August 30, 2024

What’s the Fairest Way to Tax the Wealthy?

Philip Kotler

In 1980 Ronald Reagan was elected. He promised to cut the top marginal tax rate. This he did, and the top marginal tax rate was lowered over his 8 years in office from 73% to 28% on incomes over just $29,750 — the lowest this rate had been since 1925.

Currently the top marginal tax rate is 37%. Rich Americans and their lobbyists and propagandists had managed to convince Americans that a low tax rate on the rich not only benefits the rich but also benefits the middle class and the poor. Their major argument is “trickle-down economics”. The better the rich do, the better everyone else will do.

Most American now recognize that there has been very little trickle down. First the rich keep getting richer while the middle class gets smaller. And the poor remain desperately poor in a country as rich as the U.S. There is no trickle-down. If anything, there is trickle up. What are many companies doing with their profits? They buy back their shares on the stock market which enrichens them further.

Defining the Problem

The federal government has an enormous deficit of $1.52 trillion. This excess of government spending over its revenues will be financed by treasury bonds that have to pay a high interest rate. To trim the deficit, either the federal government has to spend less or it has to raise taxes. To spend less, it would have to cut Social Security or health care assistance or other payments to the poor. Such cuts are opposed by liberal voters who favor increasing payments to citizens who are unable to put enough food on the table, pay medical bills, pay college costs, and so on.

The major hope for more revenue is to raise taxes. Taxes cannot be raised on the poor, many of whom don’t earn enough to pay taxes. Taxes cannot be raised on the middle class without driving them into the poor class. The only group who could be taxed without affecting their material well-being are the rich. The richest 1% of Americans are those earning over $525,000 a year.

The question is whether the public favors passing higher taxes on the rich. A POLITICO/Morning Consult poll conducted in September 2021 found 74% agreement with the statement, “The wealthiest Americans should pay higher taxes.” About seven in 10 Democrats and Democratic-leaning independents have supported heavier taxes on the rich each time the classic Gallup question has been asked since October 2008. That compares to a consistent third or less of Republicans agreeing.

A major part of President Joe Biden’s 2020 presidential campaign was a call for higher taxes for those at the top end of the income and wealth spectrum. Biden recently proposed a Billionaire Minimum Income Tax law that would require the wealthiest American households to pay a minimum of 20% on all of their income.

But recent legislation “leaves out most of President Biden’s proposals to pull in greater government revenues from rich taxpayers. Increases in individual income tax rates for high earners, increases in the estate tax, increased taxes on capital gains like stock and property holdings, a tax on billionaires, a plan to build out the net investment income tax and a surtax on high-income households are plans that have been scrapped from the Inflation Reduction Act.”

Yet the task remains to get Congress to discuss and research seven possible tax increases.

1. Raise the top marginal tax rate on individuals from 37% to a higher number.
2. Raise the estate tax.
3. Increase taxes on capital gains.
4. Pass a wealth tax
5. Pass a tax on high-value goods and services
6. Pass a tax on financial transactions
7. Increase corporate taxes

Here we will discuss each possible tax increase in more detail.

Raise the top marginal tax rate

What is a fairest top marginal tax rate? During World War 2, the top marginal tax rate rose as high as 90%. The country needed all the resources that it can get to survive. Later in peace time, President Reagan’s top marginal tax rate was 70%. Reagan got the tax rate down to 37%. Few Americans today would press for restoring the 70% tax rate. Some might argue for moving the top marginal tax rate to 60%, the rate found in the Nordic countries. This 60% rate has not hurt the success of Nordic countries, largely because the high taxes are turned into providing excellent health care systems, excellent universities, excellent child care and paternity care, and 4 week annual vacations, all resulting in Nordic citizens who are among the happiest, healthiest and best-educated citizens in the world.

But raising the top marginal tax rate from 37% to 60% would raise the specter of socialism or communism and sit poorly in a society based on independence and individual freedom. Most rich people believe they earned their income honestly with hard work, not just luck or inheritance. They dislike the idea of the federal government taking away some of their hard-earned income to support many people who might be undeserving, lazy or untrustworthy.”

