As President Biden likes to say, “C’mon, man.”
T.J. Kirkpatrick-Pool/Getty Images
The American Families Plan promises the bulk of American households benefits of expanded social spending on a scale unfamiliar in the U.S. since the 1960s. That expansion will be funded only by a small subset of taxpayers. Whatever the merits of the plan’s spending components are, President Joe Biden ‘s articulation creates economic gaps both for our economy and taxpayer burdens broadly. Those gaps should catch Congress’ attention quickly.
The first economic problem is a miss on who would bear the burden of the new tax increases. Coming on the heels of a proposed massive corporate tax increase, the economic misstep seems to reflect a pattern. While corporations, many individual shareholders of which are well off, may write checks to pay the tax, who bears the burden of the tax can be quite different—and is in this case. Many economists now believe a large portion of the burden of the tax would be borne by workers, not the rich and big corporations. Higher corporate taxes also reduce stock prices, pushing down values of 401(k) plan holdings, not just shareholdings of the wealthy.
Now for the increase in the capital gains tax. President Biden assures us that paying much higher capital gains taxes is a concern only for the top 0.3% of taxpayers. But the economic effects on incentives to save, invest, or take entrepreneurial risks depends on the share of capital gains these households have earned. Putting aside state-level taxes, the new tax take on $1.00 of capital gains for that “top 0.3%” taxpayer would be 43.4 cents. But taking away the step up in gains’ basis at death imposes another 40% tax on the remaining 56.6 cents, forcing the taxpayer to think about the approximately 34 cents that would remain. To residents of New York City or Silicon Valley, the rate is even higher, and the gain from risk-taking lower.
The economic question unaddressed by the White House proposal is whether a tax of 66% or higher will reduce saving, investment, or entrepreneurship. If it does, it diminishes accumulation of capital and business ideas, hindering productivity growth and, ultimately, reducing wages. Work by Douglas Holtz-Eakin of the American Action Forum suggests that a majority of the burden of such wealth taxes is borne by workers. And to the extent the administration would like to argue that capital gains (and dividend) taxes are just capitalized into asset values, they reduce the value of assets for all asset holders, not just the top 0.3%. This “shifting” of the tax, brought to you by Econ 101, implies that households generally—including those who earn less than $400,000 annually—will bear the tax. As President Biden likes to say, “C’mon, man.”
The second economic problem arises in the president’s claim that his proposal pays for the $1.8 trillion in new spending in the American Families Plan. The problem begins with arithmetic abracadabra, using 15 years of proposed tax revenue—from new taxes on “the rich”—to pay for eight years of spending. And that revenue projection rests not just on explicit taxes but also on a large increase in returns from high-income taxpayers from a much beefed-up Internal Revenue Service, returns that are necessarily speculative.
Putting aside these economic arithmetic issues, a more conceptual problem emerges. The Biden administration’s frenetic pace of large-scale spending proposals significantly changes the scale and scope of American social spending. This ramp-up is on top of tens of trillions of dollars in unfunded social spending promises in Social Security and Medicare. Whatever the merits of any of these individual social spending programs, an important economic question is whether the U.S. has a tax system to pay for them over time. It does not, and adding “soak the rich” polices won’t fill much of the gap. The 10-year revenue estimate of $113 billion for higher capital gains taxes and $111 billion for a higher top marginal income tax rate makes this point easily.
Decisions about the size and scope of government in a democracy are rightly a matter of public choice. But this choice carries an obligation of funding so that it is not simply air. It is instructive that some industrial economies, particularly in Europe, have chosen higher social spending and a larger government relative to GDP than ours. Those countries have also funded the bulk of that spending not with high taxes on capital, but with consumption taxes, like the value-added tax, the burden of which is borne broadly among taxpayers.
The VAT has many things to recommend it if the Biden agenda is the popular choice. It can raise substantial revenue. As a consumption tax, it is more efficient than higher income taxes. While implementing a VAT is equivalent to planning a one-time tax on existing wealth, consistent with the Biden agenda, it does so without the distortions of saving and investment I emphasized earlier. Combined with policies to support low-wage work, the tax need not be regressive, a point made by the late economist David Bradford decades ago. And reform could begin with changes in business taxation to emphasize taxation of cash flow, not income.
The economic point remains: The soak-the-rich plan for a much higher level of social spending doesn’t add up. The public broadly may choose to support the plan, but it will also have to pay for it in lost economic efficiency (my first point) or higher taxes (my second point).
Congress must now ask these economic questions, answers to which are not spelled out in the American Families Plan.
Glenn Hubbard, a professor of economics and finance at Columbia University, was chairman of the Council of Economic Advisers under President George W. Bush.
