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How the 'Buffett Rule' Helps the Economy

This week Congress dodged debate on the "Buffett Rule" which would require Americans earning more than a million dollars per year to pay tax rates of at least 30 percent. Opponents claim that any tax increase undermines economic growth. Supporters stress equity and the impact on the federal deficit. Truth again lies buried under the polarized rhetoric. Far from discouraging investment, the Buffett Rule—and similar measures—will boost productivity and strengthen the economy.

The Buffett Rule is a first step toward reversing a growing income gap that corrodes economic growth and productivity. The gap can be seen in the chart below, which shows the divergence in income growth for different segments of the population.

The chart shows that while the economy became much more productive over the past 30 years, nearly all the gains from that productivity boost flowed to the top few percent. Meanwhile, everyone else has received no share of that productivity increase. Their incomes have stagnated.

A large part of the income gap in this chart is due to one-sided federal tax policy. Cuts in the estate tax, cuts in the tax rate for dividends and capital gains, and cuts in the top tax brackets all shift money to the top tier.

Let's set aside for a moment the moral implications of the chart. Let's set aside the potential for social unrest and demagoguery if this trend continues. This widening income gap hurts the economy. The trend constricts the capacity of consumers to fuel growth through spending. (In fact, many consumers still have significant debt to pay off.) And it reduces the ability of American families to educate their children enough to work in our advanced high-tech economy.

How the Buffett Rule stimulates economic activity

The Buffett Rule can usher in a long-overdue series of corrections that restore balance in the economy. These corrections would shift the tax load back toward top income earners and away from ordinary working Americans. They would renew government investments in education and other productivity-enhancing programs.

These measures would strengthen the economy in several ways.

  1. Shifting disposable income from the top brackets back to the middle would stimulate the economy. Ordinary working Americans tend to spend their income increases quickly as they purchase cars, home improvements, and other goods and services. Their spending circulates widely and leads to purchasing by others. In contrast, income gains by those at the top lead to rising prices of homes, fine art, stocks, and other assets. But this bidded-up value does not circulate through the economy much. It does little to stimulate broad based growth.
  2. New public funds from the Buffett Rule should be invested directly in programs that increase the skills of America's workforce, which have slipped in comparison to international competitors. This can be done in two ways: We can provide tax credits for educational expenses. Or we can boost direct funding of higher education so that tuition costs come down. Imagine the effect if instead of cutting the capital gains rate, we used the same funds to support every family whose child pursues a college degree in a science, technology, engineering, or math field, known as the STEM field. The cost would be the same, but the productivity gain would be far greater.

We have been driven to the brink by a combination of one-sided tax cuts at the top, paid for by service cuts that reduce the productivity of the rest. While this has enriched a few, it endangers the American economy as a whole. It's time to invest in our mutual ability to contribute and compete. The Buffett Rule and other changes that raise effective rates at the top are a crucial first step.

April 19, 2012

(A version of this was posted earlier at www.usnews.com)