What makes for a fair and effective tax policy?
Congress could delve into that issue in the coming months, as it considers extending Trump-era tax cuts that are set to expire in 2025.
At the same time, the Biden administration is pushing for an extension or expansion of alternative tax credits, such as the earned income tax credit or child tax credit, which benefited millions of lower-income Americans during the coronavirus pandemic.
Battle lines in the debate were evident Wednesday during an hourlong hearing before the House Select Committee on Economic Disparity and Fairness in Growth at Washington, D.C.
According to its website, the committee is tasked with “developing solutions to the key economic issue of our time: the growing prosperity gap between wealthy Americans and everyone else.”
Wednesday’s hearing focused on potential inequities within federal tax law that disproportionately benefit corporations and the richest Americans.
The committee chairperson, Rep. Jim Himes, D-Conn., began by noting that the federal income tax system is reasonably progressive, meaning people who earn more money generally pay more in taxes, both by dollar amount and on a percentage basis.
“I think there’s broad agreement that that’s a good thing,” he said. “What’s interesting, though, is that the tax code ceases to be progressive at the very top of the income distribution.”
The reason for that, Himes said, is because the wealthiest Americans earn a large portion of their income “not from the sweat of their brows, not from punching the clock every day,” but from capital gains, stock dividends and interest payments.
The problem is that capital gains — basically the profit someone makes on their investments — is taxed at a preferential rate.
“The top tax rate is 20%, versus a top marginal tax rate on working for a living of 37%,” Himes said. “Why? The argument we hear is that that’s a good thing because it leads to more investment and more economic growth, so everyone does better if we tax capital gains at a lower rate.”
That argument, though, doesn’t seem to hold up under scrutiny.
William Gale, a senior fellow at the Brookings Institute, testified that there’s “an enormous amount of evidence” that tax cuts in general — and tax cuts for the wealthy in particular — don’t have a significant impact on the growth rate of the economy over time.
Gale noted that the federal tax burden has increased from about 2% of gross domestic product prior to World War I to about 18% today — yet there’s been essentially no change in per capita economic growth.
“Lots of factors affect the economy, but if taxes matter as much as we’re told, we would surely see a difference in growth from taxes at 18% of GDP, versus 2%,” he said.
Seth Hanlon, a senior fellow with the Center for American Progress, also testified that federal tax expenditures — the tax breaks, deductions and credits people can claim on their tax returns — are skewed toward the wealthy.
In 2019, for example, combined federal income tax breaks amounted to about $1.2 trillion — more than all defense and nondefense discretionary spending combined.
According to the Congressional Budget Office, the wealthiest 1% of Americans received $188 billion of that amount, or nearly 16%. That was more than what went to the middle 20% of American households.
Himes suggested the revenue that’s lost through preferential tax breaks for the wealthy could better be used to benefit low-income Americans.
“If we tax $1 of dividends less than we tax the work that Americans do every day, and we don’t achieve any extra economic growth, why do we do that?” Himes asked. “The income we give up on capital gains just for the top 1% of Americans would pay for an entire year of the child tax credit. That’s the choice. We can either (fund) the child tax credit, which is shown to be one of the most powerful alleviators of poverty, or we can continue to give preferential tax breaks to the top 1%, without any obvious economic rationale.”
The ranking Republican on the committee, Rep. Bryan Steil, R-Wisconsin, said the last 18-months have shown the consequences of the Democrats’ flawed economic policies.
“We’ve been living under one-party Democratic rule for a little over a year, and the results are pretty concerning,” he said. “Inflation is at 8.6%. People are getting clobbered with rising costs, and the poorest communities are being hit the hardest.”
Prior to the pandemic, Steil said, the Trump tax cuts “created real economic growth.”
“Real wages increased, median household incomes increased,” he said. “Now we see the opposite. Real wages are falling for all Americans, and they’re falling at the highest rate for the least among us. Never has the juxtaposition of policy been so stark and clear.”
Steil also said poverty rates in America haven’t budged, despite the billions invested in programs for the poor.
“In American, there’s a proven path to success that people can follow to reach the middle class,” he said. “If you finish high school, work full-time and marry before you have your first child, there’s a 97% chance you won’t live in poverty. It’s called the ‘success sequence,’ and our tax code should work to encourage it.”
Biden’s tax policies, by contrast, “fail to move low income families into the middle class in a sustainable way,” Steil said.
Committee members offered a handful of policy proposals during Wednesday’s hearing.
For example, Rep. Pramila Jayapal, D-Wash., cited her “Ultra-Millionaire Tax Act,” which would add a 2% tax onto the wealthiest 0.05% of wealthiest households “to ensure they pay their fair share.”
Chairman Himes also suggested eliminating the “step-up in basis” methodology, which resets the value of a business or investment upon the death of the owner — essentially wiping out any unrealized capital gains and allowing their heirs to inherit without incurring a tax liability.
Himes questioned what public purpose is served by allowing capital gains to be erased in that manner. However, that prompted a vigorous rebuttal from Rep. Jodey Arrington, R-Texas.
Farmers are cash-poor, Arrington said. They can’t afford to pay a massive inheritance tax, so getting rid of the step-up in basis would force them to sell the property.
“If they had to pay the unrealized gains on those assets at the point of transfer, you would see the largest liquidation of farming and ranching assets in the history of our country,” he said. “I think it’s unfair, un-American, and it would devastate the agriculture economy in the United States.”