When Will They Ever Learn?
(On Democrats, Tax, and Common Sense)
by Ed McCaffery
The Democrats’ failure to learn the most basic lesson about taxes – people don’t like to pay them -- has not only hurt them in presidential elections, ceding the position to conservative rivals, it has also affected the shape of tax policy. By not having a tax policy, Democrats fail to advance a progressive tax policy. And so when we do get tax cuts or tax reform, we get conservative tax cuts or tax reform.
Bush’s tax plan in the campaign was simple and clear – across the board tax cuts, kill the marriage penalty, kill the death tax. There were a few other twists, largely gratuitous, but the basics were apparent enough. Now President Bush is pushing through a 1.6 trillion tax cut, and the odds are that something rather like it will get enacted, and probably contribute to Bush’s popularity. That’s what happened for Ronald Reagan, and Democrats would be fools indeed to discount the possibility of a recurrence.
Let’s go back to help understand the future. Ronald Reagan had two principal campaign themes: the evil of the Soviet Union on the foreign front, and the evil of taxes on the domestic one. He ran advocating a major tax cut, and in 1981, in his first term, he delivered, with Democrats flocking on board. The 1981 tax cuts were more than twice the magnitude of what Bush II is proposing. But Reagan always cast a large shadow. In his second term, the Master Communicator struck again, after defeating Walter Mondale, who inexplicably called for tax increases in his Presidential campaign (a sin that no amount of likeability – and Fritz couldn’t outdo the Gipper in this regard, anyway – could overcome). The Tax Reform Act of 1986 saw further cuts in the income tax rate structure.
Both the 1981 and 1986 tax cuts transpired with lots of bipartisan support. But Republicans, fresh from electoral defeats of Democrats fueled by their tax stance, were in charge. The top marginal income tax rate when Reagan took office was 70%, as it had been ever since JFK cut it from 90% in 1963. Within five years, Reagan had brought that rate down to the previously unthinkably low level of 28% -- as close to a flat tax as we have ever come. But what is still not all that well known is that, on balance, Reagan wasn’t much of a tax cutter. He slashed individual income tax rates, as we have seen, but raised personal payroll taxes and business taxes to largely offset them.
That wasn’t progressive stuff. Today, some 70% of Americans pay more in payroll than in income taxes; this tax is in essence a flat 15.3% wage tax, up to the first $80,000 of earnings, after which it falls to the 2.9% medicare tax alone. (Both percentage figures are doubled to reflect the employer’s share as well as the employees -- all economists agreeing that the employee bears the real burden of his boss having to pay the tax.) Business taxes are more complicated — and yet another example of the absence of sound progressive tax policy – because businesses don’t really pay business taxes. They have to pass the costs on to someone. Whom? If you are thinking “shareholders” – think again – it isn’t rational for a capitalist with any choice to take a lower rate of return from a taxed investment when he can purchase an untaxed one. Almost all economists now agree that the real burden of business taxes falls on wage earners, yet again.
So Reagan was the Robin Hood of tax policy. He took from the rich and gave to the poor. But since what he was taking and giving were tax burdens, there is something perverse about this. Or so a progressive might think.
Post Reagan, the income tax is a rich person’s tax: 40% of Americans don’t pay it, and the richest 10% pay more than 50% of its total burdens. So if one cuts income taxes, he helps the rich. The only way to help the rich more would be to repeal the gift and estate or so-called death tax, which is only paid by the top 1-2% of the income ladder. Bush II is proposing to do both, of course, and Democrats, by and large, are scurrying to support him.
Now what could Gore and the Democrats have said, to advance a truly progressive tax agenda? How about these five simple steps for starters:
1. Across the board income tax cuts: from the bottom up.
Instead of starting from the top down, as Bush proposes, why not make changes to the income tax from the bottom up? We could raise the standard deduction, thereby getting millions of lower middle income taxpayers off the tax rolls altogether. If we still wanted to do more, cut the 15% bracket – alone – to 10%, or less. Upper income taxpayers would get some relief, but most of it would go to the middle. This would match Bush’s simplicity with a more egalitarian outcome.
2. Marriage penalty reform: bottom up or pro working family.
The marriage penalty is still not all that well understood: as I explained in my first book, Taxing Women, two-earner married couples pay it, while one-earner ones get a marriage bonus under today’s tax system. Bush’s proposal to address the marriage penalty features a secondary earner deduction, 10% of the lesser earner’s salary up to a maximum deduction of $3,000: the same law we had in place from 1981 to 1986, with the same dollar limits, unadjusted for inflation. What’s nice about this idea is that it helps just those people hurt by marriage penalties: two-earner families. What’s not so nice is that it’s not much help. More help would come from doubling the standard deduction, adjusting the payroll tax to create a second earner deduction, or more generous child-care, not per child, tax credits. Gore (as well as Clinton) actually touted the first of these ideas, but it was buried in the mind-numbing complexity of his other twenty-eight tax proposals.
