Democrats Need to Stand-Up to Special Interests and Reform Regressive Tax Policies

The top Federal personal income tax rate (see graph below) has plummeted since the 1950’s when the highest rate paid by the wealthiest Americans stood at 91%. Today, the top rate is just 39.6%, a 56% decline over 34 years.

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Source: Tax Policy Center

The biggest reductions came during the Reagan Administration, from 1981 to 1989, under the theory that reducing tax rates would spur “supply side” economic growth. Well, that hasn’t worked. Today, as TDV noted in a recent blog, Economic Growth is Anemic.

But personal income tax rates alone don’t tell the whole story.  Even though personal income rates are low by historical standards, they are still nominally progressive.

What makes the overall tax system regressive is comparatively low rates – 15% to 20% – for non-wage or “unearned” income – capital gains, interest and dividends.  And since non-wage income is a higher proportion of income for wealthy Americans, many wind up paying a smaller percentage in taxes than many low and moderate income Americans.

In addition, the payroll tax that finances Social Security is capped on incomes above $118,500 — this amounts to a further tax break for the wealthy.

One of the most extreme examples of unfair, regressive Federal tax policy is the treatment of management fees paid to hedge fund and other portfolio managers. It is called “carried interest” and taxed at a top rate of 23.8%, under the assumption that it is really long-term capital gains. This interpretation stretches the bounds of credibility.  As a recent Slate blog pointed out, even Donald Trump has taken issue with that.

The low rate on hedge fund management fees points to a closely related problem: Wall Street and big business generally appear to be writing the rules. Not only are we not sufficiently regulating Wall Street, we are giving them huge tax breaks. When the financial crisis hit in 2008, middle income taxpayers footed most of the bill. Then, the Federal Reserve stepped in further inflated asset values by holding interest rates artificially low, so we have actually rewarded Wall Street for its reckless behavior.

It is not just about Wall Street, however.  It’s a long-standing principle of Democratic politics (even if it seems to have been largely forgotten in recent years) that fairness and equity dictate that he people who benefit the most from civil society should pay a higher proportion of their income in taxes. In addition, the country badly needs the additional revenue from a more progressive tax system to invest in America, its infrastructure and its people, and grow the economy.  A look back over modern history suggests that  high marginal tax rates not only do not harm the economy – they are closely correlated to periods of strong economic growth (see analysis at politicsthatwork.com).

Of the Democratic candidates for President, only Bernie Sanders appears to support a fundamental shift to a fairer and more progressive tax system, as discussed in a recent Daily Kos blog.  Unfortunately, other leading Democrats just seem to want to nibble at the edges of the tax reform, tweaking the tax code without really addressing the underlying issue that the tax code as a whole has become highly regressive and needs a complete overhaul.  SeeTDV blog, Progressive Taxation: Not on Hillary’s Agenda.

Part of the reason many Democrats seem hesitant to tackle our regressive tax system head-on is because Wall Street is an equal opportunity contributor to Democrats and Republicans alike. Or, perhaps, Democrats are intimidated by the Republican / supply side propaganda machine, led by organizations such as the “Club for Growth” – organizations that have pumped millions over decades into aggressive campaigns against higher taxes.

Whatever the reason, it is time for Democrats to stand up to the special interests, do the right thing, and reform our regressive tax system.