Having the $1.9 trillion American Rescue Plan Act (ARPA) behind him, President Biden appears to be moving ahead with his campaign promise to increase taxes. The new taxes will be sold as “having the rich pay their fair share,” but the ultimate result will be a less productive economy with lower wages and incomes for all.
Candidate Biden’s several proposals to change taxes fell into three categories: payroll taxes, taxation of personal capital income and business taxes.
The payroll tax in America finances the Social Security system and Medicare benefits. The tax is levied half on employees and half on employers, at a rate of 6.2 percent for Social Security and 1.45 percent for Medicare. The Social Security payroll tax is paid on annual wages and salaries of up to $142,800, with no exemptions, deductions or credits. Candidate Biden proposed to levy the 6.2 percent on both employer and employee for annual wages and salaries above $400,000.
The personal income tax, which is separate from payroll taxes, goes toward general revenue. It includes a range of deductions and credits. Candidate Biden proposed to increase the top statutory rate from 37 percent to 39.6 percent, to tax dividends and capital gains as ordinary income, to increase capital gains taxes at death and to limit deductions for high-income filers.
Aside from personal income, business income is also taxed. As of 2018, the corporate rate is 21 percent of income after various deductions. Biden proposed to increase the rate to 28 percent and to limit deductions. If he follows his campaign promises, he would also increase rates on noncorporate businesses, which employ almost half of the nation’s workforce, especially due to the payroll and personal-income tax hikes already cited.
In an earlier collaboration with Texas Tech University’s Timothy Fitzgerald, the Hoover Institution’s Kevin Hassett and University of Wisconsin’s Cody Kallen, I used a tax calculator to estimate the combined effect of the complicated tax provisions on business profitability and their incentives to hire workers. On average, under the presumed Biden plan, business tax rates would be 12.5 percentage points higher than they are today, thereby reducing profitability by 16.5 percent in the short run. As such, we would have the largest ever one-time increase in business taxation. (This and what follows does not count the work-disincentive effects or the penalties on states that cut their taxes, which are part of the $1.9 trillion ARPA that Biden signed last week.)
Any empirically grounded estimate of the effects of business taxes must confront the fact that national average after-tax returns on real capital have been fairly constant over long periods of time and across a broad cross-section of countries despite large differences in rates of capital taxation. This is strong evidence that, in the long run, the owners of capital have close substitutes to investment in the businesses of a specific country. Faced with a high tax rate on their capital income, eventually they reduce investment in that jurisdiction until pre-tax profits are high enough to compensate for the high tax rate.
Even the same amount of capital investment would contribute less to economic activity because the Biden administration’s expected proposal of higher business rates would further the competitive disadvantage that businesses have with housing and other real estate investment. In effect, workers and consumers eventually pay for capital-income taxes rather than the capital owners who are legally liable for the tax.
The ultimate effect of Biden’s campaign-promised tax increases would be real wages and real incomes that are 3 percent to 4 percent lower across the board compared to the incomes we would have by keeping today’s tax rates. Does that sound like a “fair share” to you?
Casey B. Mulligan, a professor of economics at the University of Chicago, served as chief economist of the White House Council of Economic Advisers from 2018 to 2019. His new book, “You’re Hired! Untold Successes and Failures of a Populist President,” provides the inside story of how President TrumpDonald TrumpMan sentenced to nearly four years for running scam Trump, Biden PACs Meadows says Trump's blood oxygen level was dangerously low when he had COVID-19 Trump endorses David Perdue in Georgia's governor race MORE engaged with policies and politics.