Guest Contribution: “Six Practical Proposals for Progressive Tax Policy”

Today, we present a guest post written by Jeffrey Frankel, Harpel Professor at Harvard’s Kennedy School of Government, and formerly a member of the White House Council of Economic Advisers. A shorter version appeared in Project Syndicate December 17th.

It was quite a surprise, three years ago, when Donald Trump won a majority in the US Electoral College, thus becoming the 45th president.  In the search for explanations, one immediately dominated:  Democrats had not been sufficiently aware of the problem of income inequality or had neglected to propose good solutions to it.

This is presumably the logic behind radical proposals coming from some of the leading contenders for the Democratic nomination in the 2020 presidential election. Senator Elizabeth Warren, for example, has proposed an annual tax on the wealth of the wealthiest Americans (originally to be 2 % per year, but now up to 6 %).

The problem with the wealth tax is not so much that it is radical.  I, like many economists, would for example support a high carbon tax.  That is radical, but it is the most economically efficient way to respond to the problem of global climate change.  The wealth tax is not the most efficient way to respond to the problem of inequality.  It is not even one of the six most practical ways of responding.

There are at least six practical policy changes that could increase the progressivity of the US tax system.  They have all been proposed in the past by mainstream Democrats such as President Barack Obama, along with the Affordable Care Act and other ways of addressing inequality.  In most cases they have been blocked by Republicans.

They are practical in two senses. If a presidential candidate were eventually to succeed in getting them adopted, they are more enforceable than a wealth tax and more likely to avoid costly unintended side effects.  Moreover, proposing moderate policies is more likely to get a political candidate elected than proposing radical policies.  Political scientists studying recent congressional elections have found that the old median voter approach still holds.  Radical-left economic proposals do gain new voters on the left, but it turns out that they lose substantially more voters on the right.   

Here is my list of six:

  1. Reinforce the estate tax. The US might begin by restoring the estate tax on all estates above, say, $5 million. More importantly, however, eliminate the “step-up” of the valuation of the assets in the estate, which currently allows generations to pass on capital gains without ever paying tax on them.   It would be far easier for the Internal Revenue Service to place a dollar value on assets on a once-a-lifetime basis (that is, on the estate, before it passes to the heirs) than to try to do so every year. And it would ultimately accomplish the same objective as the wealth tax:  putting some friction into the inter-generational accumulation of dynastic wealth, which currently never gets taxed.

In a promising (and rare) bi-partisan move this month, Senators Michael Bennet (D-CO) and Mitt Romney (R-UT) proposed curtailing the step-up of basis and using the revenue to fund an expansion of the child tax credit. Kudos to them.

  1. Give the Internal Revenue Service the resources it needs to collect taxes. Natasha Sarin and Larry Summers have recently pointed out that the IRS currently fails to collect nearly 15 percent of total tax liabilities, a gap that primarily benefits those with high incomes.  Although it is impossible to close the gap, giving the IRS more resources would have a high “benefit/cost “ ratio and bring estimated net revenue benefits of more than a trillion dollars over the next decade.   (This is money that could be spent on lots of good causes, such as helping to put Social Security and Medicare on a sound financial footing.)
  2. Expand the Earned Income Tax Credit, to help “make work pay.” Incentives do matter.  But those trying to lift themselves out of poverty, up into the middle class, often face the steepest  effective marginal tax rate (counting lost benefits), not the rich.  Bringing the benefits of the EITC to more households is one of those ideas that would expand the size of the economic pie while also sharing it more equally: enhancing both efficiency and
  3. Make the payroll tax more progressive. The social security system is not as progressive as many think. Even workers who don’t earn enough to pay the income tax, pay a payroll tax (both directly and indirectly: employers nominally pay half of the total, but tend to pass it through to workers as lower wages). Raise the threshold at which workers start forking over.  How to make up the lost revenue?  (After all, the social security and  Medicare systems are facing huge future deficits.)  One way is to bump up the upper threshold, the level at which Americans no longer incur additional payroll taxes, from its current level of $118,500 in wages.
  4. Make the income tax more progressive. Cut the gap between the tax rates on investment income versus earned income. (Why should Warren Buffet pay a lower tax rate than his secretary?)  Also, clearly, abolish the carried interest loophole.
  5. Revisit the 2017 corporate tax cut to make it revenue neutral. There did exist good arguments for cutting the corporate tax rate, to bring it more in line with other countries.  But all Republican Senators voted for the December 2017 reduction in the corporate tax rate in the declared belief that it would boost income growth so much as to be revenue-neutral.  This has not happened, of course.  Firms turned their windfalls over to shareholders in the form of dividends and share buy-backs, rather than investing in capital as intended.  Revenue fell.  Now US firms pay virtually the lowest level of tax revenue of major advanced countries (followed only by Ireland, according to the OECD (that is 24.3 per cent of national income in 2018, down from 26.8 per cent the year before).