3. Estate Tax repeal: not a bad idea, for a price.
I have long been writing about – mainly against – the gift and estate or so-called death tax. I have testified in Congress, and my ideas are part of the current climate supporting repeal. But I have been making a specifically liberal or progressive argument against these taxes, based on the simple idea that we should want our richest, most economically productive citizens to save. Why tax the person who dies with wealth, encouraging him or her to spend it all? One thing progressives ought to do is to pay attention to popular sentiment; the death tax is widely unpopular, and there are progressive ways to repeal it.
I believe that Gore and other Democrats should support repeal, but in the context of fundamental tax reform that (a) eliminates all taxes on savings and (b) increases taxes on luxury spending. My idea, patterned after actual tax proposals such as the Nunn-Domenici USA Tax idea from the mid 1990s, would implement a progressive consumption tax, one that consistently falls on spending, not work or savings alone. Heirs would pay tax when and as they withdrew money from savings to spend on themselves: think of unlimited IRA accounts, which could be passed on without tax, on life or on death, but which would be taxed on withdrawals. It’s perverse that the rich should be getting income tax breaks along with estate tax repeal – we’re giving them more cake, and letting them eat it, too.
4. Payroll tax reform: an 800 pound gorilla.
The reason the Bush tax cuts favor the rich is that they are income (plus estate) tax cuts. The bottom 40% of Americans by income level don’t pay income taxes. But they do pay payroll ones – at a basic flat rate of 15.3%. What’s that, you say? You thought payroll taxes were only 7.65%? Think again. You pay that, but your employer pays a matching share. But that’s money that, to an employer’s mind, comes out of your pocket – if your boss didn’t have to pay Uncle Sam, he could in theory pay you. Economists all agree that employees in fact bear the employer’s share, just like consumers really pay the sales tax that retailers send into state governments.
But, you say, won’t cutting social security taxes jeopardize social security benefits? Once again, think again. If we can afford to cut $1.6 trillion of federal taxes, what difference does it make which taxes we cut? If we cut the payroll tax and put the income tax revenues into the social security system, no one would notice the difference.
If we want to reach the working poor, lower middle, and middle classes, it’s the payroll tax, not the income one, we should be cutting. Payroll tax relief can and should happen. But it will most likely have to come with a Democrat -- and one who understands taxation -- at the helm. Any takers?
5. IRS Compliance: The dog’s not barking
Finally, while I’m at it, I’ll throw this issue into the progressive tax policy agenda: let’s increase IRS compliance efforts. Why not? Audit rates for the very rich have actually fallen below those for the working poor, who often get hassled for claiming the Earned Income Tax Credit. Additional dollars on IRS enforcement would more than pay for themselves in greater collections. A simple idea is to pay IRS officials more, to keep some parity with what private market tax experts -- who advise the rich on how to avoid taxes -- get: a level playing field, so to speak. It’s ironic and agin perverse that the more the income tax gets limited to the rich, the less we pay people to enforce it.
How’s that for a progressive tax reform agenda? Imagine where we might be if Al Gore had stood up in the debates, and agreed with his opponent: we do indeed need simple, across the board tax relief. Let’s:
- raise the standard deduction, to get millions of Americans off the tax rolls;
- eliminate all taxes on savings, including the estate tax, so that we can have class teamwork, with the rich helping us all through their savings, not class warfare;
- eliminate the marriage penalty;
- cut payroll taxes for the poor and middle classes; and
- improve IRS enforcement by raising salaries to be competitive with the private market.
If that had happened, we might have a progressive President and a progressive tax policy.
Some day, maybe. Until then, we can dream.
EDWARD J.. McCAFFERY is the Maurice Jones Jr. Professor of Law at USC Law School and a Professor of Law and Economics at the California Institute of Technology. His first book, TAXING WOMEN (U. Chicago Press, 1997 and 1999 (paper)) was selected as THE PROGRESS REPORT'S Book of the Year for 1997. His second book, FAIR NOT FLAT: A SIMPLER AND FAIRER TAX SYSTEM, will be published in 2002 by U. Chicago Press.
This article copyright 2001 by The Progress Report and Edward J. McCaffery. All rights reserved. No part of this
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