Update 541 — Paying for Infrastructure:
The Financing Options and the Recovery
Last week, President Biden and a bipartisan group of Senators struck a deal on a $579 billion infrastructure package. Democrats also seek to pass a second bill worth trillions in additional spending. But unclear is how to pay for it — through taxes that might slow the recovery, or by borrowing, which wouldn’t have this effect.
The $1.9 trillion American Rescue Plan Act was, intelligently, entirely financed by borrowing. Biden has proposed taxing wealthy Americans and corporations to pay for his programs. Below, we evaluate the options for financing Biden’s proposals, applied to the individual and corporate taxes and user fees under discussion on the Hill.
The Tax Revenue Option
Biden has proposed several individual tax increases that would make the tax code more equitable. These include raising the top marginal income tax rate from 37 percent to 39.6 percent, raising the top capital gains rate from 20 percent to 39.6 percent, and closing several loopholes in the tax code that allow high-income earners to avoid paying the higher rate on normal income.
Biden has proposed increasing the top corporate tax rate from 21 to 28 percent and other measures that would require corporations to pay a fairer share.
- Individual Taxes: Politically speaking, Biden’s individual tax proposals are popular on their merits, as two-thirds of Americans agree that the rich should pay more than they currently do in taxes. A recent ProPublica report revealed that the richest 25 Americans paid an average of 15.8 percent in federal income tax from 2014-2018 by avoiding wage-based income and consolidating income in more lightly taxed capital gains. Closing loopholes may not always bring in a significant amount of revenue on their own but enjoy broad political support: 68 percent of Americans support ending the carried interest loophole.
These proposals have caused some division among Congressional Democrats. Some moderate Democrats have expressed hesitation toward doubling the capital gains rate, worrying a rate increase may harm the recovery by disincentivizing investment. Democrats from farm states have also expressed concerns that ending stepped-up basis could hurt family farmers, even though Biden’s plan includes protection for family-owned farms and businesses. Sixty-five percent of voters support raising the capital gains rate on individuals making more than $1 million a year. A smaller increase of the capital gains rate to 28 percent, as proposed by Sen. Manchin, would be a step in the right direction.
Tax Burdens on Wealthy Americans
- Corporate taxes: Large-scale tax increases of any sort are counter-stimulus when the recovery is in its infancy. But taxes on corporations polls exceptionally well. Fifty-four percent of Americans support raising the corporate income tax rate back to 28 percent, with 33 percent opposed. When corporate tax increases are characterized as a means to pay for Biden’s infrastructure plan, support increases to 65 percent, including 42 percent of Republicans. For progressives, framing corporate tax increases as necessary to make long-term investments in the economy would be successful.
Biden’s proposal is modest, given that the GOP cut the corporate tax rate from 35 to 21 percent in 2017. Earlier this year, Senate Minority Leader Mitch McConnell referred to changes to the 2017 tax cut law as his caucus’ “red line,” meaning Democrats would need to include any corporate tax increases in a reconciliation bill. Opponents of a corporate tax increase argue that costs will be passed down to American consumers in the form of higher prices on goods and services. The sentiment is shared by pluralities of Americans in both parties, though most economists say there is little effect.
Support for Raising Corporate Taxes to Pay For Infrastructure Spending
Source: Morning Consult
- User fees: User fees, most notably the gasoline tax, are commonly used by governments to fund infrastructure projects. The federal gas tax, currently at about 18 cents per gallon, finances the Highway Trust Fund. Some Republicans have floated raising the gas tax or indexing it to inflation to pay for infrastructure. A similar user fee would be a federal vehicle-miles-traveled (VMT) tax, which would assess a charge based on the distance a vehicle is driven. It may seem logical to garner revenue gathered from the utilization of physical infrastructure to pay for new projects and repairs, especially regarding businesses that benefit from the publicly provided infrastructure.
User fees are regressive, though. Those with lower incomes tend to spend a larger percentage of their income on gas taxes than wealthier individuals, even if they use similar amounts. The administration and Congressional Democrats have rightly taken a hardline stance against raising user fees to pay for infrastructure. Biden promised not to raise taxes on individuals making less than $400,000 a year, and even indexing the gas tax to inflation would result in a tax increase. User fees also poll very poorly, with less than a third of voters expressing support for raising gas or VMT taxes.
Public Support for User Fees
Source: Morning Consult
The Borrowing Option
Biden’s American Jobs and Families Plans are fully paid for over a 15-year period with his tax proposals. Congress may decide not to offset all of the new spending it passes, instead, allowing some of the spending to increase the deficit. From a progressive perspective, deficit financing for infrastructure would be favorable in opening the door for additional spending without a need for offsets. But it could also take political momentum away from using Biden’s tax proposals to make the tax code more equitable.
The political benefit of deficit financing is that spending does not have to be paired with new revenues in the form of tax increases. Deficit financing also entails a needed recognition that infrastructure spending is a long-term investment in the economy. As Sen. Brian Schatz put it last week, “characterizing paying in cash for physical infrastructure as some sort of adult, responsible position turns public finance and logic on its head.”
The bipartisan deal struck last week includes among its pay-fors “macroeconomic impact of infrastructure investment.” This is an apparent reference to dynamic scoring, which takes into account that infrastructure spending will create economic growth that will produce new tax revenues over time. Deficit financing is particularly suited to today’s economy, which has been defined by low-interest rates — and thus a lower cost of servicing the debt.
Deficit financing does carry political risks. Due to the government’s response to the pandemic, the federal deficit has grown to its highest level as a percent of GDP since World War II. While this fact alone does not need to be an immediate cause for concern, it gives political ammunition to opponents of new spending, especially if that spending is not offset. Another potential risk of deficit financing is that it could take steam away from the most ambitious of Biden’s tax proposals. If Congress is comfortable with some amount of deficit financing, it could be harder to make the case that tax changes such as raising the capital gains rate or ending stepped-up basis should be passed as revenue offsets.
The Options in Macroeconomic Context
Full control of government, and the prospect of large-scale infrastructure spending, offers Democrats a prime, but limited, opportunity to make the tax code more equitable. But while the long-term, structural changes to the Code contemplated by the administration and others may be worthwhile not just as infrastructure pay-fors but as policy objectives on their own merits, major tax increases are at odds with the broader recovery strategy laid out by President Biden, supported thus far by Congress, and reinforced by Fed policy. Opposition by congressional Republicans to these proposals is firm, so reconciliation is the only vehicle available this year. Progressives should use the strong public support for a fairer tax code, but at a time when microeconomic circumstances are ripe.