Real Tax Reform Can Rebalance Economic Power

October 2, 2017

With all the discussion on Trump’s tax plan, you could be forgiven for thinking the current tax code is a good tax system.

Today’s tax system creates a disproportionate concentration of wealth in the corporate and financial sectors, while leaving revenue on the table that could be put to productive use. In a recent paper, “Reality Check,” with my co-authors Devin Duffy and Marybeth Seitz-Brown, we catalogue the room for improvement in how we tax corporations and the financial sector. Roosevelt Chief Economist Joseph Stiglitz published a separate paper outlining our broader approach to productive taxation.

We analyze reforms that would strengthen the financial sector, such as charging a tax for excessive bank leverage and implementing a small financial transaction tax to curb speculative trading; and examine reforms that would reorient the entire corporate sector, such as reducing the pass-through entity bias, taxing private equity managers the same as their secretaries for their labor, and reducing the incentives for corporations to go deeply into debt even when they don’t need to by not allowing them to deduct interest paid on debt.

We looked at a range of estimates from government sources and academics, taking into account the wide variation that exists in assumptions that produce different end numbers.

But one thing is for sure—even without a massive overhaul to bias our tax system even more for the wealthy, our current system is in large part to blame for corporate power. 

Our proposed reforms include:

A Financial Transaction Tax, which would curb speculative trading, tame the outsized growth of the financial sector, and reduce income inequality. The revenue potential is $35.2-300 billion annually.

Taxing the amount of debt banks use to finance transactions would reduce systemic risk in the banking sector to prevent future financial crises. The revenue potential: $9.8-11 billion annually.

Reducing the corporate debt bias: The current incentive to fund business operations through debt rather than equity decreases those entities’ ability to sustainably absorb losses. The revenue potential: up to $81.5 billion annually.

Taxing capital gains as ordinary income: Eliminating preferential treatment of capital gains would reduce incentives for rent-seeking, lessen income inequality, and bring us closer to a rate of taxation optimal for economic growth. The revenue potential: $84.9-135.5 billion annually.

Reforming carried interest: Eliminating the special tax treatment for partners in private equity and hedge funds would properly classify labor income as such. The revenue potential is between $2 and $8 billion annually.

Fair corporate taxation: Eliminating loopholes that distort where businesses make their revenue (and removing subsidies for activities that harm the environment) will align corporation’s productive activity and profits. The revenue potential: $147.5-252.9 billion annually.

Reducing the pass-through entity bias: Allowing too many businesses to be classified as pass-throughs instead of corporations opens an arbitrary preferential tax treatment at the entity level, which has been a driving force for the dramatic rise in the income share of the top 1%. The revenue potential: up to $31 billion annually.

It is unlikely these reforms can pass in today’s political climate. However, the fact remains that America has enormous wealth currently captured by a small minority. By realigning the incentive structures built into our tax code, we can promote productive economic behavior while raising billions of dollars.