The Welfare Kings

May 10, 2006

Dean Baker, May 10, 2006

At a time when tens of millions of workers are struggling to pay for gas for their car, electricity for their home, and medical care for their families, the Republicans have stepped forward with a plan to help. They want to give another $20 to $30 billion in tax cuts to the rich.

This temporary assistance to the needy rich (TANR) takes the form of a 2-year extension of a tax cut that made the maximum tax rate on stock dividends and capital gain income 15 percent. While tens of millions of ordinary workers pay income tax rates of 25 percent on their wages, the Republicans argue that Bill Gates and his billionaire friends shouldn’t have to pay taxes at more than a 15 percent rate. Most of this tax break goes to the richest 1 percent of the population. This is because they hold most of the country’s stock—and even when middle income people hold stock, it is usually in retirement accounts, which are not affected by this tax cut.

The Republicans don’t argue that rich people should pay lower tax rates just because they are rich. Republicans—and many Democrats—argue that rich people should pay lower tax rates because they get their income from owning stock instead of working for a living. They argue that taxing income from stock is morally wrong because it is “double taxation.” They also argue that it is bad for the economy. Neither claim makes much sense.

The argument that taxing capital gains and dividends is double taxation is that profits are taxed once when a corporation declares its profit, then again when the profits are paid out to individuals. The story doesn’t quite work, because the corporation is not the individuals who own it, it is a separate legal entity—a principle that conservatives hold to be very important in other contexts.

The importance of a corporation as a distinct legal entity in this context is that the government grants corporations all sorts of special privileges, most importantly the privilege of limited liability. Limited liability means that shareholders are not personally responsible for the damage done by the corporations whose stock they hold. The privileges that the governments grant corporations are extremely valuable. We know this because people voluntarily form corporations. They could organize businesses as partnerships, which are not subject to the corporate income tax.

Instead, the vast majority of large businesses in the country are organized as corporations, indicating that business owners believe the benefits of corporate status exceed the cost of paying the corporate income tax. In this sense, the corporate income tax is entirely a voluntary tax. It is understandable that shareholders would like to get the privilege of corporate status without paying for it, just like most of us would rather not pay for our gas or mortgage, but in the real world you have to pay for the things you get. “Double taxation” is a nice rhetorical twist—like calling the estate tax the “death tax”—but serious people need not take it seriously.

The other argument for TANR is that it is good for the economy. TANR supporters argue that if we lower taxes on capital gains and dividends, then people will have more incentive to save. This will provide more money for corporations to invest—thereby leading to more growth.

Evaluating this argument requires a little orientation. First, any tax has some disincentive effects, whether it is on dividends, capital gains or wages. Lower tax rates on Bill Gates and friends means higher taxes on the rest of us. If we didn’t have TANR, we could cut the average tax bill by about $100 per person—for people who work for a living. This would not provide huge incentives, but a very small incentive for 150 million workers could have more impact than an incentive that is likely perceived as being very small by 1 million rich people.

Of course, we may also need the money for reducing the deficit or various forms of government spending, like financing education and health care. As a practical matter, TANR is only about 0.5 percent of the budget, but it is approximately the same size as the annual appropriation for Temporary Assistance for Needy Families (TANF), the government’s main cash welfare program.

Ultimately, TANR supporters rest their case on the recent strong growth of the economy. While the economy is now growing and creating jobs at a healthy pace, this follows a long jobs drought. The total number of hours worked in the economy still has not even climbed back to its 2000 peaks—an unprecedented slump. But we should be happy that the economy is now growing at a good pace.

Did this have anything to do with the tax cuts? Remember, the argument is that lower taxes on dividends and capital gains encourage savings, which then leads to more investment and more growth. Well, the savings rate was negative in 2005 for the first time since the Great Depression. It doesn’t look like the tax cuts are working. The White Sox victory in the World Series probably contributed more to economic growth than these tax cuts.

The basic story here is a simple one. This is not a battle over economics; it is a battle over differing conceptions of government. TANR supporters ascribe to the “conservative nanny state” view of government: that the government exists to redistribute as much income as possible to those at the top. The conservative nanny state approach to tax policy is that rich people should not have to pay taxes.

The rest of us think that the government has responsibilities to the public as a whole, not just the rich. We think that rich people should have to pay taxes live everyone else. In other words, it’s time to end TANR as we know it.

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

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