The Republican overhaul of the tax system is moving even faster than their quicksilver attempt to repeal Obamacare. Tax experts are still trying to wrap their heads around the intricate details of the House bill, while Republicans are hoping it passes before they lose momentum — aiming for a vote Thursday. Meanwhile, it’s tough for ordinary people to understand what is happening.
The crucial thing to realize is that this tax reform effort reflects more than the normal conservative allergic reaction to progressive taxation — going far beyond undoing the modest progressive grains achieved by Presidents Obama and Clinton. Three major changes stand out: These taxes are far more focused on owners than on workers, even by Republican standards. They take advantage of the ambiguity of what counts as income, weaponizing that vagueness to help their friends and hurt their enemies.
And after years of pushing for a safety net that works through the tax code, in order to keep more social democratic reforms at bay, Republicans now reveal their willingness to demolish even those modest protections. Their actions make clear that a welfare state based on tax credits and refunds, rather than universal commitments, is all too vulnerable.
Capital is eating the economy
The “reform” bill shows that the right understands how the rules of the economic game are shifting — toward capital and away from labor (even away from the labor of the wealthy). Economists studying inequality in the United States over the past several decades have tended to focus on the growing spread between the wages of workers at the top and those in the middle. The data shows that in the 1980s and 1990s, the beneficiaries of growing inequality were CEOs and other executives — who, though they exist in a whole different universe from blue-collar laborers, do receive labor income in the sense that they show up to work and get paid contractually for doing so.
“The working rich have replaced the rentiers at the top of the income distribution,” wrote Thomas Piketty of the Paris School of Economics and Emmanuel Saez of UC Berkeley, two scholars who have helped to popularize the concept of the “1 percent” in the United States, in an influential 2003 paper. (Their data covered 1913 to 1998.)
Lately, however, there’s been a switch, as Piketty and Saez, along with Berkeley’s Gabriel Zucman, recently concluded. “The upsurge of top incomes was first a labor income phenomenon but has mostly been a capital income phenomenon since 2000,” they noted in a paper updating the data through 2014. Since then, income growth within the top 1 percent has accrued to people who make their money from owning money, stock, and other financial instruments, rather than to people who make their money via skills and labor.
We’ve seen a large increase in corporate profits since 2000, increasing faster during the Great Recession, yet this hasn’t trickled down to regular people. Wages are nearly flat since 2000, and the recovery from the recession featured the weakest business investment of the postwar period. This is a genuine shift in the organization of the economy, one economists are still struggling to understand.
The Republican tax plan supercharges these changes. To a striking degree, the changes are about benefiting not just the well-off but those who are well-off because they own capital, as the Institute on Taxation and Economic Policy notes in its analysis of the Senate bill.
That’s because the plans are tilted toward corporate income tax reductions, which will largely benefit concentrated owners of stock; passive owners of pass-through businesses who don’t actively work for the firm; and people who inherit their money. (Notably, because around a third of stocks are foreign-held, a significant amount of the benefit won’t even go to US citizens. The Institute on Taxation and Economic Policy estimates that “foreign investors would receive [benefits roughly equal to the] benefits that would go to the bottom three-fifths of Americans.”)
That the Republican tax plan is regressive is reason enough to oppose it. If the United States is going to run a deficit, it shouldn’t do so in order to reduce the taxes paid by those at the top. Yet it is extra irresponsible given recent economic developments. Corporations are flush with cash from large profits and aggressively low interest rates, yet they aren’t investing. This is a big hint that large tax cuts for corporations will have very little effect on the economy. They’ll only amplify the deleterious trends we’re still struggling to understand.
Defining what counts as “income” is a deeply political act
Much of the plan involves changing the definition of “income,” in various ways. A central part of the reform plan involves reducing the taxes on “pass-through” entities like sole proprietorships, S corporations, and partnerships. This creates a huge incentive for people to take whatever it is they do for a living and redefine it as a pass-through company.
