A new proposal from Senator Elizabeth Warren (D-MA) to fund a $20.5 trillion increase in government health-care spending for a single-payer system overlooks how taxes interact and how they affect economic incentives. Her plan would create or increase many different taxes, but the proposal does not account for interactions across the different taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. types. In overlooking these interactions, the senator likely overestimates how much revenue could be raised by each tax type.
By raising some types of taxes, Sen. Warren would directly reduce the tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. of other taxes she plans to raise. For example, consider Sen. Warren’s proposal of imposing both a wealth taxA wealth tax is imposed on an individual’s net wealth, or the market value of their total owned assets minus liabilities. A wealth tax can be narrowly or widely defined, and depending on the definition of wealth, the base for a wealth tax can vary. and mark-to-market taxation of capital gains at ordinary income tax rates for the top 1 percent of taxpayers. Taxing wealth would reduce the amount of assets that investors have, reducing their after-tax incomeAfter-tax income is the net amount of income available to invest, save, or consume after federal, state, and withholding taxes have been applied—your disposable income. Companies and, to a lesser extent, individuals, make economic decisions in light of how they can best maximize their earnings. . Taxing gains as they accrue each year, rather than waiting until the investor realizes the gain when selling the asset, leads to a higher effective tax rate due to the elimination of the deferral advantage and reduces the amount of after-tax income. This raises the possibility of two-way effects, as both taxes would shrink the tax base and the potential revenue that could be raised.
For another example, consider Warren’s proposed changes to the corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. , which applies at the entity level before capital gains and dividends taxes are paid by shareholders. Sen. Warren’s proposal would increase the corporate income tax rate, lengthen depreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and discouraging investment. schedules, and apply a new and separate surtaxA surtax is an additional tax levied on top of an already existing business or individual tax and can have a flat or progressive rate structure. Surtaxes are typically enacted to fund a specific program or initiative, whereas revenue from broader-based taxes, like the individual income tax, typically cover a multitude of programs and services. on a corporation’s book profits, among other business tax increases. These would all reduce the after-tax income of a corporation, which would reduce the amount of earnings available to distribute to shareholders. This has implications for revenue estimates of both the capital gains taxA capital gains tax is levied on the profit made from selling an asset and is often in addition to corporate income taxes, frequently resulting in double taxation. These taxes create a bias against saving, leading to a lower level of national income by encouraging present consumption over investment. and the wealth tax.
These are just a few examples of potential tax interactions, but there is another problem with the proposal: it does not consider the possibility of any macroeconomic effects. As my colleague Garrett Watson and I pointed out previously: “Taken together, these proposed tax changes would raise marginal and effective tax rates on high-earning and high-net-wealth taxpayers, increase the cost of capital, and reduce the competitiveness of the U.S. tax code.” In other words, we would expect taxpayers to react to the decreased incentives to work and to invest, which would lead to lower output than otherwise might have occurred. A reduction in the level of economic output would reduce the potential revenue generated by Sen. Warren’s proposed tax increases.
Sen. Warren’s proposal to fund a single-payer system does not account for the interactions that some tax increases would have on the tax base of her other proposed tax changes. Likewise, the plan does not include an economic analysis to estimate the effects increased taxes would have on output and revenue. Neglecting tax interactions and economic effects leads Sen. Warren to overestimate the revenue that her proposal would generate.
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