The Tax Code is Hurting the Economy, but Not for the Reason You Think

16 Apr 2015 | Angela Glover Blackwell
The Tax Code is Hurting the Economy, but Not for the Reason You Think
Above: Photo credit: Lendingmemo (Flickr)

(cross-posted from The Hill)

The tax reform debate that will invariably accompany the 2016 campaign will undoubtedly include many of the same arguments from the right as we heard in 2012: too-high taxes on the wealthy are stifling economic growth; the poor “don’t pay taxes.” These conceits are still prevalent among Republicans — a report from Pew Research last month found that a third of Republicans feel that the poor don’t pay their fair share of taxes, while over half of them feel that they themselves pay too much.

The irony of such sentiments is that our tax system is holding our economy back — not because it hinders the wealthy, but because it favors them, and in so doing, furthers our nation’s growing economic inequality.  In other words, our tax code is supporting the rich to get richer, and the poor to get poorer.   While this may sound like added rhetoric, the numbers show how the status quo primarily benefits the wealthy.

To understand why this is, let’s take a look at actual tax expenditures — over a trillion dollars in tax revenue that is given back to taxpayers in the form of deductions, exclusions, favorable tax rates, and other subsidies. Over half of these expenditures, approximately $560 billion, are designed to incentivize certain activities such as buying property, investing in the stock market, or saving towards retirement.  The problem is however, that very few Americans can access these incentives – mainly just the wealthy.  That’s right, most of federal expenditures, dollars that would otherwise go to the federal budget, are being used subsidizing wealthy households.

In 2013, the top one percent of households received more benefits from these subsidies than the bottom 80 percent of households combined, according to a study by national nonprofit CFED. So while the average household in the top one percent could buy a car with an averaged $23,000 they take home each year in tax benefits, low-income households in the bottom 20 percent could just about buy a tank of gas at $77 per household.  So if you are part of the forty percent of Americans, and/or the two-thirds of people of color who don’t have enough savings to cover a short-term financial setback were your income to be interrupted, short of a couple tax credits such as the Earned Income Tax Credit (EITC), this year’s tax season won’t help you much. If you’re in the top 2 percent of earners, tax subsidies may help you get towards the 1 percent.  

Because the structure for incentives goes toward those who need it least, and largely leaves behind those that need it most, our tax policies are widening the wealth gap, and adding to already growing economic inequality.

And this inequality has a much broader impact on our economy than many would like to admit. Over the past few years, economists from the IMF, the OECD, even Morgan Stanley and Standard & Poor's have repeatedly documented the dampening effect income inequality has on our nation’s growth, with one analysis finding that our GDP would have been seven percentage points higher between 1990 and 2010 if income inequality hadn’t grown during the same period.  

So how can we build a tax code that promotes better economic mobility for all income levels? We need to take a hard look at the subsidies that we provide households through capital gains rates, deductions, and exclusions – a minute fraction of which ever reach low-income households and households of color.  On the other hand, we know that tax credits, such as the EITC or Child Tax Credit do, lifting millions of people out of poverty each year. We need to preserve and expand these tax credits, and create new, accessible credits that offer public matching funds (e.g. Financial Security Credit) or turn deductions into credits (e.g. home mortgage tax deduction). We can also support policy reforms that expand access to tax-incented savings through automatic enrollment in retirement funds (e.g. Automatic IRAs) and new products to promote savings (e.g. the President’s new myRA).  

So while candidates dust off their talking points on the debate around the carpet and drapes of our nation’s tax code (e.g., who pays higher tax rates) those who care about economic mobility for low and moderate income families should be advocating for an “Extreme Make Over: Tax Edition”: structural changes to our tax system that would put expenditures to work for all of us, not just the wealthy.