Thursday, April 16, 2009

The Need to Tax the Wealthy

The Need to Tax the Wealthy


By Dean Baker


April 16, 2009, The Economist


The quest to increase taxes on the wealthy is not a

gratuitous attack on upper income households; it is driven by

the need to raise more revenue to run the government. While

many deficit hawks been irresponsible in raising fears of an

impending collapse of the American government, the projected

deficits for years following the recovery are in fact larger

than is desirable.


There are areas of American spending at the federal

government level that could be reasonably cut, but even after

we have zeroed out the "waste, fraud, and abuse" category of

federal spending we will still likely need additional revenue

of between 1-2%t of GDP to keep budget deficits in an

acceptable range. That leaves a choice between increasing

taxes on the wealthy or imposing more taxes on the middle class.


The vast majority of the income gains in the United States

over the last three decades have gone to the richest 5% of

the population, largely as a result of policies that were

explicitly designed to redistribute income upwards. Therefore

it is far more appropriate to tax the richest 5%t of families

who have prospered than the broad middle class who have suffered.


Of course taxes can be designed in a better or worse manner.

The best way to increase taxes on the wealthy, in addition to

allowing the Bush tax cuts to expire, would be to apply a

modest financial transactions tax (FTT).


There is a long history in both the United States and the

rest of the world with FTT. Until 1964, the United States

imposed a tax of 0.12% on new stock issues and 0.04% on stock

trades. Britain still has a tax of 0.25% on each stock sale

or purchase, raising five billion pounds a year. This would

be equivalent to roughly $30 billion a year in the American economy.


Robert Pollin and I calculated that a scaled set of FTT on

stock, futures, options and other financial instruments could

raise approximately $150 billion a year. This would go far

towards bringing the long-term budget deficit down to a manageable level.


A FTT would be hugely progressive. While many middle income

families own stock, their holdings are dwarfed by the

holdings of the wealthy. Furthermore, few middle income

families are active traders. Their intention is to hold their

stock to support their retirement or their kids' education,

not to shuffle it around on a daily or hourly basis. Some

mutual funds do engage in frequent trading. An FTT would

encourage investors to move their money to funds that are

less active traders, thereby allowing them to escape most of

the impact of the FTT.


Most of the burden of the FTT will fall on wealthy

individuals who are active traders and also on the financial

industry itself. Either way, the tax will be overwhelmingly

borne by the wealthy. By raising the cost of trading, the tax

will discourage the trading that provides the revenue for the

financial industry. A well-designed tax should also

discourage the creation of exotic assets that may serve

little useful purpose, since it could lead to the tax being

paid multiple times. For example, the holder of an option on

a stock would both pay the tax on the purchase and sale of

the option and also on the purchase and sale of the stock

itself, if the option was ever exercised.


While most taxes impose some economic cost in addition to the

revenue raised, a FTT may actually increase economic

efficiency. By discouraging financial transactions that are

entirely rent-seeking in nature, a FTT will reduce the

resources used up by the financial sector, without affecting

at all its ability to serve the productive economy. The

reduction in trading volume will of course reduce liquidity

to some extent, but American financial markets will still be

quite liquid. Even with a 0.25% tax on a stock sale or

purchase, transaction costs will still only be raised back to

their mid-80s levels. And, the United States had a large and

very liquid stock market in the 80s.


There also is a powerful element of justice in imposing a FTT

in the current situation. The main reason that the budget

situation has deteriorated so much in the last two years has

been the damage caused by the irresponsibility and greed of

the financial industry. In this way, a FTT can be seen as

sort of a user tax, where the industry is effectively forced

to pay for some of the damage caused by its practices, just

as we might like to tax the output of industries that pollute

our air or water.


In short, there is a very good argument for increasing taxes

on the wealthy given the current budget situation. The

alternative is taxing those who are not wealthy. And, there

is no better way to tax the wealthy than to tax their

gambling in financial markets. A financial transactions tax

will raise revenue at the same time that it makes the economy

more productive. This is a genuine win-win situation.


© 2009 The Economist


Dean Baker is the co-director of the Center for Economic and

Policy Research (CEPR). He is the author of The Conservative

Nanny State: How the Wealthy Use the Government to Stay Rich

and Get Richer ( and the more

recently published Plunder and Blunder: The Rise and Fall of

The Bubble Economy. He also has a blog, "Beat the Press,"

where he discusses the media's coverage of economic issues.

You can find it at the American Prospect's web site.


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