If You’re Middle Class, You’re Getting Soaked : Taxes: With the recent efforts to make the tax system fairer, the middle class is now paying more than its fair share.
Most middle-income voters will be more than a little cynical when they hear politicians in Washington debating “tax fairness.” After 10 years of illusory tax “cuts” and phantom tax “simplification,” many understandably think that, whatever the politicians do, middle-class taxpayers will be left holding the bag.
The problem is that Washington in the 1980s abandoned the idea of tax progressivity--the concept that people should pay taxes according to their ability to pay.
Of course, it’s easy to see why poor people prefer progressivity. Progressive taxes take a larger share of income from those who make more. And self-interest suggests that rich people might like regressive taxes--which hit the poor hardest and the rich least.
But what about the majority of us in the middle?
Those in the beleaguered middle have a large dollars-and-cents stake in fair taxes. For the federal government’s sharp move away from tax progressivity over the last 12 years hit average families hard.
To illustrate this in stark terms, take the 1977 federal tax system as a benchmark. That was the year President Jimmy Carter took office--after a campaign during which he called the tax system a “disgrace.” But 1977 was the last year before the “supply-side” tax changes of 1978 and 1981, that promised--but didn’t deliver--relief from a system perceived as increasingly unfair to average families.
The 1977 system wasn’t perfect. But if the progressivity of the 1977 tax system--including the entire range of personal and corporate income taxes, payroll taxes and excise taxes--were applied to today’s incomes (after adjusting for inflation), effective tax rates would range from 8.1% on the poor, to 18.9% on families in the middle fifth, to 42.2% on the richest 1%.
If we’d kept the ability-to-pay principle, that’s what our tax system would look like today. The problem is: Supply-side tax theory swept through, giving us a tax system that burdens the middle class and doesn’t raise enough revenue to pay the country’s bills.
To illustrate supply-side logic at its worst, imagine abandonment of the ability-to-pay principle. It would turn the 1977 structure upside down, so the poor would pay at the rate of the rich, the near-poor at the rate of the near-rich and so forth. Since soaking the poor doesn’t bring in much--call it the you-can’t-squeeze-blood-from-a-stone principle--all rates would have to be adjusted upward by 15% to raise the same revenues as a progressive system would.
The bottom line? Nine of 10 families would pay higher taxes--about $3,000 more each, on average--under the regressive system than under the 1977 rules. The richest 1%, in contrast, would pay an average of $180,600 less in taxes.
Implausible? This would be the result if, as some ardent supply-siders recommend, the government did away with the income tax and raised all federal revenue from sales and excise taxes.
Many people fed up with the income tax’s complexity wonder why we don’t just have a flat tax--where everyone pays the same rate. Wonder no more. If we were to raise the same amount of revenue through a flat tax, everyone would pay a flat 24.4% of income in federal taxes--and nine of 10 families would pay more than under a system as progressive as 1977’s. The average tax hike would be close to $1,500 per family. Meanwhile, the richest 1% would pay an average of almost $100,000 less in taxes.
The worst thing about these hypotheticals is that they’re not all that far from the situation today. Because of the decline in progressivity since 1977, nine of 10 families pay higher federal taxes than if progressivity had remained in place. Poor families now pay 21% more, and middle-income families about 7% more. But the richest 1% pays 36% less, and the federal government collects almost $70 billion less in net revenues.
Some of the tax cuts for the rich translated into increased interest, dividends and other capital income, helping fuel an astonishing 110% increase in real after-tax income for the wealthiest 1%. Meanwhile, tax hikes on average families ate into savings and any income those savings would have generated. The bottom line is that the move away from progressivity will cost middle-income families from $15,000 to $75,000 of earnings, an average of $1,100 each in 1990 after-tax income. Poor families are out an average of about $500 each. And there is nothing hypothetical about the average 1990 after-tax increase of $113,000 in the incomes of the richest 1%.
Believe it or not, the situation would have been worse had not Congress passed the often-maligned 1986 Tax Reform Act. The 1986 act’s loophole-closing measures led to partial repair of the “Swiss cheese” corporate income tax, and even made the personal income tax slightly more progressive. Repealing the tax break for capital gains and limiting phony tax-shelter write-offs increased the taxable incomes of the very rich by close to half--so the wealthy ended up paying a bit more in taxes despite the dramatic--and excessive--cut in the top rate. Meanwhile, increased standard deductions and personal exemptions reduced income taxes on most families at least slightly--though greater Social Security taxes ate up that tax break for most of us.
One reason Republicans and Democrats alike opted for a partial turn toward progressivity in 1986 was the overwhelming evidence that the supply-side experiment had failed. Supply-side promised a balanced budget and an investment boom. It delivered unprecedented deficits and hundreds of billions of dollars in tax shelters. Since the loophole-closing 1986 act, investment has rebounded and the tax-shelter industry has withered.
But has Washington learned? Certainly President George Bush hasn’t. He is now calling for a repeat of tax policies of the late 1970s and early 1980s: more tax cuts for the very rich in the form of a restored capital-gains-tax loophole, coupled with tax increases for everyone else. The only tax increases the Administration seems willing to put on the table in the budget summit talks amount to another assault on the ability-to-pay principle. High on the Bush list are increased excise taxes--taking seven times as large a share of the income of middle-class families as from wealthy, and 16 times as large a share from the poor as from the rich.
The middle class doesn’t need any more regressivity. We can do right by our economy and our wallets if we curb the scams used by real-estate developers to avoid taxes; eliminate corporate tax breaks for mergers and acquisitions; restructure the way we tax foreign-owned companies, many of which pay little or no U.S. income tax despite billions in sales here. And we can raise the top income-tax rate to 38%, which would affect only the richest 1% of Americans, while raising the corporate tax rate to 38% as well.
Given that Bush’s “no new taxes” pledge is defunct, we know someone’s taxes are going to go up. And unless middle-class taxpayers insist on progressivity, they’ll be paying. If we don’t repudiate the regressive, flat-tax approach, Washington politicians will look to the nickel-and-dime taxes--on gas, liquor, tobacco, airplane tickets and you-name-it that, when added together, burden the middle class far more than those with a greater ability to pay. Such taxes do nothing to address the long-term U.S. need for a stable, predictable, gimmick-free way of running the country.
It’s time we asked Bush to follow the example of Abraham Lincoln, who, when he instituted an income tax to raise money for the Civil War, created a progressive tax--one that asked the wealthy to heft more of the burden of meeting a struggling nation’s needs. Similarly, Theodore Roosevelt and Woodrow Wilson, who led the country to adopt the 16th Amendment, creating a permanent national income tax that, from the outset, was progressive. Later, Franklin D. Roosevelt restored the tax fairness undermined in the supply-side 1920s.
Middle-class Americans have a choice. We can be patriotic and demand that Congress and the President make the system more like those some of our greatest leaders designed. Or we can let supply-side tax ideology heap more of the tax burden on us--and on our children, who will have to foot the deficit bill for the supply-side assault on progressivity.