The economist on income tax, bankruptcy, small business and social security.

Question: How should income tax be reformed?

Dean Baker: Well, I think restoring the tax rate to the Clinton era rate is a good one; maybe go a little bit higher. I’m worried about going too much higher because I think there is something, not so much the disincentive effects. The classic story that the conservatives like to tell us if we tax people 50% then they wouldn’t work. I don’t believe that. I just worry more that you create a lot of incentives for gaming, for tax shelters. So I don’t mind the Clinton era top rate of 39.6% on the highest income people. You can certainly knock that up two, three, or four percentage points and I don’t think you’re going to have big problems. But if you push it too much higher, I think you would have problems. I would want to get rid of a lot of the unfairness in the tax code. One of the things that jumps out at me that President Obama actually is addressing in his budget is what I call the fund manager’s tax break, where if you run an equity fund or hedge fund, you pay taxes at the capital gain tax rate rather than the normal income tax rate. That allowed many of the wealthiest people in the country to pay a tax rate of 15% as opposed to a firefighter who pays the 25% tax rate. That was pretty unfair so I would like to get rid of that along those lines. I actually would like to see capital gain income tax at the same rate as ordinary income as well, which was actually a Reagan era form. So that’s not that radical a notion from 1986. They had capital gain income tax at the same rate as normal income. So those would be some of my priorities.

The last one that I think is a really good way to raise money, both since it raises a lot of money and also reins in the financial industry, is a modest tax on financial transaction, stock trades, sales of options and futures. If you had a very modest tax, England taxes the stock traded at a quarter of 1%, so if you buy a share of stock, you pay a quarter of 1%, same when you sell it. They raise the equivalent relative to their economy of $30 billion a year on that. I would apply it to broader instruments. I’d also have an options, future, credit default swaps, the whole range, lower rates on those instruments but the whole range of financial assets. You could easily raise over a hundred billion dollars a year that way and that’s a tax that would have a minimal impact on people who are investing. Again, they won’t like the tax. No one ever likes to pay taxes. But no one who’s looking to hold stock for five or 10 years is going to be that affected by paying a quarter of 1% when they buy and a quarter of 1% when they sell it. But they will have a very big impact on the people who are actively trading, buying at 2:00, selling at 3:00. And also, the other big impact will be on the financial industry. It will take a chunk out of the hide of the financial industry which I don’t have a problem with. It has grown too large. This is a very good way to rein it in and the way I think about it is that if you go to gamble at Atlantic City, you get taxed. You pay about six percent tax on your gambling. Not on your winning. Just on your gambling. We could do the same on Wall Street.

Question: How can we leverage immigration to restore the economy?

Dean Baker: Well, there are a couple of points in immigration. First off, we have to be clear what’s going on. We’ve had a policy of people coming over to work here and that’s been an explicit policy even though it violates the law. And the idea was that gave cheaper labor than you could’ve gotten by hiring domestic workers. And that has two effects. Obviously, we have all these people come in from poor countries working at lower wages. And secondly, it does have an impact on the less educated portion of the work force. I know there’s some economic literature that finds mixed results but I’m inclined to agree with those that do find an effect on the face of it. When you talk about having more than 10 million workers come and competing with you, it’s a little hard for me to believe that it doesn’t have a downward impact in your wages. But anyhow, what I would say is that we do want to give those people full rights, let them become citizens if they choose, let them have green card status, et cetera. We want to ensure they have full rights just like workers in the United States and enjoy being in a position where they could improve their situation on the job and improve their living standards. You are going to need to regulate immigration going forward, which has to be done at the employer level: there have to be serious sanctions.

Now, the high-end workers: we have, in fact, had employer sanctions. You can’t have hospitals and law firms and universities just bring in huge numbers of immigrants and undercutting their existing workforce. That’s actually against the law and no one really tries that because if they did they would be cracked down on. So you don’t get Wal-Mart university or Wal-Mart hospital bringing in a huge number of professionals from India or some other country. And I think that’s actually unfortunate because I think it will benefit the developing countries, benefit the United States to allow more free flow of highly skilled immigrants. And it will benefit us because we would get—it’s exactly the same argument we make about trade, except it will be at the high-end rather than low-end—we would get medical services, legal services on down the list at much lower prices if we allow people from developing countries who are willing to work for lower wages because their wages in their home country are so low that it will still be a big jump up if they work for two-thirds the wages that our professionals receive. So we will get a huge benefit that way. Those workers themselves hugely benefit and there was a huge increase in living standards. And we could structure it so that the [home] countries benefit. We in effect would have some sort of tax associated with basically repaying them for their training cost in India, in China, whatever country it might be so that they might be able to educate two or three doctors for every doctor that came to work in the United States. So I think we could structure this in a way—economists like to talk about trade as being a win-win. It’s often not that way. You have a lot of losers in that story. We could structure this in a way that actually is a win-win, where people in the United States would gain, the immigrants coming to work here would gain and the home countries gain as well if we ensure that a portion of those wages were repatriated to educate more workers.

Question: Does bankruptcy law need reforming?

Dean Baker: Well, it’s interesting. It seems you’re referring to the bankruptcy reform passed a few years ago. It’s striking that one of the issues that’s been hotly debated in Congress is an effort to change bankruptcy law so that people who are going into bankruptcy could have the terms of their mortgages reissued. Right now mortgages enjoy privileged status: that contract alone cannot be reworded by a bankruptcy judge. They could write down credit card debt, car loan debt, any other form of the debt but residential mortgages cannot be rewritten. And one of the arguments that the industry, the banking industry, has trotted out is they’ve talked about the sanctity of contract, that we don’t want to create uncertainty. Now, back a few years ago, they changed the bankruptcy law to make it much harder for people to declare bankruptcy. Then, they actually did reword contracts so you could’ve borrowed money under the old bankruptcy regime where it was, I won’t say easy, but at least much easier to go into court and have your debts annulled. And then, they change the terms of the contract on you so it became much, much harder. So this inconsistency is striking, but I would argue that, in general, you do want people when they’re in over their heads to be able to go into bankruptcy and alleviate much, if not all their debt.

