Our Lost $18.4 Trillion And The Lessons For Tax Reform

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“The government is promoting bad behavior.”

These were Rick Santelli’s words on the floor of the Chicago Mercantile Exchange in the opening moments of a rant that would launch the Tea Party movement. Santelli then turned to his audience of commodity traders and railed against public policies that promoted over-leveraging and led to the 2008 financial collapse, for which the public was forced to pick up the estimated $12.8 trillion tab. Add in the $5.6 trillion cost of U.S. wars over the past decade and a half and you have a tidy sum exceeding $18.4 trillion. An amount equivalent to a full year of the U.S. GDP down the drain. Then there are the lives lost, the bodies mangled, the personal bankruptcies, the family futures destroyed, and the dreams that died in the face of lost opportunities and pervasive cynicism. And, of course, the deep damage to our national psyche, the comity of our politics, and public faith in our institutions.

These things are not Donald Trump’s fault. The wars and the financial crisis are the context of our disorder, and to take our eyes off them and focus instead on Trumpism and Resistance is to miss the point and fail to seize the moment. The promise of massive federal income tax cuts for the middle class is a palliative for the real suffering that working families have borne. And, as has become evident, those tax cuts are an illusion. Instead, Trump’s promise of massive tax cuts to his loyal and trusting supporters has become the stalking horse for massive tax cuts for the wealthiest Americans.

In its desperation to pass some form of tax legislation, the normally deliberative process has given way to cutting individual and corporate rates, and then looking for ways to offset the cost by eliminating deductions. Gone is any notion of tax reform as a process for thinking through what we tax, and why. If real tax reform were under consideration―rather than simply tax cuts to the donor class―there are steps that could be taken that would make America a better and safer place for the working class and middle class families that live paycheck to paycheck and send their children off to fight our wars. These are reforms that reflect, if nothing else, the lessons learned from the $18.4 trillion price tag of the past decade and a half of our misfortune.

First, tax reform should end subsidies for and incentives to over-leveraging at the corporate and household level.

As has been well documented, the 2008 economic collapse followed a period of massive over-leveraging--the taking on of excessive debt--at the corporate and household levels. At the corporate level, debt has been used for decades as a tool for increasing economic value, by companies, private equity funds and others. This over-leveraging in the corporate sector increases financial returns to corporations and stockholders during good times, but increases risk and vulnerability to all of us who end up paying the price when the house of cards collapses, as we learned in 2008. Corporate over-leveraging does not occur by happenstance, however. Rather, it is a specific response to incentives in the tax code, which makes debt far more attractive for funding new investments than raising equity. Simply stated, interest paid on debt is deductible from income on a pre-tax basis--which means that the federal government provides a subsidy to any company that raises funds through borrowing--while dividends are paid on an after tax basis.

At the household level, the inducements to borrowing are similarly grounded in the tax-deductibility of mortgage payments vs. the payment of rent from after tax dollars, and the stimulation of consumer credit through home equity loans. Home ownership has long been touted as the cornerstone of national social policy, but in the years since the 2008 financial collapse years, the disadvantages of home ownership have become apparent. In a world where no job is forever, labor mobility--the ability to pack up and move--has increasingly become critical to families seeking economic opportunity. As housing values collapsed in the wake of the financial crisis, families in many communities found themselves immobilized by having whatever wealth they thought they had saved over the years bound up in homes that they could not sell.

Second, a tax on imported petroleum products should fund a portion of our military expenditures.

Since the creation of CENTCOM in the 1970s, the U.S. has affirmed its policy priority of protecting access to Middle East oil for the advanced industrial world. While we have become a petroleum exporting nation in recent years, the domestic price of oil continues to be set by international market forces. Therefore, even if we are energy independent with respect to access to oil, we remain dependent on world events with respect to oil prices. If a continuing U.S. military presence in the Middle East and other energy producing regions of the world is part of the price of assuring stability in global energy markets, then it would be appropriate for some portion of our $600 billion defense budget to be internalized into the price of petroleum products. Failing to do so has the dual impact of encouraging spending on oil by allowing consumers to pay only a portion of the true cost of delivering gasoline to the pump on a reliable basis, as well as undercutting the development of alternative energy sources by keeping petroleum prices artificially low.

Third, tax reform should reverse incentives to the financialization of the U.S. economy, including the brain drain from productive sectors to the financial services sector.

Over the past half century, the financial services sector of the economy has grown as a share of national income. In the wake of Clinton-era deregulation of the financial services sector, this growth exploded, with the development of an endless array of new financial products and loosely regulated hedge funds. Along the way, the carried interest exemption in the federal tax code--which allows many in the financial serviced industry to pay the far lower capital gains tax rate on their ordinary income--attracted many of the brightest minds into finance. This combination of deregulation and tax code incentives has magnified financial returns within the financial sector, even as it has increased the financial risk exposure to the economy, and undermined innovation and invention in other, more productive areas.

Donald Trump promised massive tax cuts for his disaffected working class voters and to end the carried interest exemption that buttresses the fortunes of hedge fund billionaires, but now that a tax bill is actually under consideration, those promises have fallen by the wayside. Treasury Secretary Steve Mnuchin continues to complain that it is hard to not cut taxes for the wealthy in any tax cut plan for the simple reason that they pay most of the taxes. But, in fact, it is not difficult at all. If you don't want to cut taxes for the wealthy, all you have to do is not cut taxes for the wealthy.

As Rick Santelli pointed out, the government supports bad behavior. Donald Trump won the presidency in large measure because of anger over some of that bad behavior, and the price that working families bore--and continue to bear--for the past decades of war and economic dislocation. Tax reform can't change the past, but if we learn from that past, it can be part of creating a better future. Reduce the risks to the economy by reducing the incentives to over-leveraging that are built into our tax code. Reduce the risks of war revolving around global oil dependence by internalizing the cost of defending energy supply lines into the price of oil, and allow the markets for energy alternatives to benefit along the way. And stop the special treatment of the finance sector that serves no one's interests except for a very small, very privileged few. These are tax reforms that would benefit working families, and the rest of us as well.

Follow David Paul on Twitter @dpaul. He is working on a book, with a working title of "FedExit: Why Federalism is Not Just For Racists Anymore."

Artwork by Jay Duret. Check out his political cartooning at www.jayduret.com. Follow him on Twitter @jayduret or Instagram at @joefaces.

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