It would appear that trickle-down economics is upon us again.
The term trickle-down economics was first popularized during the Reagan
administration. The incredibly fallacious logic goes something like this. The
mega-rich are the job creators. If we devise a system that funnels even more
resources into their control they will use those resources to create even more
jobs. The result will be even greater tax receipts for the government and
greater quality of life for all citizens. We accomplish the resource distribution
by lowering and eliminating progressive income tax brackets. History doesn’t
even provide us a correlation for this, and a review of some of the details
easily debunks the claim.
Lowering the income tax provides no incentive for employers
to hire anybody or pay anybody any more. Labor expenses are already deducted
from taxable income. In other words, businesses are already not paying any
income tax on any money they spend to pay employees. If we are interested in
providing businesses a financial incentive to increase their payrolls we should
be talking about payroll taxes. However, businesses don’t care about payroll taxes
because they just take that expense out of their payrolls anyway.
Businesses simply do not hire employees because they have
more money. They hire employees when they have work that needs to be done. They
pay more for the work when the labor market conditions require it of them. Their
wages have to compete in the labor market to attract the workers they need to
perform their work. The work businesses need done increases when there is
greater demand for whatever goods and/or services they create and/or provide.
So, unless whatever social policy we are talking about contributes to increased
demand for production, there will be no increase in labor.
Likewise, lowering income taxes provides no incentive for
businesses to invest in their own growth. Businesses are only paying income
taxes on their profit. Any money they spend on growing their business is not
taxed as income. However, the deductions for large expenditures that are used
over time are required to be deducted over time as depreciation. So it is
possible to adjust capital depreciation schedules to provide short-term
financial incentive to invest now. Originally, some of President Trump’s people
were talking about tweaking the depreciation schedules in order to encourage
reinvestment. None of these ideas have made it into any version of the
administration’s tax plans. I’m not even necessarily suggesting accelerating
depreciation schedules is a good idea in the long run, but without depreciation
we are not even talking about encouraging reinvestment in growth.
There are only a few things businesses can do with the money
they save from reduced income taxes. For S-Corps, the owners can keep it
without any further tax liability. Effectively, these owners are paying income
tax on an incredibly reduced scale compared to earned income. The business can
horde it in the form of retained earnings. Large, public businesses in
particular are currently amassing incredible quantities of cash. They do this
because they can, and they don’t have anything worthwhile to spend it on. Lastly,
they can pay it out to shareholders in the form of dividends. Don’t get me
wrong, I like dividends, but they disproportionately benefit the wealthy, and come
at a cost to the overall economy when they are inflated by tax reduction.
There is a really great documentary from 2013 called Inequality for All. It was produced by
Robert Reich who was the Secretary of Labor between 1993 and 1997. It explains
how income inequality and the concentration of wealth negatively impacts
economic growth. For an economics documentary, it’s fairly palatable. If you
haven’t seen it, regardless of your political affiliation, I’d highly recommend
it. Even if you fully buy into this trickle-down nonsense and think
progressives are dirty communists, you will at least learn something about an
opposing point of view.
If lowering and eliminating progressive income tax rates is
actually counter-productive to economic growth, then why do we do it? There is
a variation of the Hanlon’s Razor aphorism I got from an old friend of mine
that I like to use. It goes something like, “It is difficult to tell the
difference between stupidity and maliciousness.” Explanations in real life tend
to be a combination of all-of-the-above, and I think that is true in this case
as well. That said, there is a very real malicious motivation behind these
sorts of policies. Wealth is relative; there are no rich people without poor
people. Limiting economic growth and mobility ensures that wealthy politicians
and the aristocrats they represent will maintain their wealth across
generations regardless of whether or not the individuals earn it or even
produce anything.
Nothing illustrates this more
than the republican position on the estate tax. Yes, after that far too long
introduction, I’m finally going to get into the tax policy. The republican position
on the estate tax, of course, is to eliminate it completely. According to the Tax Foundation, in 2014, the estate tax
brought in federal revenues of about 19 billion dollars; or about 0.6% of total
federal revenue. Relatively speaking, that is an incredibly low percent, but it
is still a significant sum of money. In my opinion, however, the estate tax is
not about revenue, but instead it serves a greater societal purpose. The estate
tax encourages productivity and discourages aristocracy by slowing down the
accumulation of generational wealth.
First, let me get one simple
thing out of the way. Whether you support or oppose the estate tax, it is in no
way some sort of double taxation. It is absolutely normal for taxation to
happen when money, property and other forms of wealth exchange ownership. For
example, income tax is paid on the money a worker earns. That worker then
spends that money, and income tax is paid again and again every time that money
changes hands. There is no logical reason why the transfer of wealth from one
generation to another should be any different. Furthermore, significant portions
of taxable estates consist of unrealized capital gains that have never even
been taxed a first time.
As far as human civilization
goes, the estate tax, and in more general terms the inheritance tax, is as old
as the written word. In the first century of the United States , however, the estate
tax came and went as a way to help finance wars. Likewise, the estate tax that
we know today was enacted in 1916 by President Wilson to help finance WWI. However,
it was first seriously introduced for its positive impact on society by
President Theodore Roosevelt in 1906. He identified the problems that wealth
accumulation through generations poses to our democracy. Be forewarned that
this is a long, old-timey quote, but in President Theodore Roosevelt words:
“It is important to this people
to grapple with the problems connected with the amassing of enormous fortunes,
and the use of those fortunes, both corporate and individual, in business. We
should discriminate in the sharpest way between fortunes well-won and fortunes
ill-won; between those gained as an incident to performing great services to
the community as a whole, and those gained in evil fashion by keeping just
within the limits of mere law-honesty. Of course no amount of charity in
spending such fortunes in any way compensates for misconduct in making them. As
a matter of personal conviction, and without pretending to discuss the details
or formulate the system, I feel that we shall ultimately have to consider the
adoption of some such scheme as that of a progressive tax on all fortunes,
beyond a certain amount either given in life or devised or bequeathed upon
death to any individual–a tax so framed as to put it out of the power of the
owner of one of these enormous fortunes to hand on more than a certain amount
to any one individual; the tax, of course, to be imposed by the National and
not the State government. Such taxation should, of course, be aimed merely at
the inheritance or transmission in their entirety of those fortunes swollen
beyond all healthy limits.”
