Back to Low Growth The impact of Joe Biden’s tax plan would be less income across the spectrum and a sluggish economy. Noah Williams

https://www.city-journal.org/joe-biden-tax-hike-plan

As the U.S. struggles to emerge from the Covid-19-induced recession, Joe Biden is running for president on a pledge to return the country to economic policies responsible for the slowest economic recovery since World War II. Biden’s plans include “reversing some of Trump’s tax cuts for corporations and imposing common-sense tax reforms that finally make sure the wealthiest Americans pay their fair share.” This means a big increase in effective tax rates on capital and on individuals with incomes above $400,000, as well as partially reversing the corporate tax cut that was a centerpiece of the 2017 Tax Cuts and Jobs Act (TCJA).

But Biden’s tax increases go far beyond simply undoing some of the TCJA, the net result of which was a $1.5 trillion tax cut. Biden would hike taxes by roughly $4 trillion, divided about equally between individuals and firms. This move would likely produce a reversal of outcomes: while the TCJA has added to GDP growth by 0.5 percentage points to 1 percentage point since 2018, the Biden tax plan would probably reduce growth by at least that much.

In fact, the effects of Biden’s proposed tax increases may be even larger—and affect a much broader share of the population—than previous evaluations suggest, owing to their “tax incidence” consequences. Tax incidence refers to who bears the burden of a tax, which may be different from whom the tax is imposed on. For example, taxes levied on producers can be passed on to consumers through higher prices.

The Biden plan’s significant increase in taxes on high incomes would also fall on businesses, leading to lower wages for workers, less investment, and lower growth. Analyses by the Tax Foundation and the Tax Policy Center both found that lower-income households would also face a higher tax burden because part of the corporate tax increase would be passed on to workers through lower wages. Though the corporate tax is levied on businesses, it is generally accepted that it falls on shareholders, capital owners, and workers, to varying degrees.

For high-income earners, the Biden plan would substantially raise effective tax rates. Biden would increase the top marginal tax rate to 39.4 percent, limit deductions to 28 percent of income, roughly double the capital gains tax to 39.4 percent, phase out business income deductions, and subject earnings above $400,000 to the 12.4 percent payroll tax. Statutorily, the payroll tax is divided between workers and employers, but the incidence falls on workers. The Tax Policy Center and Tax Foundation have found that, in total, these changes would lead to a 13 percent reduction in after-tax income for the top 1 percent of the income distribution.

The effects of this tax hike on top incomes would go far beyond making the rich “pay their fair share.” One reason: the income makeup of top earners differs from most taxpayers, whose prime source of income comes from their labor. Recent studies find that most of today’s top income earning derives from private business income, which passes through to owners and gets taxed according to federal individual income-tax schedules. As much as 95 percent of all businesses in the U.S. are such pass-through businesses, and they account for more than 55 percent of all business income (since most pass-throughs are small). In 2017, for taxpayers earning less than $500,000, wages and salaries accounted for 75 percent of total income, and business income for only 4 percent. But for taxpayers making more than $500,000, salaries accounted for 37 percent of income and business income 26 percent. At the very highest end of the income distribution, business income is even more concentrated. In 2014, over 69 percent of the top 1 percent and over 84 percent of the top 0.1 percent earned pass-through business income.

Increasing taxes on “the rich” thus means increasing effective taxes on pass-through businesses, which would lower their demand for both labor and capital. Just as part of the corporate tax gets shifted onto workers, an increase in taxes on top incomes would lead to a reduction in wages paid by pass-throughs. In a recent empirical study of a boost in top marginal tax rates, economist Max Risch found that approximately 15 cents to 18 cents per dollar of new tax liability affected pass-through employees through lower earnings. In addition, the higher levy on pass-through business capital would lead to lower investment, capital accumulation, and growth.

Lowering the returns to owning a business may also discourage future entrepreneurship—reducing future incomes and thus limiting the amount of revenue that could be raised by taxing top earners. In fact, a recent quantitative study by economist Zhigang Ge finds that the current top income-tax rate is very close to maximizing revenue. The sharp rise in top income tax rates in the Biden plan would not only lower wages and growth but may also be counterproductive in raising tax revenue.

In sum, the Biden plan’s tax hikes on businesses and high-income earners would be partly shifted onto workers and would put the brakes on economic growth. In the long run, the lower growth rate would lead to lower incomes across the income distribution. This simply reflects the interconnected nature of the economy. Corporations, pass-through businesses, and entrepreneurs don’t exist in a vacuum. Policies that reduce their incomes degrade business formation and capital accumulation and hurt the workers whom they employ. A tax plan that results in slower growth and lower wages is the wrong prescription for an ailing economy.

Photo by Win McNamee/Getty Images

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