Against Regressive Taxation

By  Fadhel Kaboub

I was recently asked to testify before the Ohio House of Representative’s Tax Reform Legislative Study Committee. I urged the committee to carefully consider the long-term negative consequences of the regressive tax policy for the State of Ohio and its residents. What follows is the gist of my testimony along with some of the data that I presented to the committee.

Working class families continue to suffer from real income growth stagnation since the 1980s despite a steady rise in productivity (Figure 1). However, in order to continue supporting the growth of the U.S. economy, household consumption (the engine of GDP growth in the U.S.) became increasingly dependent on access to credit (credit card debt, student loans, car loans, home equity lines of credit, subprime loans, reverse mortgage loans, etc.). That is why household debt as a percent of disposable income has peaked at almost 140% in 2007 (Figure 2). The proper response to this problem is an increase in disposable income rather than easier access to credit.

Figure 1: U.S. productivity and hourly compensation (Source: Bureau of Labor Statistics.)

Figure 2: U.S. household debt as a percent of disposable income (Source: Federal Reserve Bank.)

 

Economic growth is primarily driven by consumer demand (over 70% of GDP); therefore, relying on household debt to fuel consumption is unsustainable. In the absence of a federally funded Job Guarantee program, state-level progressive tax policy can intervene to lighten the burden on the middle class and on the most economically vulnerable members of society.

The least economically privileged families in Ohio are contributing a larger share of their income (11.6%) to State and Local taxes than the top 1% income earners who only pay 6.3% (Figure 3). These numbers include the federal deduction offset. 

Figure 3: Ohio State and local taxes as a share of personal income (Source: Institute on Taxation and Economic Policy (January 2013).)

More specifically, if we breakdown the overall State and Local tax structure, we find that this regressive tax burden is prevalent in the cases of Sales and Excise tax as well as Property tax (Figures 4 and 5). The only progressive component is the State and Local personal income tax (Figure 6).

Figure 4: Sales & excise sax share of family income in Ohio (Source: Institute on Taxation and Economic Policy (January 2013))

Figure 5: Property tax share of family income in Ohio (Source: Institute on Taxation and Economic Policy (January 2013).)

Figure 6: Personal income tax (State & Local) share of family income in Ohio (Source: Institute on Taxation and Economic Policy (January 2013).)

I urged the State legislators to preserve Ohio’s Earned Income Tax Credit policy, and also to enhance its effectiveness by making income tax credits refundable for families earning less than $30,000 a year (the current income tax credits are nonrefundable for families earning less than $10,000).

Recent tax cuts in Ohio have been excessively more generous to the rich than to the poor (Figure 7). This is not simply bad social policy, but most importantly a very misguided economic policy.

Figure 7: Tax cut as a share of income in Ohio (Source: Institute on Taxation and Economic Policy (January 2013).)

Businesses will not create new jobs simply because they receive a tax break. They will only hire new employees when sales and revenues increase. In other words, new jobs are created when demand for goods and services increases. This is especially true during periods of sluggish economic growth. No businessperson will tell you that he or she is going to hire more workers to produce more stuff that nobody is going to buy. No business will want to accumulate unsold inventory just because there is a tax incentive.

Tax cuts not only fail to create jobs, but they are also likely to undermine the long-term fundamental basis for economic growth. The decline in tax revenues has meant spending cuts in the most important investment areas of the State’s economy: education, health, public infrastructure, transportation, etc.

For the sake of economic prosperity and the wellbeing of all Ohioans, I urged the committee to reverse the regressive nature of the tax structure and to empower the State of Ohio to invest in education, vocational training, public health, public infrastructure, public transportation, and sustainable energy policies. These are the most important assets that will create jobs and bring business to Ohio in the long-term.

Unfortunately, Ohio is not unique in terms of its regressive tax policy. The study that I cite here shows that this is essentially the norm across all 50 states. This ought to be a wake-up call to all the grassroots activists to double our efforts to address one of the root causes of economic inequality in the United States.

 

* Dr. Fadhel Kaboub is an Assistant Professor of Economics at Denison University (OH) and a Research Associate at the Levy Economics Institute (NY) and the Center for Full Employment and Price Stability (MO). His research focuses on job creation programs, monetary theory and policy, and the political economy of the Middle East. For more on his work, visit www.kaboub.com

12 Responses to Against Regressive Taxation

  1. The wealthy should have a choice. Sit on your butt and clip coupons and get taxed progressively or avoid taxation by investing productively, creating jobs. There should be a penalty tax on foreign investment. Stop the Bermuda loopholes.