I propose that the top marginal tax rate be raised to 50%. This percentage says that high earners are helped by many things that government has done such as building roads and highways, airports, public parks, police and fire systems, prisons, clean air and water, and other enablers for the good life. The rich keep half of their earnings and the other half goes to make life better for those who are poorly paid or unable to make ends meet. Hopefully the rich can feel better and rebel less in paying higher taxes if the tax share of 50% seems reasonable to them as a way of reducing poverty and suffering.

Moving to a top marginal tax rate of 50% should be done in steps rather than in one year. It would be more acceptable and encounter less opposition if the marginal tax rate was raised by 3% each year. The tax rate would move from 37% to 40% to 43% to 46% to 50%, taking 4 years to reach 50%. The rich will have time to make the needed adjustments each tax and the final top marginal tax rate will be 50%.

To make the 50% tax rate more acceptable, the rich would want to know how this higher revenue will be used. Will the additional revenue primarily be spent in programs to reduce the suffering of the poor? Or would it primarily be used to build more battleships and tanks? Would it primarily be used to cover the costs of a multitude of federal agencies? Should the federal government set a distinct purpose for the fund that would receive widespread support and ease the resistance to the higher tax rate?

Raise the Estate Tax

The federal government can also raise more revenue for raising the estate tax. The estate of a wealthy individual upon death will be taxed at a prescribed level. The estate tax requires two decisions. One is how much of the person’s wealth should be exempt from taxation to support the heir’s living style. Currently the high-net-worth individual’s exemption is $11.18 million. This is thought to be a reasonable amount to go to the heirs. The other decision is the tax rate on the non-exempt partof the person’s wealth, which is currently 40%.

The exemption level is expected to be cut from $11.18 million to $5.6 million in 2026 in the effort to raise more estate money. The current tax rate is expected to remain at 40 percent. Wealthy persons are likely to mount a fight to preserve the $11.18 million exemption on the grounds that cutting the exemption would put a terrible burden on some farm families and small-owned businesses, forcing some to close their business and put their workers out of work. Wealthy persons would also want to lower the estate tax rate of 40%. Many of the rich label the estate tax as a “Death Tax” and favor eliminating estate taxes altogether. If the estate tax is eliminated, this would put a bit hole in tax revenue and prevent reducing the tax rates for working and middle class families. “This bill is about giving $270 billion in tax benefits (over 10 years) to the richest of the rich,” according to Democratic Representative Rick Nolan, “and the rest of the country is going to have to pay for it.”

As for raising the estate tax rate, Republicans argue that this will lead to more tax avoidance and lead talented people to work less hard or threaten to leave the country. I would counter-argue that there are a great many civic-minded talented people waiting to move up the wealth ladder and take their place.

The estate tax is here to stay. The estate tax goes back a hundred years and purports to prevent the concentration of wealth from worsening. Supporters of the estate tax argue that an exemption of $5 million for an individual and $10 million for a couple would provide enough for the heirs to continue to live comfortably, especially considering that the heirs are still left with 60% of the estate.

The estate tax only affects a small number of people each year. In 2015, over 2.7 million Americans died, and yet only 12,000 estate tax returns were filed. More than half of those reported no tax due. Estate tax provisions allow transfers to spouses, charity, and other eligible purposes without any estate tax due. About 90% of collected taxes came from estates worth more than $10 million. The majority of those affected by the estate tax are high-net-worth individuals with extensive holdings of liquid financial assets. Their lives and children’s lives do not undergo any substantial disruption.

Clearly, members of Congress will spend a lot of time debating a just exemption rate and a just estate tax rate.

