Tax Increases and the ‘Inequality’ Excuse

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( Krystsina Yakubovich/Getty Images)

Welcome to the Capital Note, a newsletter about business, finance, and economics. On the menu today: tax and inequality, Prince Harry’s new job, Pfizer’s new drug, the EU and China — trouble in paradise (?), and centuries of declining interest rates. To sign up for the Capital Note, follow this link.

Inequality and Taxes
Spending leads, taxes follow, even more so when increasing taxes is seen as a good in itself, as, say, a means of achieving a reduction in inequality.


President Joe Biden’s economic team at the White House is determined to make good on his campaign pledge to raise taxes on the rich, emboldened by mounting data showing how well America’s wealthy did financially during the pandemic.

With Republican and business-lobby opposition to the administration’s tax plans stiffening, Democrats need to decide how ambitious to be in trying to revamp the tax code in what’s almost-certain to be a go-it-alone bill. Interviews with senior officials show there’s rising confidence at the White House that evidence of widening inequality will translate into broad popular support for a tax-the-wealthy strategy.

But how good is that evidence?

Writing in the Wall Street Journal, Phil Gramm and John Early take a look at the numbers purporting to demonstrate income inequality, and, by applying some commonsense to what income actually is, find that the usual narrative is, surprise, not all that it has been made out to be.

Back in 2019, also writing in the Journal, the duo noted this:

The published census data for 2017 portray the top quintile of households as having almost 17 times as much income as the bottom quintile. But this picture is false. The measure fails to account for the one-third of all household income paid in federal, state and local taxes. Since households in the top income quintile pay almost two-thirds of all taxes, ignoring the earned income lost to taxes substantially overstates inequality.

The Census Bureau also fails to count $1.9 trillion in annual public transfer payments to American households. The bureau ignores transfer payments from some 95 federal programs such as Medicare, Medicaid and food stamps, which make up more than 40% of federal spending, along with dozens of state and local programs. Government transfers provide 89% of all resources available to the bottom income quintile of households and more than half of the total resources available to the second quintile.

In all, leaving out taxes and most transfers overstates inequality by more than 300%, as measured by the ratio of the top quintile’s income to the bottom quintile’s. More than 80% of all taxes are paid by the top two quintiles, and more than 70% of all government transfer payments go to the bottom two quintiles.

America’s system of data collection is among the most sophisticated in the world, but the Census Bureau’s decision not to count taxes as lost income and transfers as gained income grossly distorts its measure of the income distribution. As a result, the raging national debate over income inequality, the outcome of which could alter the foundations of our economic and political system, is based on faulty information.

Looking at some of the raw numbers, it is easy enough to come to a superficial conclusion about the sources of this “raging debate”:

The average bottom-quintile household earns only $4,908, while the average top-quintile one earns $295,904, or 60 times as much . . .

But while the raw numbers may make for raw politics, they do not tell the full story.

Gramm and Early:

The average bottom-quintile household receives $45,389 in government transfers. Private transfers from charitable and family sources provide another $3,313. The average household in the bottom quintile pays $2,709 in taxes, mostly sales, property and excise taxes. The net result is that the average household in the bottom quintile has $50,901 of available resources.

Government transfers go mostly to low-income households. The average bottom-quintile household and the average second-quintile household receive government transfers of some $17 and $4 respectively for every dollar of taxes they pay. The average middle-income household receives $17,850 in government transfers and pays an almost identical $17,737 in taxes, while the fourth and top quintiles of households receive government transfers of only 29 cents and 6 cents respectively for every dollar paid in taxes. (In the chart, transfers received minus taxes paid are shown as net government transfers for low-income households and net taxes for high income households.)

The average top-quintile household pays on average $109,125 in taxes and is left, after taxes and transfer payments, with only 3.8 times as much as the bottom quintile: $194,906 compared with $50,901. No matter how much income you think government in a free society should redistribute, it is much harder to argue that the bottom quintile is getting too little or the top quintile is getting too much when the ratio of net resources available to them is 3.8 to 1 rather than 60 to 1 (the ratio of what they earn) or the Census number of 17 to 1 (which excludes taxes and most transfers).

There is more data in that article to read, but now fast-forward to yesterday’s piece:

We can now show that if you count all government transfers (minus administrative costs) as income to the recipient household, reduce household income by taxes paid, and correct for two major discontinuities in the time-series data on income inequality that were caused solely by changes in Census Bureau data-collection methods, the claim that income inequality is growing on a secular basis collapses. Not only is income inequality in America not growing, it is lower today than it was 50 years ago.

