That Necessary Evil - Raising Taxes

Let me start with this paragraph from a review of Hillary Clinton's new book by Lawrence Lessig.

This is the core mistake — not just of Clinton, but of too many in the Democratic Party. America is with Reagan—“Government is not the solution. Government is the problem”—not because they believe, like Reagan, that the private market can solve every public problem, but because they believe their government is fundamentally corrupt. They see taxes as a waste — not because the poor don’t deserve help, but because they believe the government is not helping anyone except itself. Most don’t support the idea of supporting government because most believe government doesn’t support them. Government serves the “special interests,” so wonky papers declaring “we’re from the government and we’re here to help” are just the lead balloons of modern American politics.

This gets at the essence of the problem.   It is not sufficient for Democratic candidates to articulate policy positions, even as those are the natural currency in which candidates speak.  The candidates must find a way to make their message credible, which requires that they really believe what they are saying, that the voters perceive this, and that they can deliver on what they are saying as well.  This is a very high bar to get over.   One might hazard a guess that the Republicans make it easier for the Democrats, especially they who speak with a forked tongue and in such a blatant way.  But disaffected voters are apt to treat all the lying as an occupational disease - politicians, in general, go for expedience rather than speak hard truths.  In this way the Republicans contaminate the Democrats, at least in the eyes of these voters.  Something needs to be done to counter that.

About a month ago I wrote a post about doing that by walking the walk.   In a nutshell, prior to the election of 2018 Democrats should engage in demonstration projects that entailed real income redistribution, with the recipients working people earning modest wages, and with the transfers financed by more up-scale voters who were willing to contribute in this way.  I want to observe here that Lessig's review came out only last week.  So I was thinking these thoughts about making the message credible well before reading that piece. And I certainly still believe that walking the walk is the best way to deliver a credible message.

But there is a case to be made for talking the talk as well.  Indeed, as a preliminary activity to generate the subsequent demonstration projects it is probably necessary to do because the idea of income transfer demonstration projects is probably not obvious to many voters now.  Yet in my earlier post I noted that talk is cheap.  As a general matter, that makes talk not credible.  Is there some talk that isn't cheap and that as a result people will tend to believe?  If so, what is the nature of such talk?

The first point in this post is that when you tell people something that they don't want to hear and it is common knowledge that they don't want to hear it, then your message will be credible.  The second point, just as important as the first, is that while initially the recipients of the message will deny its truth, its importance, or its application to themselves, if the speaker persists in delivering the same message and does so in an even handed way, then eventually the message will get through and be accepted as the truth.

Leadership, in this setting, means delivering the unpleasant message early and then doggedly continuing to deliver it, though it might be unpopular, especially at first.  As people come to see the truth in the message, the credibility of the person delivering the message will be established.  People trust that person because the person speaks the hard truths.

Now I want to take a brief aside and consider Democratic electoral strategy.  Evidently, there is a need to get more voters to vote for Democratic candidates.  This will happen either by getting those who voted for Republicans in the last election to switch their allegiance or by getting potential voters who sat out the last election to cast votes for Democratic candidates.  This need to expand the population of voters who vote for Democrats is undeniable.  It therefore encourages candidates who offer policy positions to choose those positions by how appealing they are to such voters and as a consequence to take for granted other voters who traditionally vote for Democrats.  This is particularly challenging, however, since many of these proposals will entail additional government spending.  There is a need, then, to articulate how that spending will be financed. (The answer is by raising taxes, but the remaining questions are on whom and what will their increased tax burden be like?)  Might loyal Democrats who will see their taxes going up either opt to not vote at all or to switch their allegiances and vote Republican?

The ideal for Democratic strategists, of course, is that such voters hold firm.  But that should not be assumed.  If the little analysis I gave above is correct, the (eventually credible) Democratic leader should be talking to such voters now about their taxes going up.  To my knowledge, no Democrat is currently doing this. I find that troublesome.

I gather from this piece which appeared last week that political infighting between different wings of the party offers one explanation for why; their attention is elsewhere.  Yet most voters, myself included, don't care about the infighting.  The voters care only about the outcome.  And there is a different explanation as well.  The candidates and their strategists may not perceive a need to deliver this message.  That is a mistake, in my view.

It is also too easy in our current politics to factionalize - populists versus the powerful business interests.  This clearly has happened with the Republicans.  It seems to be happening now with the Democrats.  This makes all politics seem zero-sum and encourages a mindset of "I'm going to get mine" and do this by "sticking it to the man."  The credible leader needs to offer an alternative view.  I tried to sketch the elements of that alternative in a post called The Progressive Agenda and the Upscale Voter.   Below is the most relevant paragraph from the piece.  As it is now, upscale voters who are not themselves higher ups in large corporations are being ignored by the Progressives, as they are not in either faction.  The alternative view gives such voters a role to play, albeit not the customary one.  Leadership is about getting such voters to understand they need to play this new role.

How then might upscale voters come to embrace the progressive agenda and refrain from voting their pocketbook?  My belief is that the Democrats need to embrace a politics of social conscience and social responsibility.  I wrote about this at length in a post called The Next Deal and I have been writing about related themes for some time.  But getting from here to there will be an enormous challenge, one that needs to be faced squarely.  Here are some further thoughts on that.