The solution is not to limit firms from buying back their shares, as Senators Bernie Sanders and Chuck Schumer have proposed.  The solution is, rather, to close loopholes so as to put overall corporate tax revenue back at its pre-reform level, as intended. The biggest potential revenue-saver is to curtail the tax-deductibility of interest payments.  This is another one of those proposals that could be good for GDP at the same time it is good for income distribution.  If there is a successor to the 2007-09 financial crisis, it is now less likely to come from an excess of housing debt, and more likely to come from an excess of corporate debt — especially so-called “covenant-light” debt.  Curtailing the interest rate deduction could motivate firms to strengthen their financing structure.

Fortunately, few of the Democratic candidates have committed irrevocably to extreme policies. To draw an analogy, Senator Warren has moderated her position on health insurance.  She now sensibly says her administration might start with offering a public option to those without health insurance (“Medicare for those who want it,” as Mayor Peter Buttigieg says), rather than jumping directly to the more radical plan that Bernie Sanders insists on: “Medicare for all, even those who prefer their current private health plan.”  It is not too late for her or other candidates to adopt further proposals to address inequality that are more practical than the wealth tax and would naturally come before it.


This post written by Jeffrey Frankel.

28 thoughts on “Guest Contribution: “Six Practical Proposals for Progressive Tax Policy”

  1. Barkley Rosser

    Most of this looks good. My only issue relates to #4, where you are vague. I am part of the old gang that is out there defending Social Security against its many critics . So, this proposal is pretty vague and potentially opens the door to the DC VSP gang that includes leftover Bill Clintonites (rumor has it that his impeachment stopped him f him from pushing through on some idiotic version of this). who wanted to atl east partially privatize SS. Oh, so much Wall Street money to be made doing this!

    As it was, over a decade ago, some of us managed to get to Obama and convinced him not to do any of this, and as a result SS remains more or less what it was, pretty good actually.

    So, given all that, the details of some change in the “payroll tax,” centerpiece of both Social Security and Medicare, is an important matter. Now some move to make it less regressive might well be a welcome move. The obvious move would be to raise the current income cap on fisa, maybe even simply removing it entirely.. Of course this would bring a lot of whining from upper income earners, but anything along these lines would be a good move.

    So, Jeffrey, is this what you are proposing, or some variation of it?

    1. Jeff Frankel

      To Barkley Rosser.
      I am glad that most of the tax proposals look good to you.
      Regarding payroll taxes: Yes, I did indeed have in mind “to raise the current income cap on fisa” in part. But I suspect we part ways when I read you saying that social security is in “pretty good [shape] actually” and attacking what Bill Clinton was trying to do. (Where do you get that he “wanted to atleast partially privatize SS”)? Social security and medicare have big deficits looming in future decades; the deficits have been getting much less attention in recent years, but that doesn’t mean they have gone away. The later these deficits are addressed, the more will benefit cuts become part of the solution when the time comes. Better to raise the retirement age now. (We can compensate manual-labor type workers, provided we act soon enough that there is money for benefits.)

      1. Moses Herzog

        There appear to be various and semi-contradicting answers on Bill Clinton’s sincerity on privatizing part of Social Security. I personally do not doubt he was at least “tossing it around” in his mind. Was he as serious and as adamant as “W” Bush?? I think not even close. But if you read Clinton books, he’s often looking for “the middle road” on a smorgasbord of policy issues. It certainly fits Bill Clinton’s modus operandi:

        I have been a fan of stock markets, when they are healthily run, since roughly the age of 12, but have been 100% against this proposal since its inception, which in my mind really had seriously begun under “W” Bush, but had small inklings of being hinted at under Bill Clinton.

