Democrats's Tax Plan Would Hikes Taxes on Lower Class Too

James Pethokoukis

U.S. Economics, Americas

America is nowhere close to being ready to fund a massive welfare state expansion like the populist left desires. 

Here's What You Need To Remember: With the original Biden tax plan, tax revenue would total 19.3 percent of GDP over the coming decade, according to the Committee for a Responsible Federal Budget. Although that represents a considerable step-up from the long-term average of 17.3 percent of GDP,  America would still look like a low-tax nation compared to Scandinavia, where tax-to-GDP ratios are twice as high.

Inequality has been an overriding theme of Democratic politics over the past decade, from Elizabeth Warren’s “middle-out economics” to Bernie Sanders’ surprisingly strong presidential campaigns to the political rise of Alexandria Ocasio-Cortez.

So where’s this all going, exactly? Is America on its way to becoming a Nordic-style social democracy — or even something further to the left? Well, before speculating, let’s make one assumption: Stuff needs to be paid for, eventually. There is no “money tree,” although some novel new approaches to macroeconomics (taken seriously mostly on EconTwitter) suggest there might be. And if stuff — universal healthcare, generous paid leave and childcare, free tuition, maybe even a universal basic income — does need to be paid for, then the populists of the left have a problem.

And they know it, at least some do. AOC sure seems to know it. Here’s what she recently tweeted about efforts of some Democratic House lawmakers to restore the federal deduction for state and local taxes in legislation now moving through the House:

Bloomberg notes that if the SALT deduction were reinstated as part of the overall House plans to increase tax plan, “the top 1 percent of taxpayers — those earning earning at least $401,601 — would face a tax increase less than half as large as that if the current cap on the write-off were retained, according to data from the right-leaning Tax Foundation.”

And just how is that effort to raise taxes on rich people and companies going, even setting aside the battle of the SALT deduction? As I write in my new The Week column:

Although the plan [approved by the House Ways and Means committee] would increase the top personal income tax rate to 39.6 percent from the current 37 percent and add a 3 percent surtax to incomes over $5 million, it would raise the capital gains tax rate only to 25 percent from 20 percent. Biden would prefer labor and investment income taxed at the same nearly 40 percent rate. Nor does the plan call for the taxation of unrealized capital gains over $1 million at death, which the Biden White House supports. It also would also only limit the preferential tax treatment of “carried interest” — a major source of income for private equity fund managers — rather than eliminate it entirely. “Frankly this is a humiliating climbdown from the administration’s posture,” James Lucier, an analyst at Capital Alpha Partners in Washington, told The Financial Times. “This avoids most of the stuff that Wall Street is worried about.” And one wealth planner tweeted that the changes were “FANTASTIC for the uber-wealthy.”

So after years of Democrats bemoaning out of control inequality, the best they can do is maybe put top tax rates a bit above the levels of the Clinton era — which still might not happen — even as some fight to claw back previous tax hikes on the 1 percent. The phrase “humiliating climbdown” really is appropriate.

And consider this: With the original Biden tax plan, tax revenue would total 19.3 percent of GDP over the coming decade, according to the Committee for a Responsible Federal Budget. Although that represents a considerable step-up from the long-term average of 17.3 percent of GDP,  America would still look like a low-tax nation compared to Scandinavia, where tax-to-GDP ratios are twice as high. In other words, America is nowhere close to being ready to fund a massive welfare state expansion like the populist left desires. 

And while higher inequality in the US may help make the left make the case that the wealthy here could theoretically bear even more of the burden than in Scandinavia, the fiscal math still doesn’t work without the sort of value-added tax those nations have. Finland, Norway, and Sweden all have a 25 percent VAT, with Denmark collecting about 9.4 percent of GDP through the VAT, Norway 8.6 percent, and Sweden 9.2 percent, according to the Tax Foundation. But Democrats keep promising not to raise taxes on the middle class, or families who make less than $400,000 a year.

Of course, many populists keep ignoring this reality, which in itself is a key element of populism. In their classic 1991 paper “The Macroeconomics of Populism,” economists Rudiger Dornbusch and Sebastian Edwards identified how populists rise and what they do when in power. One key ingredient: “[Ignoring] the existence of any type of constraints on macroeconomic policy.” You know, like the need to pay for stuff. Populists love to imagine the existence of miraculous money trees. But the smarter ones don’t, and they understand their dream won’t come close to happening without everyone paying more in taxes.

James Pethokoukis, a columnist and an economic policy analyst, is the Dewitt Wallace Fellow at the American Enterprise Institute, where he writes and edits the AEIdeas blog and hosts a weekly podcast, “Political Economy with James Pethokoukis.” He is also a columnist for The Week and an official contributor to CNBC. This article was first published for Tthe American Enterprise Institute.

Image: Reuters.