It’s election day in America! Make sure you get out and vote. If you want to have a say in government policy, you need to make your voice heard. The government is going to act in your name whether you like it or not, so do something to shape it. Grab a friend or three and get to the polls!
Today, we’re picking up where we left off with Universal Basic Income.
First, we learned what it is and what the different visions for UBI entail. Then we explored the evidence that giving people money works and responded to concerns that people have about Universal Basic Income.
Most recently, we started tackling the biggest question with regards to UBI: How will we pay for it? Last week we figured out how much money we needed to find and looked for some spending cuts that could get us started.
Today we dive into everyone’s least favorite topic: raising taxes.
Now that we know the different levels of funding, and have identified some spending cuts to get us started, it’s time to go find some new money to pay for our UBI.
As I don’t have any ideas for a multi-trillion dollar side hustle, we’ll be spending a lot of this discussion talking about taxes. Because of that I want to take a quick detour to discuss the concept of taxes generally.
I don’t practice tax law, but I took tax law in law school because I’m a huge nerd. I found the theory quite interesting and illuminating. The general goal of taxation is to bring in the amount of money that you need while (a) avoiding incentivizing “bad” behavior and (b) encouraging “good” behavior. You also want to aim for taxing people’s “excess” money more heavily.
The explanation for that last part is pretty simple. If a tax is going to prevent someone from having enough money to pay for their next purchase then it is better for society if you take from the guy that won’t be able to buy a third yacht rather than from the guy who won’t be able to afford a third meal of the day for his family.
Capitalism is going to have some inequality. That’s good. We want to encourage hard work and creativity and innovation. But those who earn the most through this system are in the best position to fund the government that keeps the system functioning.
Tax and Behavior
The behavior aspect of taxation is a bit more complicated.
Every tax (and tax break) affects behavior in one way or another. Some of these effects are very small, while some can be quite large. They also vary based on degree.
For an example of degree, let’s look at income tax. An income tax, by definition, makes your labor less valuable and thus makes you less likely to do as much of it. There’s a huge difference, however, between a 10% income tax and a 95% income tax. If I only get to keep 5% of what I’m making, then I’m more likely to call it quits once I’ve saved up enough to live on.
As to the good behavior/bad behavior, we can compare different societal values. Americans value hard work, so our income tax rates are among the lowest in the advanced world. We (for better or worse) want people to buy a house rather than rent, so we have a massively expensive mortgage interest deduction to encourage buying houses.
Values can change over time. For example, we used to place a higher emphasis on economic equality. From 1951 through 1963, the top marginal tax rate went from 91% to 92% and back again. It was then in the 70% range for another two decades. The idea was that once you made enough to live comfortably on, you should contribute more towards funding the government. It also meant that there was less incentive to negotiate extravagant raises once you hit that top tax bracket, so companies put more of their profits into paying lower-wage workers and investing in the future of the company.
From 1935 through 1982, the maximum estate tax was 70% or higher. The exemption to this tax started at $50 million, decreased to $10 million, and decreased again to $5 million. The idea here was that passing $5 million on to your kids was plenty to give them a solid head start on life. You could give them more if you wanted, but they would have to pay a high tax rate on that money.
This also fit with the idea that you wanted to most heavily tax money that the person did not earn and/or did not rely on. Under this rationale, things like inheritances, lottery winnings, and other windfalls should be taxed higher not only because they aren’t “earned” through hard work by the recipient, but also because they are extra money. You plan your budget around the income from your job. You don’t necessarily plan your budget around sporadic and often-unexpected influxes of cash.
A Quick Disclaimer
Before diving into the numbers, I want to repeat the same caveat that I gave Tuesday when we were discussing spending cuts: The numbers here are rough.
I don’t have a team of economists or an economic forecasting model to work from. I would love to have found a program that lets me put in different proposals and score them. Or even just find out the specific impacts of a 35% top marginal rate versus a 45% top marginal rate.
Alas. The world is not yet as nerdy as I am and there does not appear to be much demand for something like this to be publicly available.
So all of my numbers are pulled from scoring of other people’s plans. Some of these gave an annual amount based on the year that they were scored. Some gave a ten year horizon. I took the annual value at face value even though it is likely lower than the average annual value (especially for plans scored less recently) and I divided by ten on the long horizon scores even though that will likely overestimate the value in the present year.
I hope that these roughly even out. We’re also dealing with such massive numbers and hypotheticals that rough numbers should give us a feel for what would need to be done. When Congress calls me to draft a policy I’ll work with economists and models and get the details down much better.
