Mom, and the Tax Code, Always Liked You Best

Gene Sperling looks at inefficiencies and inequities in our tax system by comparing twin brothers, one with labor income, the other with investment income, and looking at how the tax code treats each:

How to reform a winner-takes-all economy, by Gene Sperling, Financial Times: ...Lawrence Katz, the Harvard economist, has documented the increasing polarisation in the US labour market as earnings grow at the high end while opportunities for middle-class jobs dry up. Such extreme gains and losses are often due to significant differences in education or skill but as Robert Shiller ... has written, the unpredictability, speed and vastness of global markets have also enhanced the role of luck ... in determining who falls into the winners’ or losers’ circles.

Consider twin brothers with [identical] ... histories, who each took good jobs six years ago – one, fortunately, with Google, the other, less fortunately, with Lucent. Since the investment community was still betting on Lucent in early 2000 and Google was just getting established, it is hard to say that skill led one worker to $2m in stock options and the other to a pink slip and a job retraining programme.

Even though such differential outcomes can seem unfair ..., this is a price we gladly pay for a free market economy. Our progressive tax system has been part of the way the US has balanced the desire for a free economy with the values of equity. Yet, eliminating taxation on investment income exacerbates – not moderates – winner-takes-all outcomes. Consider our brothers. If the one at Lucent finds a new, $60,000 a year job, he could pay about 25 per cent in federal taxes (including payroll taxes). Yet, ... if his twin at Google can find a solid 6 per cent return investing his $2m, he can make at least $120,000 a year while paying a lower 15 per cent tax rate. If we move closer ... to zero taxes on dividends, capital gains and inheritances, the Google twin could watch his gains accumulate tax-free year after year and then pass on his wealth to an heir, tax free.

Moving the US tax code in this direction is wrongheaded on both economic growth and value grounds. ... [A] tax system that eases the Googler’s tax-free wealth accumulation but forces his brother to pay higher taxes on income earned through labour betrays American values that honour the hard work of the middle class... A better tax reform plan would prevent the most privileged Americans from paying lower taxes on their investment than typical families pay on their wages...