Saez and Zucman say that everything you thought you knew about tax policy is wrong

In their new book, The Triumph of Injustice: How the Rich Dodge Taxes and How to Make Them Pay, economists Emmanuel Saez and Gabriel Zucman challenge seemingly every fundamental element of conventional tax policy analysis. Given the attention the book has generated, it is worth stepping back and considering their sweeping critique of conventional wisdom. Spoiler: My goal here is to present these issues, not resolve them.

What should be counted as a tax?

Unlike most analysts, Saez and Zucman (hereafter, SZ) include state and local as well as federal taxes in their calculations. They also omit the refundable portions of the earned income credit and the child credit (and other refundable tax credits), which they call transfers rather than elements of the tax code. Both of these adjustments make the tax system look more regressive than under conventional measures.

What should count as income?

Unlike conventional analysis, SZ distribute all national income—not just adjusted gross income or related measures—to taxpayers.  As a result, they exclude means-tested government benefits like TANF and SNAP (which are transfers, not production) from income but they do include social security and other benefits. Relative to conventional analysis, which includes all benefits as income, their exclusion of means-test benefits makes the tax system look more regressive.

How should the distribution of taxes be analyzed?

Conventional analysis allocates the corporate tax to some combination of shareholders,  all capital holders, and wage earners. SZ allocate the actual tax payments to shareholders, arguing that the effect of the corporate tax on various groups is already reflected in pre-tax incomes (for example, if corporate income taxes depress wages, workers have lower pre-tax income than otherwise).  Compared to the conventional assumption (which they argue is inconsistent because it shifts taxes without shifting income), their assumption raises current effective tax rates for high-income households (because shareholding is skewed toward the wealthy), but also increases the decline in taxes on the rich over the past several decades as corporate taxes fell.

Is the current tax system progressive or regressive?

TPC and most other analysts conclude that the US has a progressive tax system—that is, that taxes as a share of income rise with income. Combined federal and state taxes are progressive, though less so than the federal system alone. SZ find that the combined system is almost a flat tax up to the 99.99^th percentile and then is regressive at higher income levels.  As a result, they find that the very richest households pay a smaller share of their income in taxes than do the bottom 50 percent of households.

Are private health insurance premiums a tax?

SZ argue that health insurance premiums are hidden taxes on labor income (though they do not include this in the analyses that argue that the current system is regressive). SZ note that whether health insurance is compulsory does “not fundamentally change” their argument. Rather, they claim that buying health insurance from a private insurer is a tax because it is not fundamentally different from paying taxes to a public insurer.

In contrast, conventional analysis would consider private health insurance spending to be the purchase of health services. Under this way of thinking, private purchases of health insurance are no more of a tax than private purchases of food, housing, clothing, or other items.

What is the optimal tax policy?

Conventional analysis suggests that the optimal income tax should feature a broad base and low rates. This structure reduces incentives to shelter wealth while maximizing incentives to save and invest. The standard view also commends a consumption tax, due to its many attractive features: It imposes a lump-sum tax on existing wealth and does not distort decisions related to saving, investment, organizational form, or financing.

SZ turn these arguments on their head. They argue that optimal policy would impose near-confiscatory taxes on those with very high incomes and extreme wealth and that consumption taxes are too regressive. Their goal for the tax system is not only to raise revenues from the well-to-do but also to reduce what they see as rent-seeking, undue political influence, and other socially destructive behavior by those with the most resources. As a result, they argue in favor of tax rates that exceed the revenue-maximizing rate (i.e., are on “the wrong side” of the Laffer Curve).

Can high-rate income taxes and wealth taxes be adequately administered and enforced? 

Finally, conventional wisdom argues that high taxes on the well-to-do will invite massive avoidance and evasion. In contrast, SZ exude a “policy optimism” that broad taxes on corporate and individual income and on wealth, combined with adequate IRS resources, would be straightforward to enforce.

It always is valuable—and refreshing—for respected economists to question the conventional wisdom and SZ have done so in a well-argued and dramatic fashion. Now, as Saez noted at a recent conference, it’s time for the profession to engage these claims and see which withstand scrutiny and which do not.