The Progressives' Tax Policy Paradox

 

According to the international Organization for Economic Co-operation and Development (OECD), the United States has the 4th highest income inequality among all developed countries – superseded only by Turkey, Chile, and Portugal. Yet, also according to the OECD, the United States has the most progressive tax system, far exceeding the wealthier, highly egalitarian social democracies of northern Europe.¹ How is this reconciled?

The answer is that in most countries, progressivity and income equality gains are achieved through government programs, not the tax code. According to the author of the OECD study, the United States is the only OECD country which reduces inequality more through the direct tax system rather than through transfer spending. Or as described in the Washington Post, “America’s taxes are the most progressive in the world. Its government is among the least.”

In most of the world equality gains come through progressive income support, child care, education, health, and related spending programs. But crucially all this is financed by far more regressive tax systems than we have in the United States. These countries learned that to support strong redistributionist policies, they needed tax systems that could collect a lot of tax revenue without harming economic growth. Among other features, regressive, broad-based consumption taxes are especially important. The value added tax - a revenue staple in most of the world – fits that bill.

What does any of this have to do with Minnesota? We have just emerged from a session where a lot of progressive policy cuisine was made from distinctly American tax ingredients. “Tax the rich,” “tax fairness,” and “more progressivity” were the only words on the recipe card. Any tax proposal affecting the middle class was revenue non grata.

The end of session demonstrated that under these tight philosophical and political constraints, securing enough revenue to support progressive policy ambitions isn’t easy. For example, the tax conference committee briefly noodled on whether the world of excise and gross receipts taxes on alcohol could be manipulated to build progressivity into the taxation of alcohol consumption. Is it possible to protect the average Minnesotan’s six-pack while sticking it to the Wine Spectator crowd? (Alas, it isn’t, but not for lack of trying.)

In the end taxes on high income earners, estate taxes, and corporate income taxes – regressive, but having the considerable benefit of appearing to tax the wealthy – did most of the heavy lifting. Highly regressive tobacco taxes were also essential, but proponents argued these taxes were only meant to induce people to stop smoking. $400 million was simply the price society had to be willing to pay – rather, make that receive – to support good public policy.

The call for new revenue may not be over. Many in Minnesota’s progressive community may not be completely satisfied with the results of the 2013 session. When first introduced, Gov. Dayton’s budget featuring $2 billion in new taxes was described only as “a good start.”² Concerns have already been expressed about addressing the treatment some health and human services programs received this session.

Funding future program ambitions will remain no less of a challenge than they were this session. For both practical and political reasons, progressivity advocates will have to embrace more regressive forms of taxation going forward.

Practically, we have now essentially spent all our “fairness ammunition” with respect to taxing income, especially if one gives any credence at all to the competitiveness principle of taxation. Minnesota can now claim the second highest income tax rate in the nation at the 4th tier threshold of $250,000 for married joint filers – second only to Oregon, a state without a sales tax. Plus we continue to have one of the highest corporate income tax rates in the nation but now stripped of some provisions which may have helped make the tax palatable enough to locate here. What little comparative headroom we may have had in the past with respect to taxing income has now evaporated.

Politically, further pursuit of even more progressive taxation in Minnesota may do significant damage to progressives’ own agenda. Author and scholar Monica Prasad of Northwestern University has built a distinguished academic career around investigating the sociology of taxation. In exploring why decreases in social spending took root in some countries but not others, she has concluded tax codes and tax progressivity have a major effect. Countries with stronger progressive tax codes and more punitive business taxation triggered much stronger and more aggressive conservative responses against social welfare policies and related spending. The net effect in these countries is that progressive agendas actually lost ground over time. In short: the progressivity of tax codes is negatively correlated with the amount of redistribution they do. The less progressive the tax code, the more overall progressive the fiscal system.

Selling the average Minnesotan on the idea that regressive taxes are needed to support important social outcomes is a lot more difficult than selling the idea “some people aren’t paying their fair share.” But sooner rather than later, Minnesota’s progressives will have to recognize that to achieve their vision for Minnesota, some regressive forms of taxation will need to be considered an ally, not an enemy.