      2. Barkley Rosser

        I know you were part of the Clinton admin for awhile, so perhaps you know better than I do. It may be that Clinton never proposed any privatization or use of the stock market, but he was widely reported to be full of that there was of a “Social SecurityCrisis” view that wanted to have a new round of the Greenspan Commission. As it was, it is only very recently that income has failed to exceed outflow for the system. The Great Recession was a big blow.

        That said, I am part of the Dean Baker gang that has long aegued that the hyperventilation over SSA has been wildely exaggerated. I will even out myself as coauthor of a mmo to Obama during his campaign that was floowed by him dropping his interest in doing anything to or about SSA, which then was his policy.

        I see no reason to further raise the age. That iis fine for academics and whit collar worrkers, but it is not fine for othrs. If we nned more rvenue, then I think we can handle any shortfalls by simply raising that income cap, which is just too low.

      3. macroduck

        Brad Delong, a Clinton appointed at Treasury, made considerable noise about the “free money” available to Social Security beneficiaries throu the equity premium. That was before 2008.

        1. macroduck

          As to whether SS is in pretty good shape, there have been plenty of demonstrations of how the Trust Fund could be put into actuarial balance by raising the contribution cap, the tax rate, the retirement age or a combination of the three. It is in the eye of the beholder whether that means SS is in good shape. I would, however, add to Barkley’s point about the burden on lower wage workers, who’s life expectancies have not risen at the pace of the national average. It can also be harder for older low-wage workers to find and keep work than for younger folk. Many have seen opportunity leave their communities as they age. It would be cruel to impose further economic hardship on these less fortunate in order to achieve actuarial balance. Raising the cap works toward greater equity. Raising the retirement age works against equity.

  2. Not Trampis

    Interesting .
    Let me advocate some policies since I have no idea of what occurs in Yankland. Most appropriate in the land of trump me thinks.

    Have a linear tax. This is one of Friedman’s thoughts. It is a flat tax with a threshhold to make it progressive. There are NO deductions.
    align capital gains tax and income tax.
    Have a land tax with NO threshhold.
    Have payroll tax without any threshhold It then becomes a de-facto VAT.

  3. pgl

    Two ideas that can and should be combined:

    “Give the Internal Revenue Service the resources it needs to collect taxes.”

    “Revisit the 2017 corporate tax cut to make it revenue neutral.”

    Return to good old fashion transfer pricing enforcement. Which could also be done with a move to more simplicity by getting rid of FDII, GILTI, and the BEAT.

  4. 2slugbaits

    Much of what Prof. Frankel recommends echoes what 2019 Nobel laureates Abhijit Banerjee and Esther Duflo argue in their new book Good Economics for Hard Times, which I just finished reading a few days ago. But unlike Prof. Frankel, they are somewhat more supportive of a wealth tax (see pages 251-255). But even if you don’t want to go to a full-blown wealth tax, a tax on real property could be doable and might reduce inequality given that so much of the rise in wealth is in the form of real property. The sad irony is that Trump’s base has been hurt the most by Trump’s policies. For example, a recent report found that blue congressional districts left red congressional districts in the dust in terms of GDP growth:

    Democratic districts have seen their median household income soar in a decade—from $54,000 in 2008 to $61,000 in 2018. By contrast, the income level in Republican districts began slightly higher in 2008, but then declined from $55,000 to $53,000.

    And as Trump’s base falls further behind it grows evermore resentful and tempted by xenophobic demagogues like Trump and Orban and Bolsonaro and Erdogan and the German AFD.

  5. pgl

    “Democratic districts have seen their median household income soar in a decade—from $54,000 in 2008 to $61,000 in 2018. By contrast, the income level in Republican districts began slightly higher in 2008, but then declined from $55,000 to $53,000.”

    The Brookings paper you link to is an interesting analysis. I could not tell but were those figures in this particular quote of theirs referring to inflation adjusted median household income or to how nominal income has increased over the decade.