My limited data points also mean that I have less flexibility. When looking at different rates for the Estate Tax, I can compare Obama’s plan with Trump’s plan with Clinton’s plan with Congressional Republicans’ plan. I can’t compare a $10 million exemption with a 45% rate against a $2 million exemption and a $35% rate.
And now on to the taxes. The first tax that most people think of is the income tax, so let’s start there.
First, repealing the Trump tax cuts seems like an easy way to bring in extra revenue. The cuts are unpopular and have done little to help most Americans. This would bring in $138 billion.
Next, we could repeal the remaining Bush tax cuts. This would be a much more unpopular move, but one could rightfully argue (as discussed in the previous article) that these cuts were specifically implemented because the Bush administration wanted the government surplus paid out to Americans. The surplus is now long gone, so the tax cuts have served their purpose. Repealing the Bush tax cuts would bring in $172 billion.
These two alone would raise $310 billion a year in new revenue.
The last time politicians were seriously looking at reducing the deficit, a popular proposal was a Millionaire’s Tax. This plan would put a 5.4% surtax on any income over $1 million per year. This would bring in $50 billion in revenue.
But how do we know if a 5.4% surtax on income over $1 million is the optimal tax on the right amount of income? For that, we need to dive back into some theory.
The Laffer Curve
To know where the optimal rate for income taxes is, we’re going to take a quick detour to understand the Laffer Curve.
There are a number of people, including elected officials, who state that the Laffer Curve means that lower taxes lead to increased revenue. This is a complete misunderstanding of economics.
The idea behind the Laffer Curve is relatively simple. If you have a tax rate of 0%, then the government will bring in no revenue at all. If you have a tax rate of 100%, then nobody will work and so the government will bring in no revenue at all. At a tax rate of 1% only a tiny amount of revenue would come in. At a tax rate of 99% only a few people would work and so only a tiny amount of revenue would come in.
Taking this to its logical conclusion, you end up with a graph like this, where the highest point on the curve is the maximum government revenue before you start losing revenue from too many people choosing not to work.
Where is the Peak?
It’s important to note that Laffer was just saying that a rough curve like this exists, not that 50% was the optimal rate. The reason this was initially used to argue that lower taxes would lead to increased revenue was that the top marginal tax rate in the United States was at or above 70% after 25 years of being between 80% and 91%. The rates were quite high, so most people assumed we were beyond the peak of the curve.
Economists have since gone back and forth over what that ideal rate would be. Here’s how economist Emmanuel Saez estimated the rate:
“The tax rate t maximizing revenue is: t=1/(1+a*e) where a is the Pareto parameter of the income distribution (= 1.5 in the U.S. and easy to measure), and e the elasticity of reported income with respect to 1-t which captures supply side effects. The most reasonable estimates for e vary from 0.12 to 0.40 (see conclusion page 47) so e=.25 seems like a reasonable estimate. Then t=1/(1+1.5*0.25)=73% which means a top federal income tax rate of 69% (when taking into account the extra tax rates created by Medicare payroll taxes, state income tax rates, and sales taxes) much higher than the current 35% or 39.6% currently discussed.”
Two points to note. (1) There is a lot of guesswork involved here and nobody knows the right rate. (2) Academics agree that the optimal rate is much higher than our current rate.
Whether the optimal rate on the Laffer Curve is 50%, 70% or somewhere in between, there is a lot of room to raise taxes before we start harming work incentives. This would obviously not be politically popular, but we’re ignoring politics for the purposes of this exercise anyway.
With that in mind, there are hundreds of billions of dollars that we could raise in income taxes above and beyond repeal of the Bush and Trump tax cuts by increasing the top marginal rate towards the peak of the Laffer Curve.
As I noted, my access to numbers is limited. However, even just raising rates for the top 1% of earners to a top marginal rate of 45% would bring in an additional $276 billion. If we push closer to Saez’s optimal tax rate and/or expand slightly beyond the top 1%, this number would easily top a trillion dollars.
Repeal of the Bush and Trump tax cuts, combined with an increase in the top marginal rate, would allow us to raise over $1.5 trillion a year without doing major damage to the economy.
The Estate Tax
The next tax we’re going to dive into is the estate tax, which economists tend to argue should be higher. The estate tax is a prime example of a tax that can be high without overly incentivizing bad behavior or discouraging good behavior.
The estate tax is a tax that people who receive inheritances pay on that inheritance. This is considered a “good” tax for a number of reasons. First, the person paying the tax did not do any work at all to earn the money. An inheritance rewards the recipient for their relationship with somebody that had a lot of money rather than rewarding them for hard work, creativity, or innovation.
