The International Monetary Fund (IMF) offered a blunt message to international policymakers in advance of its annual meeting earlier this month: By cutting taxes for the wealthy, politicians are jeopardizing economic growth globally and undermining prosperity.
“Increasingly, we’re aware that tax systems have to be cognizant of how they affect inequality. And there’s a need in a number of countries to be especially attuned to the needs of the middle class and those with incomes below the median,” said Maurice Obstfeld, the chief economist of the IMF.
Offsetting Inequality Through Taxation
IMF research has consistently shown that the redistribution of wealth through taxes can offset inequality. For example, research by the fund discovered that in the decade between 1985 and 1995, redistribution via taxation offset 60 percent of increases in inequality generated by market forces. Between 1995 and 2010, however, research showed that income tax systems did not respond to continuing increases in inequality – and as a result, inequality has increased significantly, including in the U.S. The IMF has pointed out that the West’s most advanced and developed economies have seen dramatic increases in income inequality over the course of the past decades and has argued that this inequality is largely the result of significant gains in income made by the 1 percent.
So, what’s the solution? The IMF argues that a progressive tax structure is key – meaning that as a person’s income increases, the percent of income tax he or she is expected to pay also increases. Many developed economies currently have a progressive tax structure. However, this has come under threat as politicians seek to cut taxes for the wealthiest. Moreover, this progressivity is undermined by substantial tax windfalls for the wealthy, even when the base income tax rates don’t actually change.
“Personal income tax progressivity has declined steeply in the 1980s and 1990s, and has remained broadly stable since then. The average top income tax rate for OECD member countries fell from 62 percent in 1981 to 35 percent in 2015,” Vitor Gaspar, director of the IMF’s Fiscal Affairs Department, and Mercedes Garcia-Escribano, deputy division chief in the IMF’s Fiscal Affairs Department, explained in a blog post on the IMF’s website. “Tax systems are less progressive than indicated by the statutory rates, because wealthy individuals have more access to tax relief.”
The Resonance of the IMF’s Warning in the U.S.
The IMF’s warning was directed at developing nations across the board. However, many have pointed out that it has a particular resonance with the Trump administration. The administration – and its Republican allies in Congress – are working to push forward a tax plan that many allege will seriously exacerbate income equality in the country by giving tax breaks to the wealthiest in the U.S., ultimately decreasing tax progressivity.
President Trump has insisted that wealthy Americans will not benefit from the plan. Critics, however, allege that his proposal includes a number of measures that essentially amount to tax windfalls for the rich. For example, President Trump’s plan would reduce the tax rate of the highest income bracket from 39.6 percent to 35 percent, repeal the estate tax (which currently only affects estates with a value of over $5.49 million), and reduce tax rates on what are known as “pass-through entities,” or businesses whose owners pay federal income tax on their profits.
Obstfeld specifically said that the U.S. needs a tax plan that would generate revenues that would allow it to invest more in infrastructure and provide more services to its aging population.
Progressive Tax Structures Don’t Have to Undermine Growth
In conclusion, the IMF’s stance is that progressive tax structures are needed to prevent further growths in income inequality. And these tax structures need not undermine economic growth. “Importantly, we find that some advanced economies can increase progressivity without hampering growth, as long as progressivity is not excessive,” Gaspar and Garcia-Escribano said.