they went up again under Barack Obama, and now back down under Donald Trump, with the biggest cuts coming in corporate taxes. The Republican tax cuts always come with false promises that they will pay for themselves. What they really do is create a fiscal straitjacket for future Democratic administrations, which are severely constrained even when they do manage to restore some of the progressivity lost under Republican control.
If Democrats win control of Congress and the presidency in 2020, they should try to undo much of the 2017 Republican legislation. But we are not going back—at least, let’s hope we are not going back—to the conditions of the world wars that allowed for the exceptionally progressive tax rates of the mid-20th century. Just as the Europeans long ago recognized the limits of what they could get out of progressive income taxes, so Democrats here need to make that adjustment and play for a long game that enables us to break out of the seesaw pattern of recent decades and establish new sources of revenue.
The rationale for new revenue is that the world we confront today requires more of a role for government, not less, in protecting both our personal economic and collective security. In the 20th century, America effectively delegated to employers many of the functions, such as the provision of health insurance, that governments elsewhere perform. But employers have been shedding those responsibilities, offloading risks onto their employees and relying more on independent contractors and part-time workers. Changes in family life have also created new needs, such as for child care, that the country has been unable to meet. We have likewise been hamstrung in making public investments not only for traditional infrastructure but also for the updated transportation and energy systems needed to adapt to rising sea levels and changing weather patterns. Climate change ought to be seen as a matter of collective defense—the defense of a sustainable environment for the nation and the entire world. Public money is essential to meet these challenges, and taxes are the only way to obtain it.
It seems to me there are three major candidates for new revenue—a VAT, carbon taxes, and wealth taxation—and two primary ways to think about strategies for enactment. One way is to start small. Just as the federal income tax was originally established at a low level in 1913, so was the payroll tax for Social Security in 1935 (originally only 1 percent on the employer and 1 percent on the worker). Establishing the rationale for a new tax is more important than obtaining its full revenue potential.
A second strategy of enactment is to propose a new tax at a higher rate and give much of the money back in the form of reductions in other taxes or rebates to individuals. This is the gist of a 2008 proposal for a VAT by Michael Graetz, who served as a Treasury official for tax policy in the first Bush administration and is currently a professor at Columbia Law School. Graetz’s idea was to introduce a VAT at 10 percent to 14 percent while increasing the standard exemption on income taxes to $50,000 for an individual and $100,000 for a couple. A politically attractive feature of the proposal is that it would not only make the tax less regressive but eliminate the need for tens of millions of households to file income tax returns. Although Graetz’s idea has other problems, the basic strategy of using part of the proceeds of a VAT to reduce other tax obligations deserves reconsideration. A VAT makes many liberals uneasy. But depending on what taxes a VAT replaces, what services it finances, and what kinds of credits or rate differentials it has, its impact could be net progressive.
Rebates to individuals have been a central feature of proposals for a carbon tax, which has the singular virtue of directly promoting sustainable patterns of energy use. Indeed, some proposals for taxing carbon have advocated it solely for its incentive effects and called for rebating all the proceeds to individuals. But while rebating some of the money makes sense as a way of offsetting the regressive impact, a carbon tax could underwrite public spending to address environmental threats. Earmarking proceeds for a National Resilience Fund, for example, would be a way to finance public infrastructure investment, disaster aid and reconstruction, and other needs currently financed—indeed, underfinanced—out of general revenue.
The third option, wealth taxation, faces inherent problems in a world economy with highly mobile capital: Try to tax wealth heavily, and its owners can move it elsewhere. That’s why at the end of his book Capital in the Twenty-First Century, Thomas Piketty calls for a global wealth tax. But while a new tax of that kind is hard to imagine, there are two more practical steps in that direction. One is to negotiate international agreements to reduce the tax evasion by the global 1 percent and capture revenue from the trillions of dollars in offshore accounts. The other is to strengthen the estate tax; for example, the current system allows wealth to be passed on untaxed from one generation to the next in perpetuity, while other people bear the burden of paying for public goods. Taxing capital gains at the point assets are passed on to heirs would not only be fair but help reduce the concentration of immense wealth in a self-perpetuating oligarchy.
In the Trump era, everyone’s attention seems to be consumed by the scandals and crises of the moment. But we need to think about the challenges that Trumpery is keeping off the agenda, and taxes have to be part of that strategic effort. Most likely, enacting a new tax like a VAT or carbon tax, or combating the various means the superrich use to escape taxation, will require a precipitating national crisis that creates unambiguous fiscal demands. The latest Republican tax cuts may well contribute to such a fiscal crisis, in which case we ought to be prepared with bolder alternatives than are currently being discussed. The long game may be on us soon enough.