Second, inheritances are a windfall. Taxing an inheritance means that you do not have to cut into a family’s monthly budget for food and housing. Plus, the people that receive inheritances tend to be people that are already doing pretty well, as having relatives with significant wealth correlates to having significant wealth of your own.
The estate tax in the United States has a rate and an exemption amount. The tax rate is paid on any dollar amount the exceeds the exemption (other than money donated to charity). If one spouse passes away, all of their assets can go to the other spouse without paying any taxes. When the second spouse passes away, the estate gets credited with both their own exemption and the first spouse’s exemption, effectively doubling the amount of money you can pass on tax free.
Right now the rate is 40% and the exemption is $11.18 million. This means that a couple can leave $22.36 million before they have to pay any taxes. Let’s look at an example.
Let’s say a couple wants to leave $24 million to their three children. If there were no tax, each child would receive $8 million. With the tax, the government gets $656,000 and each child gets $7,781,333.33. Alternatively, the couple could choose to leave $656,000 to charity instead and the government would get nothing and each child would still receive $7,781,333.33.
With the exemption where it is, only the top 0.0006% of the population has to pay any estate tax at all.
Raising the Estate Tax
I wish that I had a modeling tool to play around with and figure out how different exemption levels and different rates would affect revenues. Alas!
In the absence of such a tool, here are some plans that have been scored and how much extra revenue they would bring in:
A bipartisan Congressional plan that would set a $5 million exemption with a 35% rate would bring in an extra $12 billion in revenue.
An Obama plan to set a $3.5 million exemption with a 45% rate would bring in $24 billion.
A return to Clinton era rates, where the first million dollars was exempt, the next two million was taxed at 18%, and any above $3 million was taxed at 55%, would bring in $50 billion.
A return to 1972 levels, with a $10 million exemption and a 57.75% rate would bring in $85 billion. (And 1972 was not even the peak of our estate tax.)
Another aspect of estate tax to examine is the step up in basis.
When we sell stock, we need to pay a capital gains tax on the growth of that stock. If we buy $100 worth of stock and then sell it after it grows to $150, we pay tax on that $50 that we’ve earned. If you buy a house for $200,000 and live in it long enough for it to be worth $1 million, then you have $800,000 in earnings.
Estates don’t do that. Instead, their assets are treated as if they were purchased on the date that the person died. Nobody ever gets taxed on that $50 gain from the stock or the $800,000 from the house.
I have not been able to find a reason that this rule exists. There does not appear to be any obvious policy justification for not taxing gains within an inheritance. The only thing that I can think of is for simplification of the paperwork involved around settling estates. But this simplification comes with a very large cost.
Eliminating the step up in basis rule would bring in an extra $54 billion a year in revenue. This number would grow significantly if we coupled it with one of the new estate tax plans discussed in the last section.
A return to 1970s level estate tax rates, combined with eliminating the step up in basis, could bring in $200 billion a year.
Here’s an area that the FIRE crowd will hate to see brought up: capital gains.
Capital gains taxes have been all over the map in the United States. Originally they were taxed as ordinary income. They were eventually given preferential rates that have varied widely over time.
Looking at our tax theory, the capital gains tax gives us mixed signals. On the one hand, a lower tax encourages “good” behavior. We want people to invest. We can encourage investment by taxing investment gains less.
On the other hand, if we’re trying to tax the people that have the most “excess” cash, then capital gains taxes are a great way to do that.
The vast majority of capital gains are earned by the uber-wealthy. This is an area where the FIRE community creates anecdotes that cut against the data. There are plenty of examples of middle class folks pursuing FIRE that are earning capital gains. But we cannot forget that this is very uncommon.
In fact, over 60% of all capital gains are earned by the top 0.1% of the country. Looking at stock ownership, which is a different but heavily overlapping measure, we see that the top 10% of the country owns 84% of stocks. Of the 16% of stocks that are owned by the other 90% of the country, much are held in 401(k)s or other retirement vehicles and not subject to capital gains taxes anyway.
Which is More Important?
In light of those conflicting directives, it makes sense to see how heavily each side should weigh.
We can see that capital gains are very heavily concentrated among the wealthiest Americans. The question then becomes how much the lower tax rate actually encourages investment. And I’m not sure I see it at this point in our economic history.
If we taxed capital gains as ordinary income, would investors stop investing? I don’t really see investors bailing en masse because of the higher tax bill.