While the disparity in earned income has become more pronounced in the past 50 years, the actual inflation-adjusted income received by the bottom quintile, counting the value of all transfer payments received net of taxes paid, has risen by 300%. The top quintile has seen its after-tax income rise by only 213%. As government transfer payments to low-income households exploded, their labor-force participation collapsed and the percentage of income in the bottom quintile coming from government payments rose above 90%.

Those are 2017 data, before the Trump tax changes, but in that connection, this article recently published in Capital Matters by Demian Bedy is instructive:

Recent data published from the Internal Revenue Service find that the share of income taxes paid by the top 1 percent of filers increased under the first year of the TCJA, while the share of taxes paid by the bottom 50 percent of filers decreased.

These findings come straight from an IRS report that breaks down the tax share of income earners for tax-year 2018 — the first year of taxes filed under the new provisions. Among its changes, the TCJA lowered tax rates, nearly doubled the standard deduction, and expanded the child tax credit.

The IRS data show that the top 1 percent of filers, those with adjusted gross income of $540,009 or higher, paid 40.1 percent of all income taxes. This amount is nearly twice as much as their income share.

Despite the rate reductions under the TCJA, the tax share of the top 1 percent increased compared to 2017. In fact, the National Taxpayers Union Foundation has compiled historical IRS data tracking the distribution of the federal income tax burden back to 1980, and 2018 was the highest share recorded over that period.

The top 10 percent of filers, those with adjusted gross income of $151,935 or higher, paid over 71 percent of all income taxes. This was also the highest share recorded in the data available since 1980.

The lower half of earners, with adjusted gross incomes of less than $43,614, owed 2.9 percent of all taxes. This was a decrease from the 3.1 percent recorded in 2017. The lowest share was recorded in 2010, during the recession, at 2.4 percent . . .

There’s more, but you get the picture.

Where there has been a sharp increase in income inequality is at the very top of the pyramid. The top 0.1 percent have dramatically outpaced the rest of the 1 percent, and the 1 percent have outpaced the 2 percent, in a cascade that continues, I suspect, for some distance down (mixed metaphor) the ladder. One of the best ways of understanding the true politics of inequality is the extent to which it is, almost certainly, driven by a fight for power and money within the elites rather than concern for the poor. And this is what is triggering it this time round.

I touched on this in an article for (ahem) another publication not long after Obama’s first election to the presidency:

This is the class resentment that twists through recent remarks by another writer, a former academic who argued that it was ridiculous that “25-year-olds [were] getting million-dollar bonuses, [and] they were willing to pay $100 for a steak dinner and the waiter was getting the kinds of tips that would make a college professor envious.”

The reference to a “college professor” as the epitome of the individual wronged by this topsy-turvy state of affairs is telling: 58 percent of those with a postgraduate education voted Democratic, up from 50 percent in 1992 (those with just one degree split more evenly). If those comments are telling, so is the identity of the speaker: one Barack Obama, a politician who has explicitly and implicitly promised the managers, the scribblers, the professors, and the now-eclipsed gentry that he would finish what the market collapse had begun. He’d put those Wall Street nouveaux back in their place.

Throw Big Tech into the equation and we are in 2021.

Where inequality has risen is, clearly, in the distribution of capital, quite a bit of it the product of some of the success stories of the last few decades. This goes quite some way to explaining why this latest chapter of the fight within the elite has been directed at wealth, whether it is in the increasing interest in wealth taxes; threatened increases in the capital-gains tax rate; a lower threshold for when the death tax kicks in; higher death tax rates, or (this is technical, but I’ll get back to it), “removing ‘step up in basis’ for estates”; or, perhaps the zaniest suggestion of all, the idea being floated in New York State that, for the very wealthiest, capital gains should be taxed on a mark-to-market basis (in other words, they would be levied whether the assets in question had been sold or not). The latter is an idea of quite remarkable destructiveness, particularly given the state’s disproportionate reliance on a relatively small group of the wealthy, many of whom are doubtless already eyeing Florida real estate. And if these Croesuses should flee the state, who then will pick up the tab? I think we know. Over time, taxes initially aimed at the rich end up hitting many more than was first promised. See the income tax for details.

There is even a small preview of this in Senator Warren’s proposed wealth tax. There is a lot that is wrong with wealth taxes, a form of taxation that has been scrapped in many jurisdictions (and for good reason), and, as I have argued before, these are, to a degree, philosophical. They advance the reach of the panopticon state (not only will the richest have to declare the details of their wealth, but many others will have to explain why they are not subject to the tax).

