MITT Romney’s income taxes have become a major issue in the American presidential campaign. Is this petty politics, or does it really matter?
It does matter — not just for the US.
A major theme of the underlying political debate in the US is the role of the state and the need for collective action. The private sector cannot ensure a modern economy’s success alone.
Beyond effective regulation, modern economies are founded on technological innovation, which presupposes research funded by government. This is an example of a public good — things from which we all benefit but that would be undersupplied by the private sector.
Conservative politicians in the US underestimate the importance of publicly provided education, technology and infrastructure. Economies in which government provides these public goods perform better than those in which it does not. But public goods must be paid for, and it is imperative that everyone pays their fair share. Those at the top of the income distribution, who pay 15% of their reported income, clearly are not paying their fair share. If presidents and those around them do not pay their fair share of taxes, how can we expect that anyone else will? And if no one does, how can we expect to finance the public goods we need?
Democracies rely on a spirit of trust and co-operation in paying taxes. If every individual devoted as much energy and resources as the rich do to avoiding their fair share of taxes, the tax system would collapse or would have to be replaced by a far more intrusive and coercive scheme. Both alternatives are unacceptable.
A market economy could not work if every contract had to be enforced through legal action. But trust and co-operation can survive only if there is a belief that the system is fair. A belief that the economic system is unfair undermines co-operation and effort. Yet, increasingly, Americans believe that their economic system is unfair, and the tax system is emblematic of that sense of injustice.
Billionaire investor Warren Buffett argues he should pay only the taxes that he must, but that there is something wrong with a system that taxes his income at a lower rate than his secretary is required to pay. He is right. If Romney were to take a similar position, it could be a Nixon-in-China moment: a wealthy politician advocating higher taxes for the rich could change the course of history.
But Romney has not chosen to do so. He evidently does not recognise that a system that taxes speculation at a lower rate than hard work distorts the economy. Indeed, much of the money that accrues to those at the top is what economists call rents, which arise not from increasing the size of the economic pie but from grabbing a larger slice of the existing pie.
Those at the top include a disproportionate number of monopolists, who increase their income by restricting production and engaging in anticompetitive practices; CEOs who exploit deficiencies in corporate-governance laws to grab a larger share of corporate revenues for themselves; and bankers who have engaged in predatory lending and abusive credit-card practices. Rent-seeking and inequality have increased as top tax rates have fallen, regulations have been eviscerated and the enforcement of existing rules has been weakened: the returns from rent-seeking have increased.
Today, a deficiency of aggregate demand afflicts most advanced countries, leading to high unemployment, lower wages, greater inequality and constrained consumption. There is now a growing recognition of the link between inequality and economic instability and weakness.
There is another vicious circle: economic inequality translates into political inequality, which reinforces the former, including through a tax system that allows people such as Romney — who insists that he has been subject to an income-tax rate of "at least 13%" for the past 10 years — not to pay their fair share. The resulting economic inequality contributes to today’s overall economic weakness.
Romney may not be a tax evader. But, given that the top US marginal income-tax rate is 35%, he certainly is a tax avoider on a grand scale. And, of course, the problem is not just Romney; writ large, his level of tax avoidance makes it difficult to finance the public goods without which a modern economy cannot flourish. Importantly, tax avoidance on Romney’s scale undermines belief in the system’s fairness and thus weakens the bonds that hold a society together.
© Project Syndicate, 2012. www.project-syndicate.org
• Stiglitz is a Nobel laureate in economics.
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