COLUMN ONE : Lots of Tax Talk, No Big Change : Despite tinkering with rates, what people end up paying as a portion of income has stayed about the same for decades. The system hasn’t redistributed wealth either.

“Taxes,” said Oliver Wendell Holmes Jr., the distinguished Supreme Court justice, “are the price we pay for a civilized society.”

Ever since Abraham Lincoln imposed the first U.S. income tax to help pay for the Civil War, however, Americans often have been at each others’ throats over just who should pay to keep us civilized.

Now we’re at it again. This year’s battle of the budget has turned into a highly visible fight over the issue of fairness, with Democrats promising to “tax the rich” while avoiding harsh tax increases on the middle class. Meanwhile, President Bush’s flip-flops on whether to trade a lower tax on capital gains for higher income-tax rates on the rich have convinced many voters that the White House is interested more in protecting the interests of the wealthy than in ensuring that the burden of deficit reduction is equitably shared.

And just Sunday evening, the budget negotiations broke down again over taxing the rich. The White House insisted that the current top rate of 28% should go no higher than 31%, but Democrats held out for a package that would raise tax rates on those with incomes above roughly $200,000 to 32% while imposing an additional surtax on the superrich with incomes above $1 million.

But for all the current political firestorm over taxes, one unsettling fact remains: The tax system has proven largely ineffective in overcoming widespread disparities of wealth and income among Americans.

It’s true there was an erosion of some of the mild progressivity built into the overall U.S. system--which exacts a slightly greater share of taxes from the most affluent than from the middle class--throughout the 1970s and into the early 1980s. That trend was only partly reversed in the sweeping tax revision of 1986.

But from the beginning of the 1950s through 1963, when the top rate was set at 91%, to the late 1980s, when tax rates on top incomes fell to 28% even as Social Security taxes bit harder into middle- and lower-income salaries, what people really end up paying in federal and state taxes has changed remarkably little.

For example, middle-income families paid 24% of their income in taxes in 1988, slightly more than the roughly 23% share they paid in the mid-1960s. Although the top 10% face a somewhat lower tax burden of roughly 28%, compared with 30% in the mid-1960s, they are also now paying a greater share of overall tax collections.

Meanwhile, income inequality has risen significantly over the last two decades, but largely as a result of deep underlying currents in the economy rather than shifts in tax burdens.

“The tax system never did--and doesn’t now--redistribute income very much,” says Henry Aaron, a Brookings Institution economist who is one of the nation’s leading tax scholars.

There are strong political and economic reasons why raising taxes usually fails to help narrow the income gap.

Politically, wealthy individuals and special interest groups have great influence over the shaping of tax legislation. In the past, the higher rates moved, the more loopholes were added on the grounds that they would help stimulate certain desirable activities, such as erecting new buildings, investing in new factories and developing alternative energy sources.

And economically, the affluent enjoy such a wide variety of ways to escape taxation that efforts to “soak the rich” through sharply higher rates usually end up losing more revenue than they gain.

No matter what happens in the current political debate over taxes, the tax system’s effect on income distribution isn’t likely to change. Both Democrats and Republicans have staked out positions that are triumphs of symbolism over substance.

For liberal Democrats, their crucial goal throughout the budget negotiations this year has been to burst the so-called “bubble” by pushing the tax rate on families with annual incomes of more than about $200,000 from 28% to the hidden 33% rate paid by some who earn less.

But in hopes of luring Republicans to make a deal and to win essential support from Southern and Western lawmakers in their own party closely tied to timber interests, most Democrats have been willing to accept lower taxes on capital gains, profits on investments earned overwhelmingly by the wealthy.

“Raising the top rate to 33% and giving a big capital gains cut takes from the wealthy with one hand but gives with the other,” complains Sen. Bill Bradley (D-N.J.). “And it gives a lot more than it takes.”

Why would Democrats, trying to recapture their image as the party of average Americans, be prepared to make such an apparently unfavorable trade?

“I take the cynical view that most Democrats would like to have their cake and eat it too,” confesses one longtime Democratic tax reformer.