First, what else are you going to do with the money? The other options, as far as I can tell, are to spend it or put it in a bank account. If you’re an investor, you’re generally either trying to make more money (in which case investing is still the better option regardless of higher tax) or you’re trying to support a company (in which case the tax rate on gains is not a major factor in your decision making). It’s quite possible that my analysis is missing something here, so feel free to jump in in the comments, but I don’t see how this heavily impacts investment capital.
Second, as we’ve covered before (a few times actually) we’re pushing further and further into an economic space where capital is valued more and more highly and labor is worth less and less. This system discourages work, which (for better or worse) is something that the tax code is supposed to encourage. Putting the tax rates of capital gains and labor back on the same level would be a step towards pushing that relationship in the direction of a healthier equilibrium.
If capital gains is an area we want to dive into for more revenue, it is helpful to note that the preferential rates on capital gains cost the government $160 billion per year. Equalizing capital and labor tax rates would bring in the full $160 billion (and more if we raise income taxes as discussed above), but we could also find some middle ground where capital gains are given some level of preferential treatment, but much less than they have now.
Another unpopular place to look? Itemized deductions.
Tax deductions are places where the government has decided that they will give up some revenue to try to encourage you to do something that they want you to do. Because of this lost revenue, these deductions are often treated as government spending and are considered “tax expenditures.”
In total, the government will lose about $1.4 trillion this year alone through these tax expenditures. That’s over half the cost of UBI right there!
The largest tax expenditures in the personal income tax code are:
- Deduction for State and Local Taxes – $74.1 billion
- Mortgage Interest Deduction – $72.1 billion
- Charitable Donation Deduction – $58.6 billion
- Deduction for Real Estate Taxes – $36.4 billion
Half of these top deductions, totaling over $100 billion a year, are intended to encourage people to buy houses because the government has decided that they want people to buy rather than rent.
The problem? Economists believe that the housing market has taken these deductions into account and prices have increased accordingly. This means that the government is spending over $100 billion a year to artificially make houses cheaper, but is instead just throwing that money into the real estate market without affecting the prices that the average American pays for their home.
There are also a number of tax expenditures on the corporate side that could be knocked out for a revenue boost.
Eliminating the deferral of income from controlled foreign corporations would bring in $112.6 billion a year.
Getting rid of the accelerated depreciation schedule would be a minor tweak that would bring in another $50 billion a year.
We’re still spending $33 billion subsidizing fossil fuel companies. This should be eliminated even if we didn’t need the money.
One more thing I want to look at before we move on to the rapid-fire round: the payroll tax cap.
The payroll tax, sometimes called the Social Security tax, is set at 6.2% for the individual. This tax is only paid on the first $128,400 that you make during the year.
This means that if you make $60,000 in 2018, you’ll pay 6.2%. If you make $2.5 million, you’ll pay about 0.4%. The more money you make, the lower your tax rate is. This is a bizarre setup that not even the most conservative scholars are arguing should be applied to the tax code.
93% of the country makes less than $128,400. That means that eliminating the cap on payroll taxes would only raise taxes for the top 7% of wage earners. Plus, it would be raising their taxes to a level that is already paid by all of their lower-paid brethren.
The vast majority of proposals I could find on this front measured the impact of this policy change on how it would affect Social Security if all of the new revenue went into the Social Security Trust Fund. The only number I could find that specifically addressed revenue cited it at $100 billion a year. That article was from 2012 and cited a study from years before, so that number would presumably be significantly higher by now.
Another way to raise money is with a brand new tax. This is the route that a lot of UBI proponents take.
The most popular suggestions are a Value Added Tax (VAT) and a tax on automation.
A VAT is basically a sales tax that is charged at each point of sale rather than just the sale to the consumer. As an example, a manufacturer would pay a VAT when they buy the raw materials to make diapers. A retailer would then pay a VAT when they get the boxes of diapers for their stores. I would then pay the VAT when I somehow need to buy yet another box of diapers.
The appeal of a VAT for UBI advocates is that it can bring in a lot of revenue with one easy step. Annie Lowrey notes that a VAT at “half the European level” would bring in $800 billion a year. The numbers I found suggest that a 10% VAT would bring in $750 billion.
A VAT would almost certainly raise prices for consumers, however. The increase would be significantly less than the value of the new money that a UBI would bring them, but it is still more than the effects of the other changes we’ve discussed.
A tax on automation is much more appealing to me, but I haven’t found anyone that has attached numbers to it.
The idea behind an automation tax is that (1) the people causing an unemployment crisis should pay for the solution, (2) it is much cheaper to pay for a robot and then do repairs than to pay employee salaries, so the company is still saving money, and (3) automation is inevitable, but a tax may slow its growth enough to allow for a smoother transition.