There are two reasons for this. One is a moral issue: typically people who—and we have data on this—end up going into bankruptcy, it’s not that they were irresponsible. Instead, they’ve lost their job, there’s a family break-up or there’s a health problem in the overwhelmingly majority of cases. Really, people are generally falling in bad straights.

The second is an economic consideration. What we’re saying if we have the punitive bankruptcy laws that we really have now is that we’re, in effect, imposing large taxes. We’re having the government chase after people to tax their income, often at very high rates. And all these people complain about taxes. Well, it’s exactly the same thing if you’re having your wages taxed to repay old debts. So rather than having the government chase after people to force them in five, 10, 15 or 20 years to pay debts that they incurred, maybe when they’re very young, I think it makes much more sense to say, if you end up in bad straights, you’re not going to have to repay the debts. And let’s flip this over. No one gets into debt like that unless someone lent them money. So what this means is that there was a bad decision on the part of the lender. They judged credit risk poorly. And thinking from a free market standpoint, if you judge credit risk poorly then maybe you’re not a good business person and maybe you shouldn’t be in business. So in effect, what we said with the change in bankruptcy law is we are rewarding bad business practices. You had a lot of businesses that had made loans to people who couldn’t afford to pay them back and rather than telling those businesses to next time be more careful who you lend money to, we said, we’re going to help you get that money back. And I think that’s absolutely the wrong way to go.

Question: Do small businesses deserve special protections?

Dean Baker: I take a very mixed stance on small business. I think we want people to be able to start business. We want to create opportunities for them and make sure that there is a level of playing field. But I think in many ways, we’ve gone overboard. There are all sorts of provisions in the tax code on various regulations that have exemptions for small businesses: special loans that are available that amount to very large subsidies. You have to ask yourself, how much money do we want to give someone just because they’re opening up a business? [Opening a small business is] a reasonable thing for you to do but should tax payer, should an ordinary worker, should someone who’s working at a clothing store have to pay more money in taxes because someone across the street from them opened up a business which might well go under? For a lot of people opening a business is a bad choice for them. Most small businesses fail. I understand people wanting to give it a try and everything but we’re not necessarily doing them a favor to say, take all your life savings, borrow to the hilt, and then struggle for three years and end up with nothing. We’re not necessarily doing them a favor. So I just say we need clear eyes on this.

Some of the practices I mentioned in the book, we exempt small businesses from safety regulation. I was particularly struck by this with mining: if you’re a mine owner and you’re below a certain size, you’re not subject to safety regulation. I’m no more anxious to see a miner die in a small mine than in a large mine. I mean, it just doesn’t make any sense to me. So you have to look at this with clear eyes. So we do want people to have opportunities to open small businesses. I think it’s a good idea to have special loan facilities to be sure they have adequate access to capital. When we award government contracts, we should make sure that they’re accessible to small businesses. These sorts of things that we do, we should do more of that are reasonable in terms of allowing a level playing field between larger and smaller businesses. But on the other hand, I think we often have gone overboard. It doesn’t make sense to tax people to give money to someone just because they’ve opened a small business. That’s not a badge of honor. I don’t think anyone should pay higher taxes just because their neighbor opened a small business.

Question: Is social security going bankrupt?

Dean Baker: Well, it’s only threatened politically. There’re a lot of people who want to cut it back, but in terms of the viability of the program itself, we don’t have the latest, post-crash from the Congregational Budget Office. But the projections that they put out last summer show the program could pay all benefits through the year 2049 with no changes whatsoever. And even if we never did anything, it could still pay about 75% of projected benefits, which will be higher than what retirees are getting today. So what that would mean is if we just put the thing on autopilot, never paid any attention to it at all, come 2060, 2070, 2080, retirees in those years will be getting considerably more money than retirees do today. So this idea that there’s some huge problem is simply not true.

There’s a long range problem. It stands from the fact we’re projected to live longer, which hopefully will be true. So somewhere down the road we’ll have to make adjustments and that could take the form of raising taxes at some point in the future or we might decide to raise retirement ages. Maybe people have to work a little longer in their life, but it’s a distant problem. It’s very different from the way it’s being portrayed that here’s this program that’s about to go bankrupt. And it’s particularly pernicious that people are talking about doing something to it now. Because the workers in their 40s, their 50s, even 60s who are about to retire, they are just seeing everything they work for disappear. If they had equity in their home, much of that equity has just disappeared. They had put money in the 401-k. Most people, of course, haven’t put very much in 401-k retirement plan but let’s say they had, they just lost 30%, 40% of that. So the idea that you will take money away from these people at the age of retirement who just lost trillions of dollars, that’s really pernicious. And it’s remarkable to me that there are so many politicians that are willing to get out there and say that. Actually, I shouldn’t say that because they usually don’t put it in those terms but that is what they’re trying to do. So it faces a very real political threat.

Remarkably, the biggest threat is from the people who brought on this disaster. Look at Peter Peterson, certainly a big advocate of social security benefits. Here’s a man who worked on Wall Street, got very rich working at Wall Street and he’s using much of the money that he earned to try to undermine social security so that other people can’t enjoy a decent retirement. So his effort to take away the money from people who’ve worked for this is incredibly pernicious. They paid in for those benefits. We’re not giving them a gift. They paid for them. They paid taxes for them. And secondly, that the people are leading the charge are exactly the same people who brought on this economic disaster.

Recorded on: April 28 2009