The estate tax has basically
worked the same way since it was enacted by President Wilson in 1916. When
there is an inheritance of an estate the gross value is determined. A certain
amount of that value is exempt from tax and the rest is taxed on a progressive
scale. Originally both the exempt amount and top marginal rate were relatively
low; the top marginal rate being only 10%. During the great depression the top
marginal rates were significantly raised, and by the 1940’s they were up to 77%.
They remained this high until 1977. I point this out because the post WWII era,
particularly the 1950’s, is regarded very fondly among republicans as a time of
American greatness. During this time we had our highest estate tax, and highest
income tax for that matter. Our economy soared and the middle class grew to its
largest size ever. I would also point out that the middle class has been
shrinking since the 1980’s when the progressive tax scales were dramatically
reduced.
To be fair, in the 1970’s we were
trying to solve some very real problems with the estate tax implementation. The
exemption amount was not increasing with inflation and the tax was affecting an
ever growing percentage of the population; far more than just the “fortunes
swollen beyond all healthy limits” that President Roosevelt described.
Additionally, estates that were property rich and cash poor had a very
difficult time paying their estate tax. This is where we get the stories of
small family farms having to sell because of the tax burden. The exemption
amount was increased several times over in an attempt to alleviate this
problem.
Increasing the exemption amount
probably would have solved the problem by itself, but President Reagan used the
momentum of estate tax reform to further reduce the top marginal rate. From the
1980’s on the estate tax continued to be reduced until it finally disappeared
completely in 2010. It was reinstated the very next year, but at even lower
levels. Nowadays, the exemption amount is about $11 million (married) with a
top marginal rate of 40%. Historically, the current exemption amount is
incredibly high, and that is why only about 0.2% of estates will have to pay
anything at all. Likewise, the top marginal rate is very low compared to
historical rates. The age of small family businesses being torn apart by estate
tax liability are far behind us.
Here are my thoughts on how we
should deal with estate taxes. I think these are the two main factors. First,
the estate tax revenue is not vital to the funding of our government. And,
second, the important societal purpose of the estate tax is to push back
against consolidation of wealth. So here is what we do. We continue to not levy
any tax on married descendants. This applies only one time per pair involved of
course. We can’t have aristocrats just continuously marrying the next
generation can we? We also continue to allow an estate to be donated to
recognized charities tax free just like any other charitable contribution. Then
we get into the taxing.
First, all remaining unrealized
capital gains must be realized out of the estate and paid. That should be
relatively easy since most unrealized capital gains are in investments, like
stocks and bonds, which can be partially sold to pay the taxes. After that,
rather than taxing the estate, we tax the inheritor. There would still be some
sort of exemption amount, but it would be a lot less than it is now; somewhere
around $1 million. Then we quickly escalate to a top marginal rate of around
80% after about the next $1 million. The exempt amount would also have to be a
lifetime limit per individual. With no lifetime limit, can you imagine all the
“Inheritance Clubs” that would form to avoid the paying the taxes?
This allows for the owner of the
estate to distribute their wealth themself if they so choose. For example, let’s
look at an estate worth $10 billion under these rules. In this hypothetical
example $3 billion of that money is in unrealized capital gains. It technically
would be a little less, but, for simplicity, let’s call that 20% capital gains tax.
I’ll do capital gains some time, I promise. Or look it up; how it works is not
a secret. 20% of $3 billion is $600 million; ouch. Now we are down to a measly
$9.4 billion. Then the estate gives $2 billion to recognized charities leaving
$7.4 billion. Let’s be realistic, an estate of this size is going to have
significant business assets. If we divide the remaining $7.4 billion in
business assets equally across 7,400 individuals, perhaps the family heirs plus
some employees of the business, then there is no further tax liability.
Alternatively, under this method, should that $10 billion
estate choose to be consolidated into a single individual there would be huge
taxes. The same $600 million for the unrealized capital gains would come first.
That would be followed by about $7.5 billion in inheritance tax. That would
leave about $1.9 billion to the single inheritor. That is still quite a bit
more than the $1 million that same individual was getting with the distributed estate
not paying any inheritance tax. However, I would still say that is a very
significant limiter to generational wealth consolidation. That dynasty
certainly won’t be able to maintain their momentum for very many generations
without continually performing the “great services to the community” as described
by President Roosevelt.
The bottom line is this. If you support eliminating the
estate tax, you are saying that individuals deserve to receive unlimited wealth
based on the pure chance of their birth and not because they did anything to
earn it. Additionally, those who work and actually earn their wealth by
contributing to our production should be paying all the taxes to maintain our
government services such as military defense, law enforcement, fire protection,
and border security. Call me old fashioned, but I think it is nobler to earn
one's wealth through hard work and innovation. I also believe it is everyone’s
responsibility to contribute to the funding of our social system. And lastly, the idea that
eliminating taxes like the estate tax is helpful to our economy is laughable.
Maybe if you’re in the business of selling yachts to idle aristocrats with too
much time on their hands you might see a boost.
