The Republican candidates are in many ways stuck in a routine that does not look very promising. They all support lower taxes but are unable to square this with the fact that Americans aren't clamoring for the drastic cutbacks in public services that new tax cuts would inevitably require. They have generally tried to wish this fact away with the claim that tax cuts actually result in increased revenues (because tax breaks encourage work and investment and thus profits and incomes explode, pushing revenues up). Unfortunately for them, President Bush's own Treasury Department has refuted the idea that tax cuts come even close to paying for themselves, and recently OMB director Jim Nussle also conceded the same thing.
But we still hear this claim made at the Republican presidential debates as candidates pander to anti-tax extremists. All of them support making the Bush tax cuts permanent and must explain away the fact that this will cost $5 trillion over ten years.
Giuliani and McCain: Denying Reality to Win Over Republican Voters
To cite just one example, former New York City mayor Rudy Giuliani said on October 9 that as mayor he cut taxes 23 times, including cutting income taxes by 24 percent, which he says resulted in a 42 percent increase in the revenue collected from the income tax. (It would have been inconvenient for him if any of his opponents had pointed out that he happened to run the city during a stock market surge that boosted incomes, but no one seemed interested in making that point.) Some people have questioned his claim to have cut taxes 23 times.
Senator John McCain still presents one of the more interesting attempts to rationalize a tax policy that is truly irrational. One would like to believe that he is among the saner candidates at the GOP debates since he voted against the tax cut bills enacted in 2001 and 2003. He explained once again on September 5 that he voted against those bills because they did not include cuts in spending, which he thought were also necessary. But at the same time, he also makes the claim that "it's very clear that the increase in revenue we've experienced is directly related to the tax cuts that were enacted, and they need to be permanent." This is baffling. Why was he adamant about cuts in spending if tax cuts actually raise revenue? Under his logic, he can afford even more spending if we cut taxes.
Both these candidates are also known for their proposals to use the tax code to push families toward the individual health insurance market (the market for coverage that is not employer-based). Individual-based health coverage is usually much more expensive, has less generous benefits, and may be more likely to involve high deductibles that discourage people from getting care they actually need. Giuliani would offer deductions for such health care, while McCain would offer credits (which are slightly fairer but still have the same underlying problem).
Romney: Make the President All-Powerful and We'll Get the Budget Under Control
Former Massachusetts Governor Mitt Romney at least seems to acknowledge some relationship between taxes and public spending that coincides at times with reality. However, he claims to stand for smaller government and his strategy to bring about reduced spending, to go along with reduced taxes, is a "line-item veto." He criticized Giuliani for opposing the line-item veto that President Clinton exercised briefly before it was struck down by the Supreme Court. But the proposal Romney favors now is different and technically not a true line-item veto, although it's still possibly unconstitutional.
The legislation he's talking about would probably be similar to what the Republican House passed last year, which would allow the President to single out spending provisions in an appropriation bill (or a bill to expand entitlements), withhold funds and force Congress to vote to approve or reject the rescission (cancellation of the spending). The President would be allowed to withhold funds for a total of 90 days, even if Congress rejects the rescission. This would obviously be an unprecedented expansion of the President's power, and it's not at all clear that a president would necessarily use this power to reduce deficits (it could be used to expand them, actually).
Romney favors making permanent the Bush tax cuts for capital gains and dividends (which resulted in the current 15 percent tax rate for those forms of income) but would go further by eliminating taxes on income from interest, capital gains and dividends for families with incomes less than $200,000. Few middle-class people could really benefit from these sorts of tax cuts. Roughly three fourths of the current tax break for capital gains and dividends went to the richest 0.6 percent in 2005 (as Citizens for Tax Justice pointed out recently).
