Americans in the top 1 percent, and especially the top 0.1 percent, have seen their wealth and income multiply in recent decades as the rest of the country’s share of the economic pie shrank. Since 2000, a recent study found, the top 1 percent have made those gains almost entirely on income from capital, especially corporate stock—not on labor income. One reason may be the financial options of the wealthy: Business owners can lower their tax bills by paying themselves in dividends rather than in salary, for example.
Meanwhile, the U.S. Treasury is expected to run a 2017 deficit of $693 billion, according to the Congressional Budget Office’s latest estimate, some $108 billion more than in the 2016 fiscal year. As baby boomers retire and health-care costs rise over the next few decades, the government’s fiscal situation is expected to worsen.
“We want a tax code built for growth,” Speaker Ryan said. “We want a tax code that raises wages, keeps American companies in America, gives us faster economic growth.”
Trump, Ryan, and other Republicans in Congress are wrangling over a variety of competing goals for reform. The most aspirational is a tectonic simplification of the tax code that really would allow everyone to file using a postcard. But more realistic legislative targets are lowering tax rates on individuals and corporations as well as eliminating the estate tax and alternative minimum tax. They may also try again to kill the Affordable Care Act taxes—including those on all that investment income raked in by the wealthy.
By taxing investors less, some economists argue, you give taxpayers more of an incentive to save. The more savings in the economy, the more capital that companies and entrepreneurs can invest in ways that expand the economy and make workers more productive. Everyone, including workers, wins, according to this theory.
But there are potential negative consequences to such a policy. By lowering taxes on investors, you shift more of the tax burden to well-paid workers. This may give highly skilled and creative people a disincentive to work hard or improve their skills so they can earn more money, while also giving children of wealthy parents another reason not to work at all.
And why do people need a special tax break to motivate them to save? Aren’t there already powerful incentives to be thrifty? Invested well, money can compound and multiply over time in extraordinary ways. Wealth also provides security, status, and power—including the means to make campaign donations to politicians.
Economists have answers to some of these questions, if you trust their theoretical models. An often-cited 1999 Federal Reserve study used dozens of algebraic equations to divine the ideally efficient tax system. It concluded that the optimal tax rate on investment income is “zero.” That’s contradicted, however, by another theoretical model, published in the American Economic Review in 2009, that found the best rate is more like 36 percent.
Nevertheless, given economic theory’s recent track record, it may be better to stick to real-world data.
There’s evidence, for example, that investors feel influenced by taxes far more than workers do. If you worry about tax incentives distorting the economy, taxes on workers should worry you less: People tend to keep going to work everyday no matter what. Most economists agree that men in the prime of their careers “are not particularly responsive to the tax rate,” said University of Michigan economics professor Joel Slemrod. Similarly situated women are only “responsive at the margins.”