As I’ve said before, I’m a bit skeptical of the idea that automation is going to plunge us into a permanent unemployment crisis. However, I do think there is significant merit to points 2 and 3.
This seems like it could be a win-win, but I have no numbers to attach to it and I have seen no realistic proposals as to how a tax like this would actually be implemented.
Other taxes that have been suggested include a carbon tax ($40 billion), a national sales tax ($41 billion), and a bank tax ($73 billion).
As with eliminating the fossil fuel subsidies, a carbon tax could be useful well beyond its ability to raise revenue. I am skeptical of a national sales tax for the same reasons that I am skeptical of the VAT.
As for the bank tax – it depends. There are ways that this could be implemented intelligently that could help fight against the consolidation of power in big banks. There are ways that it could be implemented poorly that would negatively impact the economy. The nuances involved in this idea could get their own article.
Another suggestion was a small transaction fee on stock, bond, and derivative trades, which would bring in $300 billion a year.
This would again have the benefit of being targeted mostly at the people who are best able to afford a tax increase. Plus, it would discourage flash trading, which hurts average investors, and day trading, which is a bad way to build wealth anyway.
There have also been calls for a wealth tax.
Interestingly, one of the early proponents of this was Donald Trump, who in 1999 proposed a one-time net worth tax of 14.25% on people with a net worth of $10 million or more. This would bring in $5.7 trillion (in 1999 dollars!), with the aim of eliminating the national debt all at once.
Most countries that have a wealth tax have a rate between 0.5% and 1.5% that applies on net assets over a certain threshold. One proposal suggested the US adopt a 1% tax on assets over $8 million. The first $8 million would be tax free, which would prevent this from impacting the vast majority of Americans. This would bring in “several hundred billion dollars” a year.
I like the idea of having a high threshold on a wealth tax. One of the problems with a wealth tax that applies equally to everyone is that it could discourage saving. We have enough trouble with that already in this country without making the problem worse.
There have also been a few more creative ideas that I’ve come across.
One idea is that any time a company launches an Initial Public Offering, they must contribute a set number of shares to a wealth fund that will provide dividends to the public.
Another is that because the government provides patent and trademark protections, there should be a fee included in obtaining patents and trademarks that is distributed to the people.
Still another is implementing heavy taxes on the (soon to exist?) industries of space mining and tourism.
I don’t have in depth analyses on any of these because I have not seen any numbers or serious proposals attached to them.
There are also arguments that just by implementing a Universal Basic Income, the government will end up with more money.
The first avenue for this is through increased tax revenue from growth. If you put more money in people’s hands, especially lower-income people, that money gets back into the economy quickly. This stimulates growth and employment and creates a virtuous cycle.
The Roosevelt Institute projects that this would lead to an additional $500 million to $600 million in tax revenue from growth alone. I will add the caveat that this is the rosiest projection that I saw, but the theory is right at least and a few hundred million dollars a year could be expected.
Giving cash to the poor would also lead to significant decreases in government spending. Eliminating poverty would lead to a large decrease in crime. This means that the government would spend significantly less on prisons simply by virtue of having fewer people to arrest.
It would also lead to a drastic decrease in health care spending. Even if you raise the Medicaid limits (which we discussed in the last article) you would still save a lot of money. The less money you have, the more likely you are to rely on expensive emergency care. Moving to a system where more people have the resources to access preventative care would cut down costs quite a bit.
Being Less Generous
The other place to decrease costs would be on the UBI itself.
If we decide that we would rather have our Universal Basic Income be a bit less universal, then we could save a lot of money.
We could create a system where the amount of income you get each month gradually decreases as your income increases. This would make a UBI much more concise in its aim of ending poverty and could make the program significantly cheaper. Depending on where you place the cutoffs, you could end poverty for as little as $500 billion per year rather than the full $2.8 trillion that we’ve been looking at.
Of course, this means that you no longer have a Universal Basic Income. You also need to add back in some of the rules and bureaucracy that UBI eliminates. However, it is still a valuable option to keep in your back pocket. Eliminating poverty is a very noble goal, whether it happens through a UBI or not.
Join the Conversation!
Whew. That was a lot.
But we’ve now identified almost $5 trillion of revenue that we could raise if we wanted as well as a number of other speculative options. This is on top of the trillion dollars of spending cuts that we identified last week.
Combined, we can safely reject over half of these ideas and still have enough money to fund a Universal Basic Income that eliminates poverty in the United States.
So what do you think? What taxes would you raise? What spending would you cut? Do you think a UBI is worth it? Let us know in the comments!