A central Republican criticism of the $1.9 trillion Covid “stimulus” Democrats plan to ram through Capitol Hill is that taxes will have to rise eventually to pay back all the debt funding this spree. That’s more controversial than it ought to be—Democrats and their intellectual enablers seem certain money grows on trees—but it also elides an interesting question: Which taxes?
This is what no one bothered to talk about when Federal Reserve Chairman Jerome Powell testified to Congress this week about the current conduct of monetary policy—and yes, I mean taxation. Theorists and practitioners increasingly blur the lines between monetary and fiscal policy on the spending side of the government’s ledger. The next shoe to drop will be the entanglement between the Fed and Treasury on the revenue side.
Mr. Powell already does his part and then some by suppressing government borrowing costs for that large and growing portion of the federal budget Congress chooses to pluck out of thin air. This commitment was on display this week, although only obliquely since convention dictates no one admit the Fed cares about the government’s financing needs.
Mr. Powell talked up the Fed’s ability to stimulate economic growth as Covid-19 recedes, touted the stimulative potential of the kind of fiscal blowout Democrats are contemplating—and still predicted economic growth sluggish enough to justify low rates for a protracted period while also expressing a willingness to sustain exceptionally loose policy through any short bouts of inflation this nongrowth might produce. If this sounds contradictory, remember the only point that matters is the one lawmakers (and markets) actually heard: Low federal borrowing rates forever, no matter what happens.
Expect monetary policy to bleed slowly but surely into tax matters as well. The vector will be capital-gains taxation, which is booming in the current recession, contrary to all economic logic.
Surging capital-gains revenue helps explain why blue states such as California aren’t currently in the red. Politicians are taking notice. Minnesota’s and Washington’s governors are proposing higher capital-gains tax rates, the Journal reported this week, as are Democratic lawmakers in Connecticut. Some New York Democrats aim to leave no capital gain behind, even the unrealized sort—a plan is on the table to mark taxpayers’ assets to market and then tax paper gains every year.
Capital gains also figure prominently in most Democratic plans to tax the rich at the federal level. President Biden proposed on the campaign trail last year that wealthier filers pay a capital-gains rate equal to their ordinary income rate, which he would raise to 39.6%.
Note that if you’re of a tax-raising bent, this is a conversation worth having thanks only to Mr. Powell and his predecessors. Capital-gains tax revenue should be highly pro-cyclical, rising when the economy booms and sagging during downturns. Yet a perusal of data from the Organization for Economic Cooperation and Development suggests that, except for the panic of 2008, the revenue troughs of recessions in recent decades (measured as a percentage of overall revenue) have been successively shallower. There may not be a trough at all this time around.
It’s a fiscal consequence of the Fed’s growing skill at asset-price reflation. Treasury will benefit from Mr. Powell’s success in stoking stock and other asset markets to record highs over the past year even as the pandemic and attendant lockdowns throttled the Main Street economy. The growing disconnect between Wall Street prices and Main Street profits holds open the prospect that capital-gains taxation will grow ever more reliable as a revenue source. Expect lawmakers to take full advantage.
If it happens, this will mark a new and very different way of taxing Americans. The government traditionally relied for revenue on the economy’s underlying productivity. The overall dependence on personal-income and corporate-profits taxation ties fiscal health to wage growth and corporate success. This was a practical incentive, although not always a strong or effective one, for lawmakers to care about the Main Street economy.
To make the government proportionately more dependent on Fed-inflated capital gains, as Democrats are wont to do, would weaken an important tie between Congress’s fiscal role and the real economy. This is especially dangerous given mounting evidence in the economics literature that monetary and financial excess saps Main Street productivity rather than bolstering it.
Free-market critics of Mr. Powell and his predecessors argue that the “financialization” of economic activity that results from current monetary policies is profoundly dangerous to the economy and damaging to society. Now we may end up financializing revenue collection, too.
This story has been published from a wire agency feed without modifications to the text