Beware Tax Changes Billed as Balm for the Middle Class

Many perfectly legitimate tax benefits have been enacted with the misguided idea that they would benefit the middle class, when in fact the primary beneficiaries are the rich. Or, as Sen. Bill Bradley (D-N.J.) aptly noted on the Senate floor: “We sometimes have the view around here that the average American makes $75,000, and legislate accordingly.”

With the passage of the Senate tax bill, Congress is set to correct some of the legislative favors for the rich that it has enacted. But many legislators still cling to the idea that members of the middle class are wealthier than they are, either out of ignorance or deliberate dissembling. Even Bradley’s partner in tax-reform legislation, Rep. Richard A. Gephardt (D-Mo.) recently speculated that middle-class Americans have incomes reaching $60,000 a year.

Let us put the middle class into perspective. Its majority is a lot poorer than some publications would have you believe. Only 5% of taxpayers earn $75,000 or more a year. The median income for a family of four is about $26,000, for single people about $18,000. Eighty-five percent of all taxpayers earn less than $40,000. More than half of all taxpayers earn less than $20,000. Middle-class taxpayers have few investments other than homes, which do not produce income. Half the work force is covered by employer-provided pension plans.

If you are starting to see visions of little pink tract houses and tuna casseroles and polyester clothes, you have the idea.

It is a non sequitur for any legislator to assert that the middle class would be damaged by, for instance, the bill’s partial repeal of the sales-tax deduction. Seventy percent of Americans don’t itemize their returns, and most of those in the real middle class don’t have a lot of money to spend. Ditto for the consumer-interest deduction, which the Senate bill also would repeal. Even though members of the middle class have to borrow and consume most of their incomes, the deduction does not help them because most do not itemize.

There will be a lot of flak in the House-Senate conference about retaining a full deduction for sales taxes. It should be ignored for the simple reason that less than one-quarter of all sales taxes paid are deducted--by less than one-third of taxpayers, who are high-income consumers. In short, yuppies (there may be 5 million in the population) benefit. Allowing a deduction for sales taxes makes this form of tax even more regressive because the federal government picks up part of the cost for those who can afford to spend a lot.

The Senate measure’s proposed repeal of the consumer-interest deduction should be viewed as a positive step to encourage people to save. The consumer-interest deduction benefits well-off people who live even better by borrowing. Despite such a repeal, homeowners could still deduct the equivalent of consumer interest by taking out a second mortgage and using the proceeds for consumption. But the deduction does not help the middle-class purchaser of a refrigerator on credit at usurious rates because he usually does not itemize. Nor do students who are borrowing for their education. And even fewer people would itemize under either the House or the Senate bill, because both bills would raise the standard deduction.

Neither the House nor the Senate touched one of the largest and most misunderstood of all alleged middle-class benefits--the home-mortgage interest deduction. That politically sacrosanct deduction is nothing less than a federal housing subsidy for the rich. The more debt that a taxpayer has on his house, the greater the federal subsidy. The deduction primarily benefits realtors and existing homeowners by artificially raising home prices at the expense of all those who come after--that is, first-time buyers and would-be homeowners. Yet to hear the politicians tell it, the mortgage subsidy helps people afford houses. In fact, it works the other way.

The Senate Finance Committee made some mistakes. Under its bill, many middle-class taxpayers would not see their taxes cut appreciably. In a set of calculations that they won’t admit to, members of the Joint Committee on Taxation staff have pointed out that one out of four members of the middle class, especially single persons, would see a tax increase. The average increase for this group would be about $400, which is slightly more than the average tax cut for the other middle-class taxpayers. Meanwhile, the Senate measure would confer huge tax reductions on high-income taxpayers--a problem also present in the House bill.

The Senate Finance Committee realized, to a greater degree than did the House Ways and Means Committee, that lower rates would benefit the middle class more than the current plethora of deductions. The monetary value of any deduction is predicated on how much a taxpayer can afford to spend and his marginal tax rate. A deduction is not the optimal way to help the struggling middle class.