  2. Ronald E Santoni

    Thanks so much , Fadhel. A good, strong, testimony, indeed. Nothing in it surprises me: it simply reinforces
    what I believe but with more persuasive supportive stats. I’m proud to have you as as a colleague. You have a heart as well as a sharp mind. Keep up your good work .

    Warmly and respectfully, and PEACE!

    Ron

  3. Marianne Stanley

    Those graphics make often obscure content painfully visible and understandable, even for those of us unversed in economics. Thank you SO MUCH, Fadhel, for working so hard to get your very wise, intelligent and practical information “out there” for the legislators, us, and anyone who will listen! Every time I see something else you have done, from workshops to published articles, I am always relieved just knowing you are on top of things, knowledgeable and trying your best to reveal the wrongheadedness of today’s economic decisions and policies. At least you are not fiddling as Rome burns…….you’re filling those buckets as fast as you can!!!……..and I (and many others, I’m sure!) appreciate it, and YOU, more than you know!!

  4. This is certainly an excellent presentation Fadhel, but its underlying message that “household consumption is the engine of GDP growth that has increasingly become dependent on access to credit as supplied by the banking sector” is exactly the same as C H Douglas’s message back in the 1920’s. His books, “The Monopoly of Credit” and “Economic Democracy” dealt with the issue of the way purchasing power is distributed to ensure continual reliance on the banking industry for “permission to live”.
    What a different world we may have inherited had Douglas been taken seriously back them.

  5. What I cannot figure out is why economists have never made a stronger case for progressive taxation and the graduated income tax. The US became the world’s dominant economy led by a vast array of strong creative corporate enterprises during the period from 1917 through the 1970s when the Us had an income tax system that was, by today’s standards, was confiscatory at upper income levels. I believe the case can be made that the progressive income tax was a highly successful solution to the agency problem: that the tax system fostered corporate governance that greatly discouraged corporate executives from using their governance position primarily as means of building their personal fortune, that with today’s historically low marginal tax rate every corporate executive has an incentive, in what ever way possible, to transfer as much corporate resources as he or she can into their own personal account and then to invest that money in private equity funds that engage in the same practice of transferring corporate assets in to private holdings.

    Under the highly progressive graduated income tax along with the lower LONG TERM capital gains tax executives had the incentive to build strong viable institutions. At the same time corporate governance could be relaxed enabling executives a great deal creative freedom to act because the incentive to put personal gain ahead of corporate gain was greatly reduced.

    This is not an argument about “unjust” allocation of social resources, or even one in favor of the so called “greed tax”. Rather it is an argument based on aligning incentives with institutional objectives and the efficiency of investments. The highly progressive graduated income tax was a remarkably simple solution to the classic agency problem that strengthened US economic institutions. Without it the incentives of corporate executives in finance and commercial enterprise are continuously compromised.

  6. What is your theory on why hourly wages and productivity began to diverge so strongly in the early 1970s? In your view is there or should there be a difference between labor productivity meaning manual labor versus machine productivity like automation, the internet, robots. Could that account for the divergence in the 1970s meaning there was more “machine” productivity versus manual labor productivity?

    • Vincent Huang

      I believe your proposed scenario is theoretically possible. Since “machines” (capitals) are owned by the capitalists, then a larger proportion of capital used in production could mean a larger profit share of the total production. However, I think reality is unfortunately more cruel than that. The divergence more likely resulted from the fact that with the accompanied credit extension, real hourly wages have been leveraged so that workers reached a socially established subsistence level of living. That is, the lag of real wage is “offset” by household going more into debt. If we look at the first two charts Kaboub presents, it is certainly true that as soon as real wages started to stay flat, household indebtedness goes up.

      One thing we have to be careful is that correlation does not imply causation. I think that credit extension may not be the cause of stagnant real wage. Rather, credit extension may be a reaction to it. The stagnant real wage might have to do with power struggle between workers and capitalists. Perhaps looking into the history of labor union?

