Should the Bush income tax cuts be made
permanent? Answering this question is likely to be one of the first orders of
business for the new Congress. Opponents complain that the tax cut is a
giveaway to the rich. Fat cats are going to get fatter. Defenders of the tax cut
answer that the rich pay a lot of the taxes, so an across-the-board tax cut is going to
help the rich. It's inevitable.
Both sides are only about half right.
Talking about a giveaway makes it sound
like the U.S. Treasury is going to write checks to the richest Americans. But
that's not true. In fact, after the tax cuts are put in place, the rich will pay more
taxes in the future.
How can that be? The real confusion here
is between tax rates and tax revenue. You can cut rates and collect more
revenue. And you don't have to believe in the Laffer Curve or voodoo economics. You just
have to believe in growth, whether it's caused by lower tax rates or other causes.
Between 1981 and 1990, the income tax
revenue increased more than 60 percent even though rates were lower,
because incomes grew. Incomes were sufficiently higher at the end of the
decade so that even at lower rates, more revenue was collected. (The budget
deficits of the 1980s occurred because spending grew 85 percent from 1981 to 1990.)
And even with lower tax rates, the rich
shouldered a bigger share of the revenue burden. In 1981, the richest 1 percent of
taxpayers paid 18 percent of the money collected by the income tax. By
1990, even with dramatically lower tax rates for the rich, the top 1 percent paid
25 percent of the taxes. Today, that number is close to 40 percent.
When opponents of the tax cut complain
that the rich are going to get half a trillion dollars, what they mean is that
the rich are going to pay less in taxes in the future than they would have if rates
were left unchanged. That may be true. But given the usual growth in income, even
with lower rates, the rich will end up paying more in taxes than they do now.
It's not literally a giveaway to the rich.
But fans of the tax cut also are
dishonest. When they say that the rich should get a large share of the benefits from a tax
cut because they pay such a large share of the taxes, they talk about only the
income tax. But what about payroll taxes? A true across-the-board tax cut shouldn't
be limited to the income tax. It also should include the payroll tax that is
paid by every worker, rich or poor.
What we should do is get rid of the
payroll tax and create a tax bracket for low-income workers that leaves their total
tax burden lower than it is now under the payroll tax. Fund Social Security
benefits out of general revenues.
Then we can talk about an honest
across-the-board tax cut. Fans of the tax cut might settle for a smaller tax cut if it
had to be truly across the board. And opponents of the current tax cut might
support it if it helped low-income Americans.
But if Social Security receives its
funding from general revenues, the elderly will have to depend on the will of Congress to
keep benefits intact. If you think that's scary, I've got some bad news for you
that's exactly the world we're in right now. The payroll tax hides the reality.
The Social Security trust fund and the
"lockbox" are accounting fictions. When the baby boomers retire, we'll turn to
those trust funds and find out there are no real assets there, just government bonds
that will have to be paid for out ofyou guessed itgeneral revenue. With or
without a payroll tax, Congress can lower benefits or raise the retirement
age. It is the political cost of such moves that ultimately protects our Social
Getting rid of the payroll tax will lead
to a less polemical debate about tax cuts and a more honest, fair and transparent
tax system. It's probably a little too honest and transparent for a politician,
but I can dream, can't I?