In 2012, Kansas went down this road: It entirely eliminated state taxes on pass-through companies. A team of economists looking at taxpayer data has found that the main effect has been for people to simply reclassify their income to dodge taxes, while not actually starting any new businesses. Though Republicans have made some attempts to prevent a rush toward income reclassification with their bill, tax experts are raising alarms that plenty of room for shenanigans will remain.
Ordinary people usually think of income as whatever their salary is. It’s more complicated than that. Republicans are redefining different kinds of income in order to benefit their friends and harm their enemies. Passive owners of pass-through entities get their income redefined in a way that minimizes taxation. People who inherit money get their inheritance redefined in a way to hide it from taxation. Those who want to stuff money away to pay for private K-12 education get that savings defined as non-income too. These are all payouts to key Republican constituencies.
And Republicans are redefining income in other ways to punish their opponents. The state and local tax deduction that Republicans want to repeal primarily benefits people in blue states, where those taxes are higher. Republicans also want to treat graduate education tuition reimbursements as income, hitting higher education institutions — home to both climate scientists and the “politically correct” anti-right — hard. Union dues would suddenly become taxable income. The fees extracted by tax preparers, who stand between low-income people and the earned income tax credit, aren’t deductible under their plan.
The safety net created by the tax code, inadequate to begin with, is being undone
There’s a lot of focus on the exemptions the Republicans are removing, but not enough on how they interact with — or undermine — social insurance. On May 4, House Republicans passed the American Health Care Act (AHCA), their replacement for Obamacare, which later died in the Senate. A key part of the AHCA expanded the scope of the medical deduction exemption, which allows people with high medical costs to subtract those costs from their taxable income.
The Republicans lowered the income threshold for such deductions in order “to provide additional tax relief for persons, and in particular older persons with lower-incomes, who have high medical expenses,” as Washington and Lee University law professor Timothy Jost described it. This is at least an intellectually consistent, if flawed, conservative vision for how to handle health care costs: treat the sick as consumers who need to have more skin in the game by incurring more costs upfront. As people pay more upfront, the market gets to work its magic; then the tax code can help people with high medical bills both through this exemption and from health savings accounts, which the AHCA also expanded.
A mere six months after these ideas were put forward in the AHCA, House Republicans now propose entirely eliminating all of the medical deduction exemption. This would be devastating for middle-class households with an illness.
Meanwhile, the attempts to scuttle Obamacare continue: The latest Senate tax bill proposes eliminating the individual mandate. In short, Republicans are attacking both the ACA and their own tools for making medical expenses more bearable.
In the past, conservatives have explicitly stated that they hope the growing use of tax-deferred 401(k) savings plans will weaken support for, and perhaps ultimately replace, Social Security. Yet today’s GOP almost reduced the cap of 401(k) contributions — before President Trump stopped them. The adoption tax credit was part of the Republican 1994 Contract With America. It’s gone, too, in this bill. Many people in the political center don’t see the need for free college — as proposed by Bernie Sanders and others — because they believe students should invest in their own educations. And they note that student loans help them make this smart investment. Yet tax exemption for student loans is also on the chopping block.
For decades there’s been a push away from publicly provided, universal programs toward what the political scientist Suzanne Mettler describes as the “submerged state” of tax benefits and exemptions. These exemptions tend to be regressive, poorly targeted, and too reliant on the market. But they do form a coherent social insurance system for middle- and upper-middle-class families.
This safety net via the tax code is exactly what conservatives have declared war on in their new bill. They might have crafted these various deductions into a more coherent system; instead, they’re axing them to cut taxes on the rich.
Many liberals are also opposed to the submerged state. But they want to replace it with public, universal programs with broader risk sharing. That Republicans are so indebted to capital owners that they’d destroy their system in order to appease them presents the perfect opening for the left to show why we need a broader public, universal system of social insurance.
Republicans are proposing a tax plan whose benefits are permanent for owners yet expire for everyone else. They’ve taken the worst trends in the American economy — and hit the accelerator.
Mike Konczal, a Vox columnist, is a fellow with the Roosevelt Institute, where he works on financial reform, unemployment, inequality, and a progressive vision of the economy. He blogs at Rortybomb and is on Twitter @rortybomb.
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