Photo: Wikimedia/Eric Draper
My great pal Tony Fratto over at Hamilton Place Strategies is talking up the “benefits to allowing my favoured Bush income tax rates to expire and return to Clinton-era tax rates for everyone.”While emphasising the Clinton-era tax code is “