During his campaign Donald J. Trump’s main goal was to ‘Make America great again’. After his election the first thing he does is state that he is going to put America first. 10 months into his tenure this is reflected in the new bill which is passed by the House of Representatives and was meant to boost the American economy by providing jobs and having multinational company’s stay or come to America. Furthermore this is not the only result of the new bill, but other than boosting the own economy the changes in this bill will have a larger effect on ordinary Americans than is first believed (New York Times, 2017). Starting with enlarging the wealth gap, which is already a huge problem, and eliminating the obligation of people to have health insurance. The enlargement of the wealth gap is mainly due to the tax cut experienced by the very richest of Americans, who will experience a much larger cut than the middle- or lower-class Americans. Second, the corporate tax rate will drop from 35 to 21 percent which makes it possible for owners of pass-through businesses to enjoy even an larger tax advantage.
Due to the changes in taxation policy in America there will be two different effects. The first effect is that large American corporations are expected to bring back capital from overseas accounts due to the new lower corporate tax rate. The tax rate drops from 35 to 21 percent(Staff of the Joint Committee on Taxation, 2017), which will make it more appealing for American corporations to bring back their profit to U.S. accounts instead of keeping it abroad. The expectation is that this will boost the American economy as these firms will reinvest their profits in US markets which will create new jobs and therefore lower the unemployment rate. The lower tax rate is also beneficial for the competitive advantage of us firms as they have a level playing fields with firms abroad, where the corporate tax rates are around 20% (The New York Times, 2017).
The second effect is that the existing problem of the wealth gap will be enlarged because of the new amendment made for the income tax. The first effect is the change of the number of income brackets (the New York Times, 2017). the former tax brackets consisted of seven brackets, 10, 12, 22, 24, 32, 35, and 37 percent. The House bill lowers this number to four different brackets, 12, 25, 35, and 36.9 percent. This means that middle class households who pay an income tax of 22 or 24 percent will be obliged to pay 25 percent, which is detrimental for their income, wealth and purchasing power (The New York Times, 2017). Second is the proposal to dispose of the obligation for people to have health insurance. This cut will put 300 billion us dollars into the federal budget but will leave 13 million Americans without coverage, which will also increase the wealth gap because lower incomes will not be able to pay for health insurance and therefore they will not be able to pay for medical bills.
There are numerous effects that are caused by the change in taxation policy by the Trump administration. Most of these are short term effects. It is therefore interesting to study the long run effects of the taxation change on the wealth gap. Also, it is interesting to study how this can be changed using taxation. Hence, my main research question is as follows:
How can the growing wealth gap in the US be reversed using taxation?
To answer this question this essay will contain a critical literature review. The information inside is written using academic books, papers, articles and news websites. Following the introduction above will be the theoretical framework containing an analytic. This analytic will provide the general background of a tax system and its principles. It will also tell the practical problems involved with pursuing these principles and why they are not always met. Second will be the discussion where different academic sources will be consulted to answer the central question. To answer the central question an hypothesis will be formed. The limitations of the research will also be stated in the discussion. At last the paper will close with a conclusion. The conclusion will summarize the paper by repeating the central question and it’s answer..
Before an answer to the central question can be formed the main principles of a tax system should be discussed. First the main goals and principles of a tax system will be explained followed by a brief discussion on what these principles actually contain.
Most advanced economies tax around forty percent of the national income (Mirrlees p. 21). Taxing this amount cannot be without major economic disruptions. First it will result in a loss of welfare. Income tax causes the employer to pay more than the employee receives, and VAT makes a consumer pay more than the retailer receives. Which means people pay more than the market price. Because retailers continually increase prices and lower quantities the taxes will conclude in a loss on consumers and producers alike. The costs of these losses are almost always higher than the taxes they raise. This loss can be called the deadweight loss, or the social cost of taxes (Mirrlees p. 28-29). This deadweight loss can be counted as a loss of welfare in society.
Other than reducing the welfare, it also influences people’s behavior. This happens in several ways. The first effect taxes have on people’s behavior is the income effect. Submitting or increasing income tax will make the net sum that people receive for their hours of work decline. if workers are encouraged to work more to maintain their same standard of living this is called the income effect. The second effect is called the substitution effect. Income tax makes an hour of work less valuable than before. Making it less valuable people will be encouraged to work less. This effect being called the substitution effect (Mirrlees p. 29)
Though these negative effects exist, taxes are still needed for a government to achieve social and economic objectives. So the challenge for tax design is to minimize these negative effects while achieving these social and economic goals. Other than achieving these goals we need taxes for other reasons as well. First is that the government needs to raise revenue to pay for its collective expenditures. The second is that taxes are used to stimulate economic growth. Other than the negative effect which was that it reduced welfare, taxes are used to stimulate economic growth. Third is, that taxes are used to steer people in such a way that they make the right investments. This is most used to encourage people to invest in technological development, which will also stimulate economic growth. The final objective for taxes is to achieve social goals. Which comes down to redistributing wealth from the richer classes to the lower classes of society (Mirrlees p. 22-28)
To achieve these tax goals a tax system must be submissive to several principles. These principles are required to design a tax system. (Mirrlees p. 39). These principles are that a tax system should be neutral, simple and stable. For a system to be neutral it means that it should threat similar activities in similar ways. Threating these activities in similar ways will remove an incentive of people to feel disadvantaged by another. Though we want an system to be neutral we also want some activities to be treated in a different way(Mirrlees p. 40). Activities that are harmful to the environment and consumptions that are bad for our health like cigarettes are taxed in different ways to discourage people to perform these activities or consume these goods. So although we cannot achieve a completely neutral system, making it as neutral as possible will also improve the simplicity and stability of an system and so it should be pursued.
