Democrats Should Get Ahead of Bush on Tax Reform

Posted February 11, 2005 at 4:29pm

Democrats have allowed President Bush to seize the initiative on Social Security reform, but they still have time to beat him to the punch on another priority: tax reform. [IMGCAP(1)]

Bush has appointed a bipartisan tax reform commission that’s not due to report until July 31. That gives Democrats an opportunity to put progressive ideas on the table early.

And for input, they should study two proposals, one a year old and the other forthcoming, from centrist sources.

The first is the “radical tax reform” agenda advanced last year by Maya MacGuineas, president of the Committee for a Responsible Federal Budget and fiscal policy director at the New America Foundation.

The core of her agenda is replacement of the regressive payroll tax with a “progressive consumption tax” that would encourage savings.

The other idea, known as “family-friendly tax reform,” will be unveiled this month by the Progressive Policy Institute, the think tank of the centrist Democratic Leadership Council.

It proposes to consolidate and enrich tax benefits currently offered for retirement, college, home-buying and children. It would pay for them by closing 100 corporate tax loopholes costing $400 billion per decade.

So far, Bush’s major approach to taxes has been to cut them, to the tune of $2 trillion over the current decade and more if these cuts are extended.

Aides say that Bush’s ideas for tax-deductible health savings accounts, retirement accounts and education savings accounts, plus lower taxes on investment income, amount to piecemeal tax reform — a gradual conversion of the income tax system to a consumption-tax system.

Critics argue that this approach, “tax reform by subtraction,” benefits those wealthy enough to save and those who currently file itemized tax returns. They also tend to complicate the tax system.

On Jan. 7, Bush charged his nine-member commission, headed by retired Sens. Connie Mack (R-Fla.) and John Breaux (D-La.), to recommend ways to simplify the tax code and “share the burdens and benefits of the federal tax structure in an appropriately progressive manner.”

The prospect of a new tax reform debate has led Republicans to float — or re-float — proposals such as a national sales tax, the “flat tax” and Ways and Means Chairman Bill Thomas’ (R-Calif.) proposal to replace the corporate income tax with a European-style value added tax on purchases.

It’s time for Democrats to get into the game with something beyond the idea, suggested by Sen. John Kerry (D-Mass.) in 2004, to repeal Bush’s tax cuts for people making $200,000 or more.

MacGuineas, in an Atlantic Monthly article in January, said that such “left-leaning” proposals — raising marginal tax rates on the highest-income brackets, for instance — are “the wrong choice” because “the purpose of the tax code should not be to punish rising incomes or wealth creation.”

“Besides,” she wrote, “there are limits to how much we can tax income and capital gains without undermining our competitive position in the world.”

She did argue that over the past several decades, the tax system has become less progressive, less efficient and less able to meet the government’s obligations.

Cuts in individual and corporate taxes, increases in state sales taxes and reductions in capital gains taxes have “shifted the tax burden increasingly down the income scale from the rich to the middle class and the working poor” — precisely those who have profited least from the productivity gains.

Payroll taxes for Social Security and Medicare, the largest federal taxes that most Americans pay, are especially regressive. Wages are taxed at 15.3 percent whether the earner is making $25,000 a year or $250,000.

And the Social Security portion (12.4 percent) applies only to wages up to $90,000, so the $25,000 earner pays a much higher effective tax rate than the $250,000 earner, the bulk of whose income is exempt from the tax.

“And investment and employee benefits — which accrue disproportionally to high-income earners — go entirely untaxed, making the system still more regressive,” she wrote.

“Moreover, given increasing global competition and our graying population, it is very important that our tax system not only encourage savings, but also discourage harmful consumption.”

To do this, she would eliminate the payroll tax and replace it with taxes on the difference between what a person earned and what he or she saved — a consumption tax like sales taxes and value added taxes, but more progressively imposed.

Her idea is that people would pay no tax on the first $25,000 of spending, 10 percent on spending from $25,000 to $100,000 and 15 percent on spending above $100,000.

“The less you spent, the lower your tax rate would be,” she wrote. Low-income earners would for the most part be taxed less onerously, since they spend less. Middle- and high-income earners would have an incentive to save their money, preparing for retirement and bolstering the country’s long-term economic prospects.”

MacGuineas also proposes broadening the base of taxes by closing corporate loopholes, limiting deductions on employer-provided health benefits, taxing pollution and the use of nonrenewable resources and imposing user fees on television’s use of the airwaves.

In the meantime, the PPI proposal calls for consolidating current retirement, college, homeowner and “family” tax breaks into single categories and making the benefits richer for lower-income participants.

The breaks would be available to people regardless of whether they filed tax returns, and in many cases would be refundable credits, meaning they’d be available to people who earned too little to pay income taxes.

One part of the proposal involves creation of universal pension accounts that the government would open with a $500 “stake” and that workers would carry from job to job.

The “family” portion would consolidate and enlarge per-child benefits currently available to $3,500 for the first child to a maximum of $7,000 per family. The college tax break would double from the current $1,500 per year to $3,000, and beneficiaries would have to agree to perform two years of public service.

Bush has shown good faith in appointing a bipartisan panel to consider tax reform. Democrats ought to write their plans in the same spirit — not to score points, but to get something passed that will make the tax system more simple and fair.