Rationale for Obama’s Tax Policy

On the campaign trail, Barack Obama was asked a question about his increasing taxes for those making more than a quarter million a year. In his impromptu exchange with the now famous “Joe the Plumber,” Obama used the phrase: “when you spread the wealth around, it’s good for everybody.” It was a lengthy exchange in which Obama tried to explain his rationale for raising taxes for higher income Americans and providing tax relief for middle class Americans. The exchange included a detailed discussion of the flat tax, a value added tax, a number of tax-related issues, and the importance of small businesses for America; but it is this one short phrase “spread the wealth around” that has been seized upon by Obama’s opponents.

John McCain made hay with it in the third and final Presidential candidates’ debate and since then, his running mate has taken to referring to the Democratic Presidential candidate as “Barack Obama the wealth spreader.”

Barack Obama himself has not repeated that phrase. Indeed, “wealth spreading” is not the best rationale for this tax policy. It is entirely appropriate to have a progressive system of taxation, where the rich pay higher tax rates than the less rich or the poor. One rationale for this is the benefit principle of taxation According to the benefit principle, those members of society who benefit the most from the systems of society — the system of law and order, rules of commerce and business, the educational system, and the public infrastructure — should pay the most.

In recent times, even though there is a slight progressivity in marginal tax rates, average taxes actually paid by people are roughly quite flat. It is as if there is a flat tax. The loopholes and myriad allowed deductions in the tax code result in a great extent of tax avoidance; and, in addition, there is also some outright tax evasion. So that, some observers see the present system as being, in effect, a flat tax system; but with the inefficiencies of a complex tax code that necessitates an army of tax professionals to navigate the system. An “in-effect” flat tax would not be such a bad thing. But things have reached such an extreme that we see a receptionist at a doctor’s office paying higher average tax rates than the doctor. That is, lower wage earners are paying a larger share of their income in taxes than high-income earners. This is clearly in violation of the principle of progressivity of the tax system and the benefit principle of taxation.

Tax relief for the middle classes and slightly higher rates for the higher income classes (those with incomes higher than $250,000 a year) is necessary to restore the balance in the tax system. The tax system, over the last few decades, has become too skewed against the middle income classes. For example, the payroll tax increased from 6 percent in the early 1960s to over 15 percent in the 1990s, and that is where it stands today. The payroll tax, ever since its inception, has been a highly regressive tax. It falls more heavily on people with lower incomes. Warren Buffet recently pointed out that his receptionist loses more of her income in payroll taxes than he does. He called it “class welfare,” that is, welfare for the rich.

The taxes on the rich, proposed by Obama, are not “to pay for the tax cuts” for 95 percent of the Americans; they are intended to have the richest 5 percent pay at a higher rate for the higher level of benefits this group has been receiving from society. The lower 95 percent is also required to pay taxes, commensurate with the benefits it receives.

In recent years, William H. Gates Sr. has expounded the benefit principle of taxation (in his support of estate taxes). According to this famous Dad, philanthropist, and co-author of Wealth and Our Commonwealth: Why America Should Tax Accumulated Fortunes:

There is no question that some people accumulate great wealth through hard work, intelligence, creativity, and sacrifice. Individuals do make a difference, and it is important to recognize individual achievement. Yet it is equally important to acknowledge the influence of other factors, such as luck, privilege, the cooperative efforts of others, and society’s investment in the creation of individual wealth. It is not punishment to repay your government for having had the benefit of living in this country.

About a hundred years ago, President Teddy Roosevelt (a Republican) in his 1906 State of the Union address succinctly summarized the benefit principle:

The man of great wealth owes a peculiar obligation to the State because he derives special advantages from the mere existence of government.

Increasing taxes on the super-rich in America is merely having them pay to society in proportion with the benefit they receive from the existence of organized society in the form of government. It is an essential part of the continuous dynamics of the creation of wealth — a healthy circular flow from the government to its people and from the beneficiaries of government back to the government.

Nandinee Kutty
Dr. Nandinee K. Kutty is an economist and a policy consultant. She is an editor and contributor for the book Segregation: The Rising Costs for America (Routledge 2008). She is the author of numerous research papers published in peer-reviewed journals of economics and public policy. Dr. Kutty was formerly a professor at Cornell University. Her published research papers and op-eds are currently on the reading lists for courses taught at various universities in the U.S. Her e-mail address is nndkutty@aol.com.

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