More than that, and again to repeat myself:

A wealth tax is a sophisticated, lighter touch derivative of feudalism, but the core of it is undeniably the same: Even if only contingently, the state (“the king”) has, theoretically, a call on everything a citizen owns.

Squaring that with the idea of a free society is not . . . straightforward.

As noted above, to believe that these and other such measures will, in perpetuity, only affect the very richest is a mistake. That is not how tax history has worked out.

In a recent article for Capital Matters, Daniel Pilla highlighted the way that this could already be seen in some of the subsidiary provisions of Warren’s proposed legislation:

One of the IRS’s chief compliance tools is “information reporting,” which comes from the “information returns” the IRS uses to collect data. Form W-2, which reports wages paid by an employer to an employee, and 1099 forms, which report interest, dividends, independent-contractor payments, etc., are two prominent examples of such “information returns.” But there are literally dozens of other forms that the IRS uses to collect data so that it can verify the income reported on tax returns.

The scale of that data is staggering. In 2019 alone, a total of 3,503,499,195 information returns were filed with the IRS. The U.S. population in 2019 was 328,239,523, meaning that more than ten information returns were filed with the government for every man, woman, and child in America in 2019 — not even counting income-tax returns.

Yet according to Warren, it’s not enough.

Under her bill, within twelve months of enactment, the IRS must create a palette of new regulations designed to force the reporting of “any information concerning the net value of assets” that the agency deems relevant. The reporting burden may be based on “ownership, control, management, claim to income from, or other relationship to assets” subject to taxation under the law, including “financial institutions, business entities or other persons” with any connection whatsoever to persons liable for the tax. Moreover, business entities owned by persons subject to the tax must “provide estimates of value of the [business] entity itself.” And in case you’re planning on avoiding the new requirements, the bill further provides that the IRS is empowered to write new regulations specifically deemed “necessary to prevent taxpayers from avoiding the purpose of information reporting.”

Now, a reasonable person might ask whether all this data might not simply overwhelm the IRS, making enforcement of reporting requirements untenable. Well, the “We’re Here to Help” crowd thought of that also: The law would direct the IRS to “develop a comprehensive plan for managing efforts to leverage data collected” to enhance compliance efforts, with the stated goal of addressing “noncompliance with such requirements.”

In 2019, there were 154.1 million individual tax returns filed. Warren’s wealth tax is directed at only the richest .5 percent of filers. Do you think the IRS needs a doubling of its budget to handle just .5 percent of America’s taxpayers? No, friends, the enforcement component of the Ultra-Millionaire Tax Act of 2021 is not just for ultra-millionaires. It’s for you.

If Warren’s bill passes, you should expect the IRS to hire legions of new auditors and tax collectors who’ll be turned loose on American taxpayers over the next ten years. As the tax code becomes more voluminous and complex, more people make honest mistakes in calculating their taxes. This reality leads to tens of millions of penalty assessments. In 2019, the IRS assessed over 40 million civil penalties. Nearly 33 million were assessed against individuals, the vast majority of whom are honest taxpayers caught in tax-code booby traps and potholes they didn’t even know existed. Those same people then became the targets of a blizzard of IRS notices and payment demands, and, if that fails, eventually, tax liens and levies. Ultra-millionaires tend not to have this problem; they can afford to just pay their taxes, because they’re ultra-millionaires. But when middle-income Americans fall into tax debt, they become enforcement victims precisely because they don’t have the money to settle up.

And that’s the most sinister thing about Warren’s bill: It purports to be a crackdown on the richest Americans, but in reality will most likely hit ordinary taxpayers the hardest.

Plus ça change, and all that . . .

Meanwhile, in the case of any changes to the step-up rules, the new regime could bite much more deeply than advertised, and very quickly indeed, particularly given the plans that are floating around to reduce the death-tax threshold and, quite possibly, increase the rate at which it is charged, too. When someone dies, his or her assets are valued at market for estate-tax purposes, and tax is paid on that basis. One small compensation is that the asset is revalued to that level (the “step-up”), so that the legatee (who will indirectly have already paid tax on that asset on the basis of the new market price) can then treat the market price at which the estate has already paid tax as the basis for calculating his or her capital-gains tax liability at the time that asset is eventually sold. That seems both logical and fair, a rarity in the tax system. It now seems as if this “break” is under threat. If it is scrapped, and this change applies even to those who would not have been subject to the estate tax in the first place, an important means of building up capital across less wealthy generations will have been destroyed. As a result, this “reform” may actually increase inequality.