Now let me return to messaging from our political leaders and their discussion of taxes, because there are other errors being made that result from the progressive agenda focusing more on the spending side of the various policies and giving short shrift to the revenue side.  Let me articulate two principles about taxation - one that applies to all voters, the other that mainly concerns those voters who will be seeing their taxes increase.

The first principle is about fairness.  I was raised, and I believe most Democratic voters believe similarly, that a system of progressive taxation embraces fairness.  Progressive taxation means that marginal tax rates rise with income.  The system has this now, but we tend to not ask how much those marginal tax rates should rise.  The current tax brackets can be perused here.  The thought I want to advance is that the bottom three brackets should be left alone while the top three brackets should be adjusted upwards, with the adjustments themselves progressive.  Some attention needs to be given to how this would be done.  For the sake of illustration only, not as a concrete proposal, consider changes so that the 33% bracket after adjustment has marginal rate of 35%, the 35% bracket after adjustment has marginal rate of 40%, and the 39.6% bracket after adjustment has marginal rate of 50%.  While I don't want to defend these particular numbers at all, the illustration does demonstrate what a fair approach to raising taxes looks like. The burden of the tax increase is broadly shared, but those with higher income bear more of the burden. That is the goal for any tax increase proposal.

Much of the fairness issue arises because capital gains receive different tax treatment from earned income.  (The marginal rates in the paragraph above pertain to earned income.)  Getting capital income and earned income to be treated the same way for tax purposes should be a primary target for making the system fairer.  We have a long history of favorable tax treatment for capital income.  So it will be no easy matter to change the system to erase that, but it should be a primary goal for any Democratic candidate. 

Alas, that is not the whole story.   Some of the fairness issue arises because popular deductions, particularly the deduction for mortgage interest paid on the primary residence, actually subsidize upscale voters who own expensive homes.  The original intent of the deduction probably was earnest, to encourage home ownership.  So capping the deduction as opposed to eliminating it outright might be the more sensible solution.  Something similar applies to charitable contributions.  The deduction on those too need to be subject to a cap.   Coupling this with raising marginal rates for the higher income brackets is the fair way to increase tax revenue. 

The second principle, which really only pertains to those who will be seeing their tax burdens increase, is a need to get to the bottom line.  These people want a straight answer to the question - how much will my tax burden go up?   They deserve that much.  If we are asking them to bear more of the burden in the name of social responsibility, we should be clear on how much more we're asking from them.

This makes the way progressives do policy proposals now problematic, because each proposal has to come up with a revenue stream to fund it, and that pits those paying the increase in tax against those recipients who benefit from the proposal.   A better way would be to consider a package of proposals, e.g., either shoring up ACA or moving to a single payer healthcare system, infrastructure investment, subsidies for low and moderate income students to attend college, subsidies for small business so they can afford to pay an increase in the minimum wage, disaster relief in the wake of global warming, and perhaps a handful of other policies that are deemed equally important now, such as reducing the deficit or assisting states that can't meet pension obligations.  Once the list is generated the next step is to come to a ballpark calculation of the total expenditure entailed.  Then that expenditure must be compared to the incremental tax revenues generated from the tax increase proposal.

The two need to be brought in line.  Credibility overall depends on that.   As it is now, progressives seem to act as if they can keep going to the well ad infinitum and the factionalist rhetoric encourages this by focusing on the benefits only and not paying attention to how the revenues to pay for those benefits get generated.

It may very well be that this is done in stages, particularly on the spending side, owing to the nature of the legislative process itself.  Nevertheless, the planning should happen as above, in accord with normal budgeting practice.

Let me switch gears and make one more point before closing.  There have been a spate of pieces recently on the issue of whether tax cuts spur economic growth, which I take as the core supply side economic proposition.  The Democratic candidates need to say something here about their proposals and economic growth. This needs to counter the Republican view, so let's briefly review that.  In an economy that produces widgets and is at full employment, the only way to get more output per capita is to have process innovation in the production of widgets or to have product innovation, so a new and better type of widget emerges.  Tax cuts are supposed to incentivize innovation.

But we live in a knowledge economy where much of GDP (knowledge goods) are fundamentally public goods, in the sense that the incremental cost of supplying such a good is zero.  Many of these public goods are now distributed by some semi-private mechanism.  For example, the New York Times articles I've linked to above are free to somebody who otherwise never reads the New York Times.  But there is a quota and if you want access to the New York Times above the quota you must subscribe.  Further, this observation about semi-private mechanisms continues to hold for such free services as Facebook.  In this case users implicitly pay by being exposed to the ads, which they would prefer not to see.

If users and potential users are demand constrained by their income, then GDP can go up simply by giving these users more income.  The users then will be willing to buy more content by subscription. These same users will be more attractive to advertisers because they have increased income to spend on the advertiser's product. So, a good case can be made that the economy is demand constrained more than it is supply constrained.  Then, the Democratic proposals will be pro growth because they address the demand constraint.

This is another argument I haven't heard from Democratic candidates, but one they should be making.  Getting more income into the hands of working class people is not just a matter of fairness.  It will be good for the economy too.

I will close with the following observation.  Eventually the infighting needs to end and Democrats need to get on the same page.  Consideration of raising taxes in the manner sketched in this piece offers a path toward reconciliation.  My hope is that it will happen sooner rather than later.