Thompson: Alternative Maximum Tax, Paid for by Cutting Social Security
Former Senator Fred Thompson recently introduced his own tax plan, which involves eliminating the AMT, extending the Bush tax breaks, and cutting the corporate rate to 27 percent. His plan also allows taxpayers to choose to pay under the existing system (minus the AMT and with the Bush tax cuts) or under a simplified system that would have just a 10 percent rate and a 25 percent rate and almost no deductions or credits. This is essentially a plan introduced last month by the House Republicans that CTJ dubbed the "Alternative Maximum Tax." Because the "simplified" option would eliminate refundable tax credits now available to low-income working families, it would be of no benefit to the poorest one-third of Americans. Wealthy families, however, would get huge tax reductions.
When asked recently how he would pay for his plan, Thompson said that his tax cuts would cause "growth in the economy" that would result in more revenue. The only change in spending he mentioned was his plan to cut back the Social Security benefits that are promised to future retirees.
Huckabee: The National Sales Tax
Former Arkansas Governor Mike Huckabee continues to tout his plan for a 23 percent national sales tax to replace all other federal taxes. Supporters call this plan a "Fair Tax." CTJ studied the idea of a national sales tax in 2004 and found that in order to maintain current revenue levels, this sales tax would have to be around 50 percent. Low-income households would pay more for everything they buy, while the wealthy would hit the jackpot with tax-free capital gains, dividends and interest.
At the October 9 debate Huckabee made the astounding claim that this national sales tax plan "untaxes the poor in our culture." The "Fair Tax" plan does include a monthly, prepaid rebate to households that would theoretically balance some of the regressive effects of the tax on low-income households. But CTJ's study in 2004 of a similar plan found that even after accounting for these "prebates" as supporters call them, the plan still increases taxes on the poor and cuts them for the rich. Further, if the rate would really be as low as 23 percent, that implies massive cuts in public services will be necessary -- and these cuts probably would not come at the expense of the wealthiest families.
Democrats: Social Security Stealing the Show
The recent debating among the Democratic candidates has been a little more sane but still confused. A disproportionate amount of time and energy has been focused on whether or not the cap on earnings subject to Social Security payroll taxes (currently at $97,500) should be raised to deal with the alleged crisis the program is facing.
On October 30, Senator Hillary Clinton made the important point that the talk of "crisis" is generally a talking point used by conservatives who want to privatize the program. This is largely true. The assumptions used to make dour projections about Social Security's insolvency starting in 2041 are considered unreasonably pessimistic by many economists. It's also important to remember that benefits rise with wages, which usually rise faster than inflation. As a result, even if the pessimistic economic assumptions are borne out and benefits scheduled to be paid in 2041 must be reduced by 25 percent, they would still be larger in real terms than those benefits paid today.
Clinton also made the valid point that the most important thing we can do now for Social Security is to start with "fiscal responsibility." The only real problem Social Security has right now is that through the Bush years Congress and the President have spent the Social Security surplus. Social Security currently is taking in more in payroll taxes than it pays out in benefits, and this surplus can be used to pay down the national debt, thus making it easier for us to pay benefits when the baby boomers retire in large numbers. However, Presidents and members of Congress have typically spent these surpluses on other things, except for a period during the 1990s under President Clinton. Finding a way to balance the budget without spending the Social Security surpluses, in other words, basic fiscal responsibility, is indeed the place to start.
Senator Clinton did falter however, when she argued that raising the payroll tax cap would be a tax increase on middle-class Americans. Senator Barack Obama pointed out at the next debate on November 15 that only 6 percent of taxpayers have incomes above the cap so it's simply dishonest to say that raising the cap would constitute a tax increase on "middle-class" people.
But then again, Obama himself seemed to be accepting this logic on October 30, when he said that perhaps they should raise the cap, "potentially exempting folks in the middle -- middle-class folks..." Most people probably took that to mean something like what John Edwards has proposed, which would not raise the cap for people with earnings between the current cap and $200,000 but then raise it for those with incomes beyond $200,000. This would of course create a very peculiar "donut-hole" in the Social Security payroll tax between $97,500 and $200,000 in earnings.