For a tax system to be simple sounds almost logical. It adds transparency and lowers administrative costs (Mirrlees p. 42). Simplicity may sound logical but the world being complex enough achieving it is a different thing. Corporations and individuals will try and find every way to pay as less taxes as possible, loopholes are inevitable (Mirrlees p. 42). With loopholes being formed tax authorities will have to create new rules and legislations. These rules will be followed with different ways to avoid the tax payments, some legal, some illegal. This cycle continuous making the tax system less simple every time new legislation is added. As with neutrality, simplicity will promote the other main principles as well. And even if total simplicity is hard to pursue it should still be aspired.
The last principle is that a tax system should be stable. When a tax legislation is changed it will cost individuals and corporations time and money to get adjusted to these changes. Making it harder to set future plans and bet on future investments. Which will make it less attractive to do so. If individuals and corporations choose not to do so this will be disadvantageous to the economy as a whole and will eventually result in less income from taxes (Mirrlees p. 44).
All principles have a possible influence on each other. For example a more simple system is a more stable one and a more neutral system is a more simple one. Changes in legislation will have a bad influence on these principles and will cost the tax payer a lot of money. Nevertheless it is better to change a bad system then to keep it with tax payers money being wasted on bad legislation (Mirrlees p. 44)
In the introduction we concluded that the new American tax bill is enlarging the wealth gap in the US. This part of the essay will discuss what the long term effects will be for the economy en eventually if a different approach to tax will be able to change this. And with that answer the central question stated in the introduction.
To asses wat the future effects of the growing wealth gap will be we first have to give a brief insight in how the wealth gap evolved throughout the years. Before the wealth gap was so great in America the income equality was larger in Europe. Around 1910 the top 10 percent of the population earned between 45 and 50 percent of total income. In the United States this percentage was 40 percent (Piketty, Saez p. 893). Then between 1914 and the 1950s and 1960 the inequality dropped to 30 percent with a slight rise since the 1970s to 35 percent. In the us the opposite happened. Instead of dropping the wealth gap increased with the top 10 percent of society earning around 35 percent of national income in the late 1960s. after being stable the income of the top 10 percent rose from the 1970s-1980s till 50 percent of national income right now (Piketty, Saez p. 839). The main reason why income inequality has dropped in europe and enlarged in the US is because of the direct consequences of the first and second world war. Destruction of capital assests, lack of investment due to the absence of savings, and a fall in the prices of assets like real estate and stock markets (Piketty, Saez p. 840).
The main reason for the growth of inequality in wealth and income is the constant competition between technology and the education following it (Piketty, Saez p. 842). With technological breakthroughs being made every day, the skills that are needed to make use of this technology stay behind. By enlarging education en with that the skills employees will be able to earn higher income which will close the gap in wealth and income that is currently there (Piketty, Saez p. 842).
With the US education being based around private schools and most of them not being funded by the government, most people have to count on savings to educate themselves. Wealthy Americans require less saving to go to college because the money is already there. The new US bill includes the removal of a deduction for the savings in college funds. Which makes it less attractive for people to save for college and go there. To catch up with the technology there is it is key that American employees educate themselves and every deduction or funding by the government contributes to the cause.
If the US government has any incentives to close the wealth and income inequality in the near future they should focus more on reducing the pressure around saving for college, or start funding education partly or as a whole (Piketty, Saez p. 842). This will leave a hole in the tax budget. To fill this hole the American government could increase the income tax for the highest earners in the American economy. Increasing the corporate tax would scare of big American corporations to stay in America and will cause them to perform most of their actions overseas where corporate tax is lower, so this is not an option. It could also lower the income tax percentage for lower earners to relief pressure and give an incentive to save up for education. At last the hypothesis:
The growing wealth gap in the US can be reduced if the US government invests in educating the population by reducing tax pressure on lower class Americans.
The limitations found in this research are that most of the literature is out dated because the American bill change took place so recently. Furthermore there is an absence of empirical data to support the research. Any suggestions for further research would be to apply an empirical based investigation, using empirical data, to see if the development of education and technology really closes an existing wealth gap.
The goal of this literature review was to address a recent tax development and find a way to a to improve the tax system. The new tax American tax bill is a major disruption of the current tax system. Lowering corporate tax and reducing the tax pressure on the most wealthy of Americans. The lower class Americans are the ones to suffer from this new bill with an increase in their income tax, the loss of health care and certain deductions such as the tax on college savings. This results in an enlargement of the wealth gap. The research question is therefore:
How can the growing wealth gap in the US be reversed using taxation?
first we laid out the basic principles that are used to construct a well-designed tax system. Taxes should be neutral, treating similar activities in similar ways, second taxes should stay simple to favor transparency and keep administrative costs as low as possible. And last a tax system should be stable, this is needed to guarantee security throughout the years, and prevent tax payers from losing unnecessary money. Changing a tax system to much would scare of future investments . These principles are coherent. By consulting different academic sources we came to the conclusion that the best way to reduce a wealth gap is to make the population educate themselves to be able to land higher earning jobs. And follow up with the technological developments being made. This goal can be reached if the US government focusses on making education more accessible for the lower earning incomes. And using taxes to do so. This could be done by switching the current tax pressure from the lower earning incomes to the more wealthy Americans and make them pay for the flaws that are currently present.