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Hullabaloo


Tuesday, November 29, 2011

 
A step in the right direction. Mostly.

by David Atkins

Harry Reid is launching a volley on behalf on the middle class:

Democrats are offering a bill that would cut taxes for most families next year by about $1,500, paying for the cut by taxing income above $1 million.

The idea is to extend and expand a tax cut passed for this year that has let workers off the hook for 2 percent of their Social Security payroll taxes. The new version offered Monday by Sens. Harry Reid (D-Nev.), Bob Casey (D-Pa.) and Chuck Schumer (D-N.Y.) would boost that figure to 3.1 percent, or half the 6.2 percent payroll tax, for 2012.

The measure would give employers the same break on the first $5 million of their payrolls, as well as waive the tax entirely on the first $12.5 million in payroll for new workers -- in the hopes of creating an incentive to spur hiring. They estimate it would benefit 98 percent of small businesses.

The tax cut would be paid for by slapping a 3.25 percent tax on adjusted gross income above $1 million, which wouldn't kick in until 2013. Reid said the bill would cost $255 billion, but would be paid for by the surtax, which has no sunset date.

The Republicans are refusing to go along with it, of course. While they haven't offered a specific counterproposal to offset the payroll tax cuts, it will likely be highly regressive and designed to wedge the middle class against the poor, in an election where the Democrats will be looking to highlight income inequality between the middle class and the very rich.

So far so good. This is exactly the ground Democrats should be playing on, and puts the lie to the idea in many voters' minds that the two parties are just mirror images of one another. There are serious policy differences here with serious consequences.

That said, there are two troubling issues that come to mind:

1) Though I haven't written about it much, I've long championed payroll tax cuts as good policy. Payroll taxes are highly regressive, and a drag on hiring. I'm painfully conscious of that as a small business owner. Payroll taxes and healthcare costs are the two big hits to a true small business' pocketbook when in comes to investing in the company and expanding the workforce, even when there is sufficient demand. Cutting existing payroll taxes puts more money in regular people's pockets, which in turn theoretically increases demand. So that's all good. Offset the budgetary issues involved in cutting taxes and you're good to go (by the way, since the GOP is seeking alternative offsets, doesn't that suggest even the GOP knows these cuts don't pay for themselves?)

The sticking point with payroll tax cuts is that they fund Social Security. By cutting payroll taxes, the social security fund gets hit, which makes it easier for politicians to pretend that Social Security is "in crisis." From a theoretical good government standpoint, this shouldn't matter: regressive taxes that hurt hiring can be cut, and alternate progressive revenue streams found to cover the loss in funding. Certainly, the lack of a self-sustaining dedicated revenue stream didn't stop us from invading Iraq. America manages to find the money for things it wants to prioritize, and Social Security should be no exception.

From a practical political standpoint, however, the closed system of payroll taxes to Social Security benefits has kept it from major cuts in the past, and from being considered a "welfare program." Dedicated revenue streams for Social Security should be created through progressive taxation, but the likelihood of that actually happening is next to nil.

Which means that a payroll tax cut today might turn into an excuse to cut Social Security tomorrow.

2) The knock on Democrats lately has not been so much that we cater to the interests of wealthy, but to the interests of Wall St. and the financial sector. Of course, those two are in many ways synonymous, but in other ways they are not. Recall that even as Bill Clinton deregulated Wall St., he increased the marginal tax rate on the wealthiest Americans. Many of America's wealthiest citizens like Warren Buffett would be happy to pay more in taxes on a personal level (they would hardly notice the difference, but the impact on the budget would be significant). But they would mostly oppose increases in taxes on the 15% capital gains rate, which is where most of the money is really made.

Democrats took a lot of heat and made a lot of progressives really angry when the Bush tax cuts for the wealthy were extended by the Obama Administration. But it's important to remember that the Republicans were holding many other priorities hostage in exchange for those cuts, including the START treaty and unemployment extensions. Commentators can argue endlessly over whether the trade was a good one to make (I happen to think it wasn't), but it's deeply unfair to say that Democrats, including President Obama, don't want to kill the Bush tax cuts for the rich. They do. Most Democrats, given the wherewithal to do so, will create a more progressive income tax system just as Bill Clinton did.

That's an important point, especially considering that simply allowing the Bush tax cuts on the wealthy to expire will go almost halfway to killing our current budget deficit.

But the problem isn't that. The problem is that the bigger lack of progressive punch in the tax code doesn't apply so much to marginal rates on income (though that's certainly a factor), as it does to rates on speculative behavior. And that's where the sickness in the system lies: we have incentivized speculative behavior at the expense of slower, constructive long-term investment in stable enterprises.

The 15% capital gains rate is preposterously low; a higher rate would affect a few middle class 401K holders, but by far the most affected class would be the super wealthy. Capital gains is where they really make (I refuse to use the word "earn", as it would be a misnomer) their money. Doubling the capital gains rate to 30% would make long-term investors take a hit as well--but not as much as speculative short-term day traders. For a long-term investor, a good investment is still a good investment whether taxed at a 15% or a 30% rate. But for a speculative short-term grifter, many trades wouldn't be worth the risk at a 30% rate. And that's a good thing. If that means many day traders would have to find a different line of work, then good. Consider it a sin tax. Update: as pointed out in the comments, the capital gains rate is only for investments held over a year. Thanks for the correction.

Similarly, a transaction tax of even half a cent on each trade would go completely unnoticed by responsible long-term investors, but would do serious damage to the front-running and blatant cheating that is high frequency trading:

High-frequency techniques are used by Wall Street banks and hedge funds, but it is new independent firms that account for the bulk of this new kind of activity. Most of them were founded in the last 10 to 12 years. Many are still relatively small, employing a dozen to a hundred people, though some have as many as 250.

Trading mostly with their owners’ money, they scoop up hundreds or thousands of shares in one transaction, only to offload them less than a second later before buying more. They can move millions of shares around in minutes, earning a tenth of a penny off each share.

As a group, they earned $12.9 billion in profit in 2009 and 2010, according to the Tabb Group, a specialist on the markets.

These sorts of taxes on Wall Street behavior are not only where the money is, but also where the real impact on public policy is.

Redistributive progressive taxes on the wealthy are a good thing, but they don't really address the problem of how the great disparity in income happened in the first place. All they do is mitigate a public policy problem by treating its symptoms. Don't get me wrong: treating the symptoms is good. But it's in taxing speculative short-term gambling on Wall Street, with the aim of encouraging long-term productive investment in activity that actually creates stable jobs, that legislators can help cure the disease.

Update: It looks like the payroll tax cut doesn't harm the Social Security trust fund after all: the money is mandated to be paid back from the general fund. This is all a big semantic game, of course. It's all money going into the federal system and then coming back out again. But it's important to quell Republican talking points that Democrats are "weakening Social Security."

As I said, if politicians want to continue to fund Social Security at its current levels, they can find a way. The rest is posturing and political gamesmanship.


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