Real Tax Reform: Quit Taxing Work!
The GOP’s “United Framework for Fixing our Broken Tax Code” is a disingenuous reform proposal that trades tax cuts that appeal to the middle class for tax cuts that favor special interests likely to reward lawmakers with large campaign contributions. They claim that it is a “bold tax reform will deliver more jobs, fairer taxes, and bigger paychecks to the American people.” That claim is the only bold thing about this proposal. A plan designed to benefit most U.S. citizens would be supported by analysis of the record low labor force participation rate and stagnant wages. It would ask and answer questions like “How can we make it easier for businesses to hire workers and for workers to support their families?” Cutting the top corporate tax rate may not have much impact at all on employment and wages, yet it seems to be the top priority for this proposal. Real reform focused on jobs, fairness, and better wages would take a very different approach — by eliminating the payroll tax.
False Premise, Wrong Incentives
My definition of “bold” federal tax reform would at the very least include neutral impact on deficits and preferably narrow the gap between revenue and spending. Promising cuts for everyone who pays taxes is certainly popular, but it is the opposite of bold when there is little or no mention of spending cuts. The GOP claims tax revenue will actually grow as a result of economic growth. Evidence does not support such “supply-side” claims in general, and there is even less reason to believe cuts to marginal tax rates will lead to net revenue increases. There is merit to the idea of flattening and lowering tax rates as a simplification and fairness measure that eliminates numerous special exemptions and deductions. But instead of calculating how much overall rates could be lowered by closing these loopholes, the plan targets a “competitive” top rate and leaves negotiation of offsetting measures for later.
The GOP plan aims to increase investment — but is that really a problem when we have a record high in stock markets and interest rates near zero? I don’t think so. We do have a jobs problem that I believe has been caused by policies that favor investment in capital at the expense of labor — especially debt. More of the same will only make the problem worse. In this economy, reducing the tax burden on business is more likely to lead to more stock repurchases than hiring. If we want more jobs, we ought to look at policies that are directly tied to hiring.
Obviously, this leads us to the payroll tax, which applies to every dollar of wages up to the specified limit ($127,200 in 2017). Half of the total of 15.3%, which includes 12.4% for Social Security and 2.9% for Medicare, is withheld from employee’s paychecks and the other half is paid by employers. This non-trivial tax raises the cost of hiring and lowers compensation for every employer and worker, and it’s a serious burden on the self-employed, who have to cover both parts. For many if not most wage earners, it is a larger burden than the federal income tax.
Bold? Eliminate this job-crushing tax immediately. The biggest beneficiaries will be the working poor and small businesses. Employers will no longer be punished for hiring and may actually be able to afford raises. Lots of people will have a little more money to spend or to save as they wish. Contrary to the supply-side theory, there is evidence that income support — placing money in the hands of consumers — has positive impact on the economy. But I’m not suggesting we rely on growth to pay for this cut. The boldest part is what replaces the current system.
Fiscal Responsibility
Social Security and Medicare benefit payments, which total over $1.5 trillion annually, have for many years been the largest federal outlays. Both are considered “mandatory” expenditures, meaning they are not subject to Congressional appropriations. Eliminating the taxes that are supposed to fund these programs does not eliminate the obligations. It does, however, open up a couple of debates that in my opinion are long overdue. The first is how the tax code should be amended to replace the revenue stream and the second is how retirement plan benefits will be determined without payroll tax contributions.
The revenue question is daunting. The GOP plan has many elements but is small in comparison to my alternative; they take a decade to achieve cuts I’d make in year one. More importantly, the GOP plan follows a political tradition of concentrated benefits and dispersed costs (cutting taxes for a few while paying for it through deficits that cost everyone later). Cutting the payroll tax will benefit 166 million American taxpayers and their families. However, that is very costly and cannot be paid for by taxing others. We have to look at general revenues such as the income tax and how to raise it equitably.
Almost everyone above the poverty level ($12,060 for individuals and $24,600 for a family of four) will have to pay more income tax, but many low and middle income taxpayers will be better off because their paychecks are at least 7.65% larger. I welcome the GOP idea of revisiting thresholds and marginal rates. But first we should look at spending, including tax expenditures. Tax fairness, in my view, demands elimination of special exemptions, including broad-based deductions from income such as for home mortgage interest — which favors the wealthy and encourages debt. On the other hand, I would retain deductions for retirement and health plan savings because they are important components of income security that will be needed to supplement and ultimately replace Social Security benefits for all but the poor (the topic of the next section).
Entitlement Reform
It’s just a matter of time before young people awaken and take action to resolve the fiscal disaster and inequity they have inherited. Our country faces enormous debt that is destined to grow out of control due to entitlements and defense spending, yet Congress has yet to demonstrate interest in tackling the problem. The comprehensive assessment of budget priorities mentioned above as part of tax reform could help with top line decisions (i.e., how much we are willing to spend on wars vs. benefit payments). But especially with our aging population and a shift to general funding of Social Security benefits, it is vital that we take a close look at distribution formulas.
For starters, the current system is unfair because a lot of the taxes paid by young workers go to wealthy retirees. I’m not suggesting default on promised benefits, but I do think we should freeze them at current levels and reform the system as a true safety net. In other words, while no one will get less than they have already “earned,” payments should converge to actual needs (benchmarking at the poverty level). Moreover, eligibility should begin at 21 instead of 62. Yes, this is looking a lot like a basic income guarantee — the subject of an article I wrote over four years ago that details a negative income tax approach and the distribution of costs and benefits. Now that’s bold!