Increase Taxes on Capital Gains

Realized capital gains is the money from the sale of a capital asset (stock, real estate, etc.) at a price higher than the one you paid for it. If the investor sells the appreciated asset in less than a year, the short term gain is taxed as ordinary income. If the investor holds the appreciated asset for more than a year, the gain is taxed at less than ordinary income. For many years, the long term capital gain tax rate was 15%. The 2024 long-term capital gain tax rates are 0 percent (up to $44,625), 15 percent (up to $89,250) and 20 percent (over $492,300).

If your asset goes up in price but you do not sell it, you have not realized your capital gain and therefore you owe no tax. Vice President Kamala Harris favors putting a capital gains tax even on appreciated assets that have not been sold yet. Supporters argue that the current system of capital gains taxation incentivizes wealthy Americans to hold assets indefinitely to avoid taxation on appreciation. The wealth is passed on generation after generation without any tax. Harris says her proposal would apply only to taxpayers worth $100 million or more.

Pass a Wealth Tax

A proposal on taxing wealth would have to define what constitutes wealth. Wealth could be defined as fungible assets that have a market value. But the decision might be made to only tax stock and bond holdings, not real estate and business properties.

Senator Elizabeth Warren and Senator Bernie Sander both proposed an annual “wealth tax” on Americans with more than $50 million in assets. Emmanuel Saez and Gabriel Zucman, two economists at the University of California, Berkeley, have been advising Warren on a proposal to levy a 2 percent wealth tax on Americans with assets above $50 million, as well as a 3 percent wealth tax on those who have more than $1 billion. So far, Congress has tabled these proposals.

Pass a Tax on High-Value Luxury Goods and Services

Most goods and services carry a sales tax or a value-added tax. There is a further question: should the government add a surtax on luxury goods and services. Luxury goods would include expensive cars, mansions, private airplanes, private boats and yachts, private swimming pools, furs and expensive jewelry and clothing. Understand that buyers of these goods already pay more dollars. If the sales tax is 10 percent, then a $1000 watch would be taxed at $100. The question is whether to put an additional luxury tax on watches costing $1,000 or more. If the answer is yes, how high should the luxury tax rate be?

The purpose of a luxury tax is to gain revenue from people who have the means and whose life style would not be diminished by that tax. Luxury taxes would reduce the resources used in making luxurious goods and increase the money available to make more affordable housing, city swimming pools, and other socially useful goods. The luxury tax aims to redistribute resources from the rich to the poor.

In the 1990s, the federal government imposed a 10% luxury tax on fur, expensive jewelries, airplanes and cars worth $30,000 and above. In the case of cars, big opposition came from the European car manufacturers that made some of the most expensive cars in the world. The U.S. motivation was to protect lower price American cars from the competition. But even General Motors and Ford, producing the Cadillac and Lincoln, respectively, objected. Meanwhile European countries were charging luxury taxes on European luxury cars. The U.S. 10% luxury tax on cars led to a sharp decline in sales of expensive cars. This caused so much opposition from producers of luxury cars that the luxury tax law was repealed.

As another example of taxing luxury goods, in 2014, the Nigerian Government, suffering from declining oil revenues, planned on setting the following luxury goods taxes:

• 10% import surcharge on new private jets;
• 39% import surcharge on luxury yachts;
• 5% import surcharge on luxury cars;
• 3% luxury surcharge on champagnes, wines and spirits; and a
• 1% mansion tax on residential properties valued above a certain level.

These rates were implemented but faced such stiff resistance that these luxury taxes were abandoned. Luxury goods owners said that these taxes would kill a large number of jobs and leave these workers jobless and in need of public assistance.

The major question remains “What are the specific goods and services that will constitute luxury goods and services?” The answer differs in countries with quite different economic levels and even within these countries. In the UK, chocolate covered biscuits are considered luxury goods yet plain biscuits and cakes are considered necessities. In Norway, cars and chocolates are considered luxury items and are liable to luxury taxes. The term “luxury tax” is sometimes applied to “sinful items” such as sugary drinks, tobacco and alcohol. Hence the concept of a “sin tax”. This could have adverse effects on the affected businesses and by extension, the economy.