“They want to be perceived as restoring progressivity through a higher rate on the rich,” she says, “while winking at the same time at the party’s wealthy contributors by saying, ‘Look, I got this capital gains tax break for you.’ ”

On the other side of the aisle, Republicans have also talked one game while ending up playing another. Bush defends his effort to hold down the top income tax rate as necessary to prevent Congress from raising taxes on everyone else as well. But Bush was quite willing as part of the budget agreement negotiated by White House officials and congressional leaders and rejected by the House to impose a higher tax burden on middle- and lower-income Americans.

Moreover, under former President Ronald Reagan, the GOP promoted income-tax cuts as a benefit to all, arguing that the overall economy would gain as the wealthy took advantage of lower marginal tax rates that would allow them to keep more of their income to make productive investments in new enterprises.

“To help the poor and middle classes,” argued George Gilder in “Wealth and Poverty,” his early-1980s encomium to supply-side economics, “one must cut the taxes of the rich.”

But it didn’t work out that way.

Average income, adjusted for inflation, grew by almost 16%, and the income of those in the top 1% soared by 87% to almost $400,000 from about $214,000. But despite the general prosperity of the decade, the lower-middle-class and working-class voters who provided the decisive edge for Reagan actually saw their real incomes stagnate or even shrink during the 1980s.

Changes in taxes, however, were only a small factor in the widening gap between the rich and the poor. While analysts still argue over the reasons why the post-World War II trend toward slightly more equal incomes reversed direction in the mid-1970s, the most common explanations revolve around the entry of the huge baby boom generation into the work force, the spread of two-earner families and the growing disparity between skilled and unskilled labor as the U.S. economy became more exposed to global competition.

Whatever the reasons, voters who have not shared in the economic gains of the 1980s now want revenge, argues Kevin Phillips, the iconoclastic Republican whose recent book, “The Politics of Rich and Poor,” helped galvanize Democrats to rally under the fairness banner in this year’s budget wars.

“The 1980s were the triumph of upper America,” Phillips wrote, “an ostentatious celebration of wealth, the political ascendancy of the richest third of the population and a glorification of capitalism, free markets and finance.”

But the current debate reflects the widespread confusion over what role the tax system can realistically play in curbing such excesses. At the same time, it continues to mirror the power of well-connected individuals and special-interest groups to shape the tax code to their own benefit.

While most Americans, in theory, favor a progressive tax system that imposes higher taxes as income rises, in practice lawmakers repeatedly have undermined that goal by inserting a wide variety of tax incentives that were designed to encourage certain types of investments or economic behavior.

“Congress doesn’t like to hand out explicit subsidies,” says Alan Reynolds, chief economist at the conservative Hudson Institute in Indianapolis. “But handing out tax breaks provides a hidden subsidy without having to acknowledge the cost.”

As a result, whenever rates have risen in the past in an effort to force the wealthy to pay more, rich taxpayers have invariably managed to escape such burdens through a host of perfectly legal loopholes.

In the 1950s and early 1960s, for example, when the top rate was 91%, the richest 1% of America’s taxpayers ended up paying little more than 25% of their income in federal taxes. The wealthy learned to divert their income to tax shelters, invest in tax-free municipal bonds, buy luxuries for themselves by running up business expenses and take advantage of popular deductions such as those for home mortgages and charitable contributions to avoid facing an oppressive tax burden.

Finally, in the one significant effort in history to reverse the expansion of tax breaks, Congress agreed to eliminate many such loopholes in 1986, finding that the wider tax base actually forced the rich to pay more despite sharply lower rates.

“Most people think the only way to improve progressivity is to raise the rates on the rich,” says Joseph Minarik, staff director of the Joint Economic Committee in Congress. “But tax reform in 1986, even though it was not intended as a soak-the-rich plan, shows that you can improve fairness by closing loopholes even when you’re lowering the top rate.”

It all depends on how tax rates are cut.

