Capital Commentary is the weekly current-affairs publication of CPJ, written to encourage the pursuit of public justice.
Stewardship and the Fiscal Cliff
December 14, 2012
By John Anderson
The looming fiscal cliff is a set of tax increases and federal spending reductions due to take place on Jan. 1, 2013, the combination of which is forecast by the Congressional Budget Office (CBO) to put the U.S. economy back into recession in 2013. Avoiding a sharp economic downturn in the short run is important to ensure employment opportunities and income security for as many Americans as possible. But, the long-term fiscal outlook is unsustainable and requires serious policy action.
Two biblical principles should guide our thinking on policy responses. First, we should be mindful of our obligation to be good stewards of the resources with which God has entrusted us (c.f. Genesis 1:26-30). That involves both providing an economy in which growth can flourish to improve wellbeing for our population and assuring that the tax system is as efficient as possible, not wasting resources. Second, we need to heed the many biblical admonitions to provide for justice—giving people their due (c.f. Job 34:10-12). That involves both assuring that human initiative can receive its due reward and providing support for those in desperate need.
Stewardship requires us to have a sustainable fiscal system. Trillion dollar annual deficits and a 16 trillion dollar debt are not sustainable. Annual federal deficits must be reduced substantially in the long-term but carefully in the short-term. That requires comprehensive reforms of both major entitlement programs (Medicaid, Medicare, and Social Security) and the federal tax system. We cannot ignore the need to reform entitlements as they grow and crowd out discretionary spending. Furthermore, it is imperative that we reform the tax system being mindful that the efficiency cost of raising tax rates is large. As economists Joel Slemrod and Jon Bakija have shown, the benefits of broadening the tax base (by eliminating exemptions and deductions) and lowering tax rates are substantial, even if revenues are increased. As a basic stewardship matter it is essential to make tax bases as broad as possible and to keep tax rates as low as possible.
Justice requires us to have a system that gives people their due. Unfortunately, the political focus has narrowed almost entirely to the question of income tax rates for the top 2 percent of taxpayers. Many consider it a matter of justice to raise the statutory rates on the wealthy. That view mistakes the concept of justice and misses the reality that the current federal tax system (individual and corporate income taxes, payroll taxes, and estate taxes) is already highly progressive. Ranked by cash income quintiles, the average federal tax rate (total federal taxes paid as a percent of cash income) rises from 0.5 percent in the first quintile to 25.1 percent in the top quintile. In the top one percent the average tax rate is 31.2 percent. Federal taxes rise with income at an increasing rate. Furthermore, if we consider only the individual income tax, the most important source of federal revenue, the effective tax rate pattern is extremely progressive. The bottom two quintiles receive payments (net negative payments) equal to 10 percent of the total income taxes paid while the top quintile pays 94 percent. The share of income tax paid by the top one percent alone is 40 percent.
President Obama proposes to extend the 2001 and 2003 tax rates except for those with incomes above $200,000 (single) and $250,000 (joint), and return to the 2009 estate tax regime. The non-partisan Tax Policy Center, a joint project of the Urban Institute and the Brookings Institution, summarizes the president’s proposal by saying, “As rough justice, therefore, you can think of the president’s $1.6 trillion target as being almost entirely composed of his proposed tax increases on high-income households.” Rough justice, indeed.
Firms are rushing to accelerate dividend payments into this calendar year before tax rates rise dramatically, revealing another aspect of tax justice. One feature of the 2003 tax reform reduced the double taxation of corporate income paid to individuals as dividends. The net income of corporations is subject to a 35 percent tax rate. If dividends from this income are then paid to shareholders another tax is applied at the individual income tax rates. The 2003 reform reduced the top dividend rate to 15 percent, reducing double taxation, but with the expiration of the law that rate will rise to 39.6 percent. Justice is not well served by increasing the double taxation of dividend income.
The current fiscal trajectory of the U.S. federal government is not sustainable. The ultimate solution for long-term fiscal sustainability is to enact both tax reform and entitlement reforms. Both are essential, but neither can be accomplished by January 1. What is necessary is a sincere commitment by both sides and a framework to reform the tax system and the major entitlement programs over the next 18 months. Anything less than comprehensive reforms will violate our obligation as good stewards and will create further injustices in our tax and transfer system.
—John E. Anderson is the Baird Family Professor of Economics at the University of Nebraska and served as a senior adviser with the President’s Council of Economic Advisers, 2005.
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Capital Commentary is a weekly current-affairs publication of the Center for Public Justice. Published since 1996, it is written to encourage the pursuit of justice. Commentaries do not necessarily represent an official position of the Center for Public Justice but are intended to help advance discussion. Articles, with attribution, may be republished according to our publishing guidelines.”