Finally (for now) there is the fact that increasing taxes on capital will increase the cost of capital. The higher, one way or another, the taxes on capital (and capital gains, realized or otherwise), the greater the potential return that will be required for investors to step up. That is going to mean less investment, fewer jobs and less growth. As building blocks for recovery, those are not good starting points.

Around the Web
Meaningful and Meaty

The Wall Street Journal:

No longer a working member of the royal family, Prince Harry has a new job: executive at a Silicon Valley startup.

The Duke of Sussex will become chief impact officer of BetterUp Inc., the fast-growing coaching and mental health firm, the company plans to announce Tuesday.

The role is the latest foray into business for the duke who, with his wife, Meghan Markle, relinquished roles as full-time working members of the British monarchy and have tapped into their celebrity with a string of lucrative deals in recent months.

“I intend to help create impact in people’s lives,” Prince Harry said in an emailed response to questions about why he’s taking the job. “Proactive coaching provides endless possibilities for personal development, increased awareness, and an all-round better life.”…

“It’s a meaningful and meaty role,” said BetterUp CEO Alexi Robichaux, who said he was introduced to Prince Harry through a mutual friend and began conversations with him last fall . . .

Treating COVID, as well as preventing it . . .

The Hill:

Pfizer on Tuesday said it has begun early stage U.S. clinical trials of an investigational, oral antiviral drug for COVID-19.

According to the company, the candidate “has demonstrated potent in vitro antiviral activity” against the virus that causes COVID-19, as well as activity against other coronaviruses, suggesting the potential for use to address future threats.

The candidate is a class of drug known as a protease inhibitor, which has been long used to treat HIV and hepatitis C. The drugs work by blocking a critical enzyme, a protease, that the virus needs to replicate.

“Tackling the COVID-19 pandemic requires both prevention via vaccine and targeted treatment for those who contract the virus. Given the way that SARS-CoV-2 is mutating and the continued global impact of COVID-19, it appears likely that it will be critical to have access to therapeutic options both now and beyond the pandemic,” Mikael Dolsten, Pfizer’s chief scientific officer, said in a statement.

Dolsten said the drug candidate could be prescribed at the first sign of infection, without requiring that patients are hospitalized or in critical care . . .

EU and China: Trouble in Paradise?


Fewer than three months after it was agreed, progress to pass an EU-China deal giving European companies better access to Chinese markets has sharply reversed after tit-for-tat sanctions.

China blacklisted five members of the European Parliament and its sub-committee on human rights on Monday in response to Brussels’ sanctions against Chinese officials accusing them of human rights abuses in Xinjiang.

The parliament, whose approval the China comprehensive agreement on investment (CAI) requires, cancelled a Tuesday meeting to discuss the deal in protest.

The centre-left Socialists & Democrats, parliament’s second largest group, said the lifting of Chinese sanctions was a condition to enter talks on CAI.

“There has to be a solution of these sanctions before we come back to ordinary business on this,” said Bernd Lange, the German Social Democrat who chairs the parliament’s trade committee.

Lawmakers across the political spectrum had already raised concerns about forced labour in China, some saying it should ratify International Labour Organization conventions on this issue before the investment deal is passed.

Reinhard Buetikofer, the chair of the parliament’s China delegation who is among those sanctioned, said the accord had appeared set for approval in a year, during the French six-month EU presidency.

Random Walk
As someone disturbed by the current low-interest-rate environment, this was, well, an interesting pushback:

From the Bank of England’s Paul Schmelzing:

With recourse to archival, printed primary, and secondary sources, this paper reconstructs global real interest rates on an annual basis going back to the 14th century, covering 78% of advanced economy GDP over time. I show that across successive monetary and fiscal regimes, and a variety of asset classes, real interest rates have not been ‘stable’, and that since the major monetary upheavals of the late middle ages, a trend decline between 0.6–1.6 basis points per annum has prevailed. A gradual increase in real negative-yielding rates in advanced economies over the same horizon is identified, despite important temporary reversals such as the 17th Century Crisis. Against their long-term context, currently depressed sovereign real rates are in fact converging ‘back to historical trend’ — a trend that makes narratives about a ‘secular stagnation’ environment entirely misleading, and suggests that — irrespective of particular monetary and fiscal responses — real rates could soon enter permanently negative territory . . .

H/t: Bloomberg 

— A.S.

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