In the early 1980s, the top tax rate was cut from 70% to 50%, corporate taxes were slashed, and capital gains rates reduced further to 20%, but Social Security taxes rose dramatically. As a result, the rich paid a smaller share of their income in taxes while the middle class and poor paid more.

But when the top rate was slashed even further in 1986 to 28%, the wealthy began to bear a bigger tax burden because tax shelters were closed and the poor were largely exempted from federal income taxes.

Although the level of progressivity in the U.S. tax system has diminished from the mid-1960s, it has returned to almost what it was in the mid-1970s.

In 1980, for example, the effective rate of federal, state and local taxes on the top 10% of all taxpayers was 28.5%, according to detailed estimates prepared by Brookings Institution tax experts. By 1985, that burden had fallen to 26.4%, but it has now rebounded back to 27.7%.

The overall tax system, assuming that corporate taxes are paid by shareholders rather than consumers, is at best only mildly progressive today. And to the extent that corporate taxes are passed on to consumers in the form of higher prices, the real tax burden of different income groups is just about the same.

House Democrats, in moving to reshape their own budget proposal last week to ensure that the wealthy pay a greater share of the added tax burden, tried to craft a capital gains tax cut that would prevent many rich investors from taking advantage of it. It was targeted at small businesses, homeowners, and owners of assets such as timber that take years to earn a profit.

But even longtime tax reformers question whether the House Democratic approach, which excludes stocks and bonds and limits the tax advantage to $100,000 over a lifetime, makes economic sense.

“Politically, it may be a clever move but it’s a lousy Rube Goldberg tax policy,” says Bruce Fisher of Citizens for Tax Justice, a labor-supported group that advocates higher taxes for corporations and the wealthy. “The whole idea is to get the Southern ‘timbercrats’ on board behind a Democratic plan. But all it really does is open up a Pandora’s box to more abuses of the tax code.”

History bears Fisher out. Take the oil and gas percentage depletion allowance, a generous tax break that was first proposed in 1918--largely as an emergency World War I measure to encourage the drilling of new oil wells to fuel the war effort. By the time Congress finally approved the bill in 1919, the war was over.

Nonetheless, the depletion allowance, although scaled back in size in recent years and limited to smaller oil producers, lives on today. Moreover, says Sen. Bradley, “the oil depletion allowance encouraged other special interests to seek comparable relief, which the legislators from the oil states supported for fear that otherwise the non-oil states (would) oppose oil depletion.”

As a result, more than 100 different “minerals”--including such diverse products as oyster and clam shells, gravel, talc, sand and corundum--have been granted special tax breaks over the years. There is even a tax break applying to clay used to make flowerpots.

That’s why proposals to create new tax breaks or revive some old ones, even under a new rubric and promoted as only having a limited impact, are likely to open the door to even greater loopholes in the future.

“People like low rates,” says Brookings’ Henry Aaron, “but they don’t often recognize that the only way to keep them low is to prevent loopholes from creeping back into the tax code.”

THE U.S. TAX BURDEN: WHO PAYS

Effective rates of federal, state and local taxes by population percentiles, selected years.

Income group 1966 1970 1975 1980 1985 1988 Lowest 10th 16.8% 18.8% 19.7% 17.1% 17.0% 16.4% 2nd 10th 18.9 19.5 17.6 17.1 15.9 15.8 3rd 10th 21.7 20.8 18.9 18.9 18.1 18.0 4th 10th 22.6 23.2 21.7 20.8 21.2 21.5 5th 10th 22.8 24.0 23.5 22.7 23.4 23.9 6th 10th 22.7 24.1 23.9 23.4 23.8 24.3 7th 10th 22.7 24.3 24.2 24.4 24.7 25.2 8th 10th 23.1 24.6 24.7 25.5 25.4 25.6 9th 10th 23.3 25.0 25.4 26.5 26.2 26.8 Upper 10th 30.1 30.7 27.8 28.5 26.4 27.4 Average 25.2% 26.1% 25.0% 25.3% 24.5% 25.4%

Source: Brookings Institution