  7. I agree with your overall assessment (greater income vs. greater credit). Also, in reality, the local income tax (a bane of those of us who live in NE Ohio) acts as a regressive tax on the poor and the working middle class. I see this daily in the winter months in my tax practice. It is not unusual for middle-income working households (say, $35,000 to $60,000) to pay anywhere from 2.5 to 3.75 percent of their gross incomes (that’s a lot–remember that state income tax starts with a federal adjusted gross income calculation) for local income tax. The worst combination that I see is for residents of Warrensville Heights who work in Cleveland. Cleveland taxes payroll at 2.0 percent. Warrensville Hts. taxes residents at 2.75 percent (I think Maple Heights, next door, taxes residents at 2.6 percent), but most of these localities do not give full credit on residential income tax for work city income tax. A few, at lower nominal rates, give no credit at all. The fatal Warrensville Heights combination works out to a combined tax of 3.75 percent, which for most residents of that city exceeds what they would expect to pay in state income tax (you have to earn a lot of money in Ohio to owe state tax at an effective rate of 3.5 percent, or even 3.0 percent). That is an absurd result, which, combined with conflicting tax jurisdictions (RITA, CCA, self-operated or generic, etc.), causes an enormous compliance burden that compounds the effects of the drain on income. And it definitely is regressive. I regularly encounter Warrensville Heights or Maple Heights residents who owe $1,000 for local income tax even though they were properly withheld at work. Such a tax can only drive out (or drive to despair) the types of residents that those cities should want to keep.

    I doubt that any of these situations was contemplated when the first state income tax was adopted about 40 years ago (city income tax started to spread about ten years later). As a reform, I would support having the state take over the city income tax collection system, preferably to abolish it. To reimburse the cities, the state could raise the sales tax (no more regressive than the local income tax) by 0.5 or even 1.0 percent. At the very least, the state should require the cities to grant full credit for work city tax on residential income tax returns. In my Warrensville Hts. example, that simple reform alone would reduce the effective tax rate to 2.75 percent of gross income.

    The Governor knows, and the State House should know, that the local income tax is a big deal discouraging the location of enterprises within the cities and spreading industrial development out into the townships (and with it, urban sprawl). One of Governor Kasich’s first crises was the threat of American Greetings to leave Brooklyn (a suburb of Cleveland) for Indiana when Brooklyn raised the local income tax by 0.5 percent. He persuaded them to stay in Ohio (they plan a move to the western suburb of Avon) by offering some partial offsets through state tax credits. I think the local income tax, as it is, is a show-stopper for industrial development in the cities of NE Ohio.

    The state income tax structure right now is reasonably good for businesses and probably now ranks in or near the top five for industrial states. It is not anywhere near the discouragement to good jobs in Ohio that the local income tax is.

    You probably recall that Voltaire’s watchword on the subject of the oppressions of church and state for intellectual inquiry in 18th-century France was “Ecrasez l’infame!” We need to make that our watchword regarding the local income tax.

  8. The government-backed counterfeiting credit cartel, the banking system, is highly regressive since the rich are more so-called creditworthy* than the poor.

    *No one is worthy of stolen purchasing power.

  9. Timing of reduced share of productivity going to workers coincides with largest reduction in high Marginal Tax Rate (MTR). Let’s prove causation, not just corelation.

    Would any CEO, CFO of Enron, World Bank, TBTF banks risk fraud charges if their income was limited by high MTR?
    Would limit on their income prevent seizing parts of IPO proceeds for management salaries and bonuses instead of using those proceeds for investment purposes?
    Would high MTR keep additional resources inside corporate budget enabling easier spread of productivity gains giving more equal distribution over all employees?
    Would healthier corporate budget, due to high MTR, prevent some corporate bankrupcies that came with business cycle?
    Would there be margin calls for debt levereged with stock in corporate ownership calling for more collateral when stock price falls?
    Would workers have to resort to higher debt in order to keep with standard growth expected and planned?

    The most important question; Would high savings of few, that low MTR allowed, push interest rates ever lower and public deficit higher in order to keep employment up? (this is how we came to such low interest rates and low inflation by FED using Taylor Rule and Philips curve)
    These high savings forced and allowed for easier credit terms but in the end there was no wage push inflation to ease debt burden.

    This is only a regurtitation of what Robert Avila wrote about but i tried to push about for last 4 years.