Cut the Tax on Capital Gains, Open the Door Again to Special Interests : Revenue: Reduction won’t benefit the middle class, as Bush claims. Adjusting Social Security and cutting spending are the real answers.

Money, it is said, is an emotional intensifier. Tomorrow--April 16--is tax-filing deadline for most of us, and prompts intense reflection on the current state of the American government. Most of the reflections, unfortunately, are melancholy.

Ever since Ronald Reagan pushed through his first tax-reform act almost a decade ago, successive waves of tax changes have roiled the Congress, disrupted business and confused the taxpayer. Congress and the Bush Administration are once again caught up in a frenzy of tax tinkering, marked by posturing, prevarication and, sadly enough, outright ignorance on all sides.

Most of the blame for the current confusion rests squarely with George Bush. Oddly enough, for a man of such normally supple ideologies, he seems hellbent on pushing through a capital-gains tax reduction, regardless of the cost in political comity and congressional relations.

For all its flaws, the current tax law, passed against great odds in 1986, established the laudable principle that taxes exist primarily to raise revenue. The 1986 law was a kind of self-denying ordinance. By setting a generally low overall tax rate and eliminating a large number of exclusions and deductions, the government forswore trying to micromanage the economy through the tax law. Experience showed that all such efforts invariably went awry, skewing economic activity and creating a parasitic tax-shelter industry for the benefit of the idle rich and their lawyers and accountants.

Changing the capital-gains tax violates that hard-won principle, and inevitably, has opened the flood gates to a host of additional proposals to benefit this or that special interest. Perhaps even worse, the Bush Administration’s defense of its capital-gains tax has produced a caterwauling of statistics that marks some sort of a new low in the misuse of numbers for political purposes. It is flatly false that a capital-gains reduction will benefit the middle class, as Bush claims. Almost all the benefits will accrue to people with six-figure incomes.

The capital-gains tax debate has reopened the controversy about who benefited most from the 1986 reforms. The facts here are simple, although they’ve been obscured in the clouds of confusion. The rich are paying more taxes than ever before--but their incomes have risen even faster than their tax bills, so they are relatively much better off. It’s not clear why the Administration is trying to hide this fact--after all, it’s what the supply-siders said was supposed to happen. If tax rates are lowered, people will make--or declare--more income and revenues will rise.

Enter now the liberal wing of the Congress, charging that tax reform has shifted tax burdens disproportionately toward the poor and middle class. There’s subtle prevarication involved here as well.

The lower half of wage earners are, in fact, carrying proportionately more of the tax burden than they used to. But that’s not because of the 1986 tax reforms, which actually eliminated income taxes for most of the working poor. It’s because of Social Security tax increases, pushed through the Congress in 1983 by a bipartisan coalition, prominently including none other than Sen. Daniel Patrick Moynihan (D-N.Y.). Congress rallied behind the Social Security tax increases after it had shouted down Reagan’s ill-scarred attempt to roll back middle-class entitlements in 1981.

And now, of course, it is Moynihan who is lashing out hammer-and-tong at the Social Security tax as though it were some kind of rich Republican plot. Moynihan is right, of course, that a tax levied only on the first $51,300 of income is harshly regressive. But he has not had the courage to pursue his analysis to its obvious conclusion.

Social Security taxes have grown so oppressive because of runaway entitlements programs, a substantial portion of which flow to people who don’t need them. Shockingly, only about 20% of federal transfer payments are means-tested. But the middle classes like their entitlements, and as last year’s catastrophic health-care fiasco proves, Congress will always quail before the organized power of the well-off old. By breaking the link between entitlements and the payroll tax, as he proposes, Moynihan will simply guarantee that benefits can spiral endlessly out of control, their true cost lost in the foggy reaches of the U.S. budget deficit.

This brings us to the link between Social Security taxes and the budget deficit. For once, the confusion surrounding the use of Social Security “surpluses” to mask the true size of the federal operating deficit seems born of honest ignorance rather than political cynicism.

The Social Security Trust Fund cannot build up a surplus the way a private saver can. Excess payroll taxes are invested in government bonds, which are simply a promise by the government to make a future payment--an IOU--just as the government’s promise to make a future entitlement benefit is an IOU. It is merely substituting one federal IOU for another.

Social Security payments are always made out of current national income. If old people have a high proportionate claim on real resources--food, clothes, cars, houses--in the year 2015, for example, other people will have less, regardless of the level of payroll taxes in 1990. Social Security payments, that is, are always a transfer between current generations.

Surpluses now ease the future Social Security burden only indirectly. To the extent the government reduces its current spending, there will be more money for productive industrial investment (although there is no guarantee it will be invested productively). Wise investment now will mean a bigger, healthier economy 20 years from now, so the drain of resources to the old will be less painful.

So how can we “squander” our Social Security surpluses on the federal operating deficit, as Federal Reserve Chairman Alan Greenspan has charged? Squandered Social Security surpluses are no different from any other squandered tax resource. Tax dollars that are siphoned into subsidies for wealthy farmers, or pin money for the well-to-do elderly, or B-2 bombers that no one knows what to do with, waste national resources and create less wealth for future generations, no matter which pocket the taxes come from.

But the answer to that problem is to cut foolish and wasteful spending, not to raise more taxes. And that, Congress and the Administration have proved themselves wholely unable to do.