Never Mind the Fiscal Cliff, the ‘Reverse Subsidy’ Is the Real Crisis

Imara Jones Dec 12, 2012

Contrary to popular myths in both political parties, the dramatic gains in wealth by the super rich are underwritten by everyone else as a result of skewed values embedded in the U.S. tax code. This means that the top 1 percent of America’s wealthiest households—97 percent of whom are white—are subsidized by the rest of the tax base, which is disproportionately black and brown when compared to this elite group at the top.

This “reverse subsidy”—which reached a crescendo under George W. Bush—was brought about through fundamental changes in America’s tax policy over the past three decades. These changes lowered the overall tax burden for the rich more than for everyone else. Most importantly, they taxed income from work at up to twice the rate as income from wealth.
This legacy of inequity is key to understanding the reverse subsidy’s role in the current fiscal debate. That’s because as wealth piled up for the rich, less revenue flowed into government coffers. In order to make ends meet, the U.S. Treasury borrowed huge sums of money. These annual deficits, up to the tune of $1 trillion a year, formed into an enormous debt. The consequence of these debts and deficits is what we’re grappling with right now.
Though the benefits of tax cuts overwhelmingly flowed to America’s economic elite and helped boost their wealth to stratospheric levels, the debt to which they contributed is held collectively by everyone. Therefore, as a matter of right and wrong the “reverse subsidy” is a pure and simple economic injustice.
Beyond principle, the collateral damage caused by the reverse subsidy is also key to evaluating its impact. In an attempt to minimize annual deficits, the government squeezed parts of the budget focused on education, housing and transportation. The strain these areas have come under has created additional barriers to economic opportunity for people of color, and make it that much harder for the average household to make it.
Given the increase in the reverse subsidy over the past decade—and its corresponding impact on economic fairness—it’s no surprise that the U.S. has astoundingly low economic mobility. According to Nobel Prize-winning economist Joseph Stiglitz, the chance of moving from being poor to rich is less in the United States than in any other advanced economy on the planet. One out of three blacks and one out of four Latinos is poor.
Sadly, these against-all-odds probabilities are a logical consequence of the wrongheaded tax choices that were made, especially in the last decade beginning with George W. Bush.
The Tipping Point
Within his first six months in office in 2001, Bush enacted the largest tax cut in American history: almost $2 trillion over 10 years.
According to the Center for Tax Justice, 40 percent of the benefits of this tax cut went to the top 1 percent of income earners. If you include the top 5 percent of income earners, half of all the benefits of the Bush tax cuts went to just 1 out of 20 Americans.
Income tax rates for the highest income earners fell from 39 percent to 35 percent. Rates in fact were reduced for most Americans, and the Earned Income Tax Credit—which aims to put more money in the pockets of the working poor—was expanded.
But the tax cut with the biggest consequence was for the rich, on capital gains. The tax rate on capital gains, which is income from wealth, fell from 20 percent to 15 percent—half the rate for income from work.
Powerful shifts in tax policy have noticeable economic consequences.
During the past 10 years the top 1 percent have seen their share of national wealth reach historic highs, while middle class incomes have stagnated and poverty is stuck at decades-high levels. The reverse subsidy enables a miniscule number of Americans to benefit while the rest pay for it.
According to Clinton administration Labor Secretary Robert Reich, the richest 400 Americans now have more wealth than half the country—150 million people—combined.
But as the reverse subsidy helped the rich, it has harmed the fiscal health of the nation as a whole.
As Andrea Campbell wrote in a recent Foreign Affairs article, “the adoption and continuation of the Bush tax cuts has slashed federal revenues by about three percent of GDP, to levels not seen since shortly after World War II.” In fact, according to data from the Tax Policy Center, revenue for the federal government was 20 percent less in 2011 than in 2000, the year before the Bush tax cuts began to take effect. This was even true before the financial crisis of 2008 tanked tax receipts further.
Moreover, as Campbell points out in her piece, “America the Undertaxed,” the nature of the tax levies has changed in a way that’s not beneficial to working Americans, in spite of the Earned Income Tax Credit. Corporate taxes contribute three times less to federal revenues than in 1950, but federal payroll taxes—paid by all Americans who work regardless of income—have effectively doubled in the last 40 years.
These unfair tax polices, which play an instrumental role in the reverse subsidy, were key to transforming America’s surplus in the year 2000 into a sea of red ink less than three years later. Annual budget deficits averaged half a trillion dollars a year, and total debt doubled during the term of the 43rd president.
Analysis by the Center for Budget and Policy Priorities in 2003—before the war in Iraq—declared that the surplus had “disappeared” mostly due to the Bush tax cuts. From its earliest days under Bush, the reverse subsidy showed the harm that it could do.
Even counting the then war in Afghanistan, tax reductions wiped out three times the amount of the surplus as did all the emergency post-911 spending. Once the Iraq war got underway, America’s precarious financial position went totally off the rails. But it’s important to highlight, contrary to popular wisdom, that America was in financial trouble well before troops landed in Afghanistan or Iraq.
Fiscal weakness then as now is attributable to the Bush tax cuts, the largest proportion of which flowed to the top 1 percent. In fact, according to Zachary Goldfarb of the Washington Post, the cost of all the Bush tax cuts over the next 10 years is greater than the entire fiscal hole that President Obama and Speaker John Boehner are trying to close.
Unequal Impact
Though most benefits of the tax cuts accrue to America’s wealthy elite, the debt to which they are a lead contributor is held by everybody. The imbalance created by this debt—fueled by the reverse subsidy—is undermining America’s economic future. Those who bear the burden of debt are not the same as those who gain most from it.
The overall size of the debt now poses a threat to 95 percent of American taxpayers.
According to the Simpson-Bowles Commission, delayed action on the debt could cause the economy to contract by more than it grew last year and ultimately be twice as expensive to pay down.
As we have seen, economic crises hurt average Americans far more than they do the economic elite. Even as Americans are picking up the pieces from the economic recession, according to Joseph Stiglitz, up 90 percent of the new wealth created in the last two years has flowed to the top 1 percent. The reverse subsidy skews losses to the many and gains to the few.
Additionally, Simpson-Bowles estimates that without action on the deficit federal interest payments on the debt could climb to a $1 trillion a year by 2020.
At this level, the amount spent on interest payments would be twice as large as that devoted to education, housing, transportation, scientific research, and other economic opportunity initiatives put together. These investments are essential to giving Americans a shot at economic advancement. The longterm debt now threatens them.
But the most consequential impact of the reverse subsidy is not what it will do to programs that allow Americans to climb the economic ladder but what it has already done.
In an effort to blunt the impact of tax cuts on the budget during the last decade, economic opportunity investments have declined for the past 10 years.
According to the Congressional Research Service, non-defense discretionary spending fell as a percentage of national income from 2000 onward. It only rose with emergency stimulus spending in 2008 which has tapered off dramatically. Last year the administration and Congress agreed to $1.5 trillion in cuts which will send spending on education, housing, veterans benefits, transportation and the like to its lowest levels in almost 30 years.
As long as the many subsidize the few through the reverse subsidy, we won’t have the resources to get the American dream going again and to do something meaningful about record inequality. In fact, as Andrea Campbell points out, America collects fewer taxes than almost any other advanced economy, and has the largest gap between rich and poor.
Therefore, the reverse subsidy is a substantial impediment to making progress across a whole host of economic justice issues. Hopefully those currently arrayed around budget negotiating tables in Washington will recognize it as such. If not, average citizens will continue to finance eye-popping tax breaks for the rich, underwriting a key component of the super elite’s wealth, just as they have done for more than a decade.
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