Here’s Why Tax Rates Should Vary With the Economy

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They say there are two certainties in life: death and taxes, but what is even more certain is that our current tax code is hated by pretty much everyone. On one side are low and middle income earners, who resent the preferential tax treatment of capital gains and corporate tax loopholes, while on the other side are the wealthy, who resent being forced to pay more in taxes as their income bracket increases.

The issue of socio-economic fairness in taxation will not be easily resolved but one approach could mitigate the problem for both taxpayers and the government.

When business is good and unemployment is low, there is less need for the government to support the economy and less need for high taxation, but there is also less resentment towards wealth accumulation since the majority of people are financially comfortable. Exactly the reverse happens when times are bad. Therefore, since it is the economy that determines both the need for taxation and our attitude towards it, it stands to reason that the ideal tax code should be tied to the economy, and vary with it.

Logically, when the economy is bad, the government needs to pump money into the system in order to jumpstart growth, not take money out, and so high taxes make no sense. What would make sense is for the government to peg tax rates to GDP, unemployment, and other indicators of economic health, reduce them during a recession and ratchet them back up as the economy improves.

For argument’s sake, the government could lower the tax rate on ordinary income to 15 or 20 percent (with capital gains and other taxes going down proportionally) during a downturn and bring it back up to the current level gradually. This has the dual benefit of providing an immediate stimulus to citizens while reducing the need for the government to increase the money supply (as it had to do during the post-2008 recession). In addition, any deficits the government runs up during the downturn could be made up by the taxes generated in better times.

The central idea behind variable tax rates is not to expand or contract the total tax pie but to smoothen out the money supply during economic cycles. From the government’s standpoint, tax receipts are lower during a recession anyway (since people make less money), and since high taxes can actually impede the pace of recovery, lowering taxes in the near term is a smart course of action. The faster the economy recovers, the sooner the Treasury can increase its tax receipts, especially as tax rates rise in pace with economic growth, and from the taxpayer’s perspective, relief during tough times is exactly what is required to help people and businesses get back on their feet and return to productivity.

The tax code can never be perfectly ‘fair’ since people’s definition of fairness itself can differ by their personal income level, but by timing taxes to the nation’s capability to pay them, the government can do a lot to reduce the burden on every strata of society and lessen the pinch of perceived (or real) inequality. Since both political parties agree that our Byzantine tax code needs to be rationalized, variable tax rates might be a good place to start.

SANJAY SANGHOEE is a political and business commentator. He has worked at leading investment banks Lazard Freres and Dresdner, as well as at multi-billion dollar hedge fund Ramius. His opinion pieces appear in Christian Science Monitor, TIME, Bloomberg Businessweek, FORTUNE, and Huffington Post, and he has appeared on CNBC’s ‘Closing Bell’, MSNBC’s ‘The Cycle’, TheStreet.com, and HuffPost Live on business topics. He is also the author of two thriller novels. For more information, please go here.

3 comments
dellflorida
dellflorida

Maybe tax rates should be indexed to the Consumer Price Index and go up when inflation goes up.