  6. Alan Goldhammer

    The one best thing that can be done is to implement a VAT as most other western nations have. Such a tax cannot be gamed in the same way corporate and individual income taxes can and are. Corporate income taxes are generating a lower percentage of federal revenue than they did a generation ago. My own preference is to eliminate them and let the VAT pick up the slack. If it is needed, make it a reasonable rate and eliminate all tax preferences. Real estate holdings have so many loopholes and are another area ripe for reform.

    As others have already noted, unrealized capital gains should be captured as part of estate reconciliation (I hesitate to call it a tax). This is complicated area in that one needs to find a fair way to treat real estate versus financial assets. Even within real estate there are marked differences in passing down the family house versus commercial real estate (apartment buildings, shopping centers, etc.).

  7. Ed Hanson

    Prof. Frankel

    Your are not a simplistic economist, so I was surprised at the simplistic analysis of the Corporate tax rate reduction and whether it was revenue neutral. I believe it is wrong to only look at the tax revenue generated by corporate taxes alone to determine the neutrality of the cuts. Much of the surprising low unemployment rate is because of the corporate tax rate reduction. The high employed numbers show that business did grow at a rate not expected. Much of the additional revenue from the extra employed, both income and payroll, should be attributed to the corporate tax rate reduction. Also, future year projection of corporate tax revenue should be used in the calculation of tax neutrality not a single first year of implementation.

    Not mentioned in your progressive tax ideas were the parts of the President Trump tax cuts that created progressiveness. My favorite was the limit on state taxes which could be itemized and used by the rich to reduce their taxation. Do you consider that a practical implementation for progressive tax policy?


    1. pgl

      “Much of the surprising low unemployment rate is because of the corporate tax rate reduction.”

      This line right here should tell the discerning reading to skip the rest of Ed’s latest little lecture. Come on man!

    2. pgl

      I know Ed Hanson is fact adverse but let’s check with FRED on how real business investment is doing:

      Real Private Nonresidential Fixed Investment (PNFIC1)

      OK – maybe Ed is Mr. Magoo but if he looks really closely he might realize that real business investment is falling.

  8. joseph

    Why not ban share buybacks? It was illegal up until around 1985 and the stock market worked just fine. Stock buybacks are simply a financial engineering scheme that allows shareholders to avoid income taxes if they instead received their earning as dividends. Buybacks serve no economic purpose except tax avoidance for shareholders.

    But if you insist on keeping stock buybacks, then simply tax them exactly the same as dividend earnings distributed to shareholders. A 1099 received for dividends should be no different than a 1099 received for a stock buyback. It’s just another way of distributing earnings to shareholders.

    1. macroduck

      Buy backs and special dividends are, in fact, one of the main uses to which the corporate tax windfall has been put. This is also what happened in a prior corporate profit repatriation holiday so should not surprise even Ed, but apparently Ed is unaware.

      Not aware of the 1985 change in law. What change was that?

  9. joseph

    Ed: “Much of the surprising low unemployment rate is because of the corporate tax rate reduction.”

    You can’t really blame Ed because that is exactly what esteemed economist Kevin Hassett wrote yesterday in the Wall Street Journal.

    You may wonder why economists get such low respect from the public as a profession. Part of it is because their fellow economists give a pass to political hacks like Hassett. “Hey, he’s one of ours. We have to give him some respect.”

    Sure some economists will go after economist wannabes like Stephen Moore when he spouts garbage. But he’s not a real economist, so safe to attack. But economists are eerily silent about the quacks in their own profession like Hassett.

    Economists are going to have to face up to it. If they won’t police their own profession, then the public are going to have to assume they all suspect.

    1. pgl

      Kevin Hassett pushed hard for that corporate tax cut on claims that it would lead to a YUUUGE increase in business investment. Of course his forecast was way off. Then again some 20 years ago Hassett wrote an entire book predicting that the DOW would soon hit 36000. How did that work out?

    1. Willie

      Absolutely. I don’t understand why one form of income is any different from another. Income is income. I don’t care how you get it. If it’s money you didn’t have before, then it’s income and should be taxed like other income. To say that taxing capital gains is a form of double taxation, as I have heard some argue, is to ignore the idea of a cost basis. This also applies to estate taxes, which are absolutely not death taxes in spite of the rhetoric.

