How tax code devalues labor

If Congress really wants to encourage work effort, it should show it by lowering the tax on wages and salaries compared to other income sources. MCT
Random Economics

Congress should encourage, not discourage, labor.

Why would Congress consider work something that should be discouraged? Yes, I know, all politicians say they want to create jobs and will do everything possible to make sure people have the ability and incentive to find a "good" job, whatever that may be. But what politicians do is a lot more important than what they say, and the tax laws in this country are structured to favor almost all types of income over wages and salaries.

A favorite government tool used to encourage specific economic activities is the tax break. These activities receive special deals because they are deemed desirable and worthy of government support. In essence, the government picks winners and losers by having different tax structures.

For example, in order to lower our dependence on foreign energy, the stimulus bill included breaks for energy conservation and alternative-energy sources. In Pennsylvania, the shale industry went untaxed to encourage exploration. And the City of Philadelphia has used a property-tax abatement to foster housing construction.

If tax breaks are given to those activities that are deemed to have special value, what does it say about those activities that are taxed at higher rates? Policymakers are indicating they consider the competing activities to be of lower value. That is precisely the issue with how we treat income.

The tax code says people should earn their income from almost any means other than labor. Wages and salaries are taxed at just about the highest rate of any income source. There are special low rates for dividends, capital gains, and interest income - especially from state and local debt - but if all you do is make your money from wages and salaries, you pay a higher tax rate.

Consider the tax-free treatment of interest on state and local government securities. Most state and local governments issue bonds for schools, roads, and other infrastructure projects, and imposing no federal income tax means interest on the securities can be reduced. That increases construction by making the projects more affordable.

Interestingly, the federal government does tax interest paid on Treasury securities. That creates a strange commentary about federal activities: If you lower the tax to encourage one type of activity, but don't lower it on similar types of activity, you are basically saying the higher-taxed activity is less worthy. Do members of Congress really believe their spending has less value than what municipal governments do? And do we really want to encourage more local construction?

It is possible, if all your income is municipal-bond interest, that you could pay no taxes. Those who earn interest from munis will pay much lower taxes than those who earn the same amount on wages or salaries.

Similarly, there is the issue of dividends, which are currently taxed at a 15 percent rate rather than the 25 percent to 35 percent rate on income. The argument is that corporations already pay taxes on that income. If the owners of the corporations, the stockholders, have to pay taxes on that income as well, the company income is actually taxed twice.

Though the double-taxation argument may have merit, the reduced tax rate affects only those stockholders of companies that pay dividends. Stockholders in so-called growth companies, which tend not to pay dividends, don't get that benefit. Is the government really trying to encourage dividend payouts rather than faster business growth? And once again, those who receive income from dividends rather than wages will pay lower tax rates.

Finally, there are capital gains, where the reduced tax rate of 15 percent was supposed to foster investment. However, over the long run, neither households nor businesses invest based on tax rates. Also, capital is raised internationally, and those living in foreign countries would not worry a whole lot about what the tax rate is, because they are probably not paying the tax anyway. The result, though, is that those who earn income from capital gains pay lower tax rates.

By imposing higher tax rates on wages and salaries compared to income from interest, dividends, and capital gains, the tax code clearly values investment income more than labor income.

If Congress really wants to encourage work effort, it should show it by lowering the tax on wages and salaries compared to other income sources. If it doesn't want to show a preference, it should consider all income equal and tax all sources similarly.

 


Joel L. Naroff is a nationally known economist, and is president and chief economist of Naroff Economic Advisors Inc. of Holland, Bucks County. Contact him at jnaroff@phillynews.com.

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