The idea, however, remains to get the wealthy class to contribute more towards easing the deprivations that ordinary families experience.

Pass a Tax on Financial Transactions

A great amount of money is spent every weekday on buying and selling stock. The mass of securities traded in the United States is in the hundreds of trillions of dollars. The aim of traders is to make a profit through betting on the rise or fall in the price of specific stocks or in the stock market as a whole. At best, this is a form of gambling rather than creating new value. It is a game indulged in largely by persons who have discretionary income. Fifty three percent of Americans have no money in the stock market. Most stock traders have good income or wealth.

Senator Bernie Sanders of Vermont proposed placing a tax on financial transactions. He proposed a small excise tax, such as .0001%. This tax on a $1,000 trade would cost the stock trader 10 cents. A $100,000 trade would generate a tax of only $10. The nonpartisan Tax Policy Center estimated that this tax would raise $185 billion over 10 years. That amount could finance an ambitious expansion of prekindergarten programs for 3- and 4-year-olds and restore funding of college assistance for low-income students.

This tax on financial transactions might reduce the amount of high-frequency trading, much of which is automated and used to make windfall profits through taking advantage of small differences in price in milliseconds. Automatic trading accounts for over 50 percent of the trades in some exchanges. This kind of trading does nothing for ordinary investors and can destabilize financial markets.

Financial transaction taxes have been used in countries with thriving financial markets, including Britain, Hong Kong, Singapore and many others. Eleven countries of the European Union agreed to implement such a tax in 2013, though pressure from opponents caused the introduction to be postponed

Increase Corporate Taxes

Corporate tax is imposed in the United States at the federal, most state, and some local levels corporations. Since January 1, 2018, the nominal federal corporate tax rate in the U.S.A. is a flat 21% following the passage of the Tax Cuts and Jobs Act of 2017. Like individuals, corporations must file tax returns every year. They must make quarterly estimated tax payments. Groups of corporations controlled by the same owners may file a consolidated return. Corporations may be subject to foreign income taxes, and may be granted a foreign tax credit for such taxes.

Almost half of all private employment in the United States is within businesses that do not pay a corporate tax, but which rather pass the business income through to the owners’ individual income taxes.

At least 55 of the largest corporations in America paid no federal corporate income taxes in their most recent fiscal year despite enjoying substantial pretax profits in the U.S. This continues a decades-long trend of corporate tax avoidance by the biggest U.S. corporations. It appears to be the product of long-standing tax breaks preserved or expanded by the 2017 Tax Cuts and Jobs Act (TCJA) as well as the CARES Act tax breaks enacted in the spring of 2020. The tax-avoiding companies represent various industries and collectively enjoyed almost $40.5 billion in U.S. pretax income in 2020. Instead of paying taxes, they received $3.5 billion in tax rebates.

Some Liberals plead that the corporate tax rate should be closer to 30%. Conservatives argue that the corporate tax rate should much lower than 21%. This debate about the appropriate corporate tax rate comes up from time to time.

Conclusion

This review of federal tax policies aims to answer whether tax rates are sufficiently high to raise enough money to keep the federal deficit from further exploding. Clearly the amount of taxes raised not only falls short of covering the government’s necessary expenditures and leaves nothing to spend on further reducing the plight of the poor. One hopes to gain further tax revenue by raising taxes on the wealthy. The wealthy are the only group in the population that continues to get richer. Wealth begets more wealth. Therefore the public feels justified in setting higher taxes on the wealthy. But the wealthy must feel that the level of redistribution is reasonable and necessary. The rich might accept a top marginal tax rate of 50% if they have confidence that the extra revenue will be put to good use. They might accept a somewhat lower exemption rate on estate taxes. They probably will strongly resist a wealth tax and lightly resist taxes on high value goods and services and taxes on financial transactions. All of this will be debated int the public and in Congress. Hopefully the solutions that are reached will be convincing to the general public and even to a sufficient number of members in the wealthy class.