      I am slowly coming to the opinion that corporate taxes could slowly be eliminated, so long as all perks that accrue to shareholders, employees, executives, or anybody else, get taxed as income. Tax use of airplanes, use of leased cars, health insurance, and everything else as income. Because it is income. If the corporation wasn’t paying tax, it would have no deductions, either. The distortions that deducting executive salaries and perks would be reduced with the elimination of that incentive. This is way too simplistic, and it has plenty of flaws. But, it’s an idea that has been floating around my head in various states of focus for a while.

  10. JF

    The huge net wealth of US residents is a symptom of a structural fault in the revenue system of the national govt which holds itself to taxing only current period flow based on income and payroll and other flow-taxes. The Democratic Party should stand, as a first principle, for holding the line on the trend of shifting tax burdens to day to day living, moving toward other types of tax regimes and overall design of the system. Under this principle, the VAT should be opposed at the national level just as state and local sales taxes should not be deductible ever as national should encourage shifts away from these regressive forms affecting day to day living for the bulk of the population. Financial asset trading taxes and increased taxation of financial service firms and banks are examples of shifting incidence/burdens more toward accumulated wealth.

    As for Social Security, it is financed from the current economy but it uses the anachronistic tie to current payroll taxes to raise revenues to pay retirees, and there is no reason why other tax types could not be used to raise additional revenues to cover payment claims, which should increase to reflect the huge success of the economy. Social Security serves as an overlapping generation and current period arbiter, its retiree payments return earnings, human capital investment returns that were not offered in wages in the past and now. Yet looking at the net wealth position of the US, clearly the return of earnings is too low, Social Security should pay more to retirees. The first principle says to avoid raising payroll taxes as a financing design matter, as this burdens current day to day living for current workers, while an increase in the upper bracket income tax rates draws on the success of the huge economy and can easily finance such increases.

    Finally, the bias is the structure of the revenue system, a system now tied to marginal income taxation, a tax regime which can be changed to employ net worth as a pointer toward base and income tax rate ‘schedules’ that reflect the simple and obvious point that ALL of the income for people of wealth is on their margin and should be subject to new base and rates schedules (to raise revenue sufficient to finance the purposes set out in the public’s laws). This modest change would then provide worksheet data of use during compliance audits and help economists and other researchers who can more easily study net worth as part of the economics of a society (rather than ignoring it as the current structure does).

    1. Moses Herzog

      Koalas in the Christmas tree??? Come on man!!!!! Kangaroo meat doesn’t smoke well on the grill, that’s why you’re getting all that dark smoke in the air. donald trump says just use a large SUV and the old fashioned lightbulbs from the 1930s and you’ll be ok after some time.

      BTW, your embassy hasn’t apologized to George Papadopoulos yet. What up wit dat?? Do you have any idea how bad prison food tastes??

  11. joseph

    macroduck: “Not aware of the 1985 change in law. What change was that?”

    Actually, the change in stock buyback law occurred in 1982, and it was really a corporate friendly reinterpretation of existing law by the SEC.

    Under the Securities Acts of 1933 and 1934, stock price manipulation was illegal and stock buybacks were considered on method of price manipulation. So while buybacks were not explicitly prohibited, they exposed corporate managers to lawsuits over price manipulation, so very few companies risked it.

    In 1982 Reagan’s Wall Street friendly SEC head wrote a new rule, 10b-18, that provided a safe harbor for stock buybacks. New rule said that if company managers followed certain precise conditions for their buyback, the SEC would guarantee them a get-out-of-jail-free card which prevented anyone from suing them for stock manipulation.

    This opened the doors to the rampant stock buybacks you see today, going from almost nothing in 1982 to over $800 billion today.

    These buybacks have no economic benefit. They don’t increase the value of a company by a single dime. What they do instead is allow rich stockholders to avoid paying taxes on dividends. They also provide a perverse incentive for company managers. Management is often rewarded by stock options. Stock options do not collected dividends, so if company managers direct earnings toward stock buybacks instead of dividends, they are increasing propping up share prices and thereby the value of their own stock options.

    Really, there is no economic excuse for stock buybacks. They do not create any new wealth. They merely transfer it to insiders while avoiding taxation of income for others. The stock market worked just fine for half a century without buybacks.

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