It's also important to note that Social Security replaces a proportion of earnings (a smaller proportion for high-income people), but only those earnings that are actually covered by the Social Security payroll tax. So just as there is a limit on what wages are taxed for Social Security, there is a limit on how much a wealthy person can collect in benefits. It's unclear whether or not plans to raise the cap on wages covered by Social Security payroll taxes would also raise this limit on benefits that can be collected by wealthy individuals.
The Need to Focus on Undoing the Bush Tax Cuts
Lately, the Democratic debates have not focused on the most important tax issue of all, which is also the one they largely agree on. Will the Bush tax cuts be made permanent or not? None of the Democratic candidates would make them permanent (at least not entirely). This is crucial. CTJ projects the total cost of the Bush tax cuts over the 2001-2010 period to be about $2.4 trillion, all deficit-financed. Even if the Bush tax cuts are allowed to expire at the end of 2010, as they are scheduled to under current law, the interest on the increased debt resulting from these tax cuts would keep costing us -- to the tune of $1.5 trillion in the 2011-2020 period. Then, if the tax cuts are made permanent on top of all that, that would cost another $5 trillion from 2011 through 2020.
But the Democratic candidates want to hold on to some tax cuts for the "middle-class." Which tax breaks to extend therefore becomes a trickier question. Each of the Democrats wants to stand up for the middle-class, but there is some confusion about what that would even mean. Former Senator John Edwards would repeal the Bush tax cuts for those with incomes above $200,000, but IRS data for 2005 show that only 2.7 percent of taxpayers had adjusted gross income above this level. The top 2.7 are the only folks who would lose their tax cuts.
Senator Barack Obama tries equally hard to appear pro-middle-class. His plan would cut taxes for 150 million Americans at a cost of $85 billion a year. He would give families a credit of $1000 (or $500 for unmarried taxpayers) and eliminate income taxes for seniors whose income is below $50,000 (although seniors in this category pay little in income taxes anyway). The credit would essentially offset payroll taxes on the first $8,100 in earnings. But it's not entirely obvious that what people in this income category really need is more tax cuts when the revenue spent on this plan could be spent on health care, retirement security or energy efficiency.
But Edwards and Obama both are certainly moving in the right direction. They would both restore the progressivity of the tax code that has been reduced dramatically under Bush. They also want to reduce the tax code's bias for income from wealth over income from work. Edwards would increase the tax rate for capital gains to 28 percent for those with incomes above $200,000 and Obama would raise it to as much as 28 percent for those with incomes over $250,000. When Bush took office, capital gains, which flow mostly to the wealthy, were already taxed at a special low rate of 20 percent. In 2003 that was reduced to 15 percent and dividends, which were previously taxed as ordinary income, were also made subject to the special 15 percent rate. As a result, people who live off of their investments or inherited wealth can actually pay federal taxes at a lower rate than many middle-income people. Edwards and Obama would both end this outrageous feature of the tax code with their higher rates for capital gains.
There are some minor variations among these plans. Edwards wants to make the first $250 in income from wealth (interest, capital gains, dividends) tax-free, which could save a middle-income family $63 at most each year. Obama would eliminate capital gains taxes on startup businesses, which is a strange idea because capital gains is not involved in the starting up of businesses but rather in the selling of assets. But these details are far less important than the overall progressive direction in which both candidates would take tax code.
Senator Clinton has spoken in more general terms about her ideas on taxes. She would also restore much of the progressivity lost during the Bush years by repealing the Bush tax cuts for those with incomes above $250,000. She has not stated whether she would also propose further tax changes for capital gains.
The Democrats' Plans Still Have Costs
But even these more progressive tax plans have costs that must be addressed. The Bush tax cuts expire at the end of 2010. That means that when Democratic candidates say they will do away with the Bush tax cuts for families above a certain income level, that really means they're going to extend the tax cuts for families with incomes below that level. In other words, new tax cuts are being offered, just not to the richest Americans. Whether and how we would pay for these new tax cuts, along with the health care plans and other initiatives promised by each Democratic candidate, is crucial and has not been fully explained yet by any of them.