Data show now is precisely the time to move to a progressive income tax

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This November, voters have the opportunity to ratify an amendment to the Illinois Constitution that will permit the state to use a graduated rate structure for its income tax. If the amendment is ratified, the new rate structure, called the "Fair Tax" by proponents because it raises revenue in a manner that corresponds to ability to pay, would impose higher income tax rates on the wealthiest 3% in Illinois, while actually cutting income taxes for the bottom 97%.

In a normal economy, the Fair Tax would raise around $3.6 billion in new, annual revenue. Of course, the current economy is anything but normal, as the nation continues to struggle through a record setting recession caused by the pandemic. This has led those who oppose the Fair Tax to claim now is a particularly bad time to raise taxes, as doing so will make the recession worse. The research, however, indicates just the opposite is true.

Nobel Prize winning economist Joseph Stiglitz reviewed how the various states dealt with their respective deficits caused by the Great Recession. He found that those states which closed deficits by raising taxes progressively — and used the new revenue from such progressive tax increases to maintain or enhance funding of core services — realized a positive private sector multiplier of up to $1.50 for every tax dollar so raised and spent. This helped their economies recover faster from the Great Recession than states which relied on spending cuts to resolve budget deficits.

The reason for this positive outcome has everything to do with consumer spending, which accounts for roughly 67% of all economic activity. See, the best spenders are low- and middle-income workers, whose earnings have been flat or declining after inflation over the last 40 years. Because of that, they have what economists call a high "Marginal Propensity to Consume" or "MPC." That just means their spending generally increases or decreases in proportion to increases or decreases in their incomes. So when these workers receive a tax cut, as they would under the Fair Tax, they’re likely to spend every dollar of that tax relief buying stuff in their local economies.

Conversely, affluent individuals have very low MPCs — meaning an increase or decrease in their incomes does not generally result in a corresponding change in their consumption patterns. Which isn’t surprising, once you consider the tremendous growth in income they’ve realized over the last four decades. For instance, the average, inflation-adjusted income of the wealthiest one% in Illinois ballooned from $411,177 in 1979, to over $1.4 million by 2017. In fact, the wealthiest 3% in Illinois — who are the only folks who would pay more under the Fair Tax — saw their disposable, after-tax incomes grow by over $16 billion between 2016 and 2017 alone. So it’s easy to see why taxing them more won’t reduce their spending.

Moreover, when Illinois state government spends the newly raised revenue from the Fair Tax, most of that spending will go to the four core service areas of education, health care, human services and public safety, which collectively account for over 95% of all state spending on services. Given that all of these service areas are labor intensive, that spending primarily goes to cover the wages of the teachers, social workers, health care providers and correctional officers who provide those services in communities across Illinois.

This also stimulates the economy, because those public sector workers are all middle-income, meaning they have high Marginal Propensities to Consume. Hence the wages they receive from state government become spending in the local communities in which they live. This in turn generates the positive private sector economic multiplier Stiglitz found stimulates job creation.

In other words, given how the data show that progressive tax increases that allow continued funding of core public services actually help stimulate private sector job creation during recessions, now is an especially propitious time to implement the Fair Tax.

• Ralph Martire, rmartire@ctbaonline.org, is executive director of the Center for Tax and Budget Accountability, a fiscal policy think tank, and the Arthur Rubloff Professor of Public Policy at Roosevelt University.

via Daily Herald

October 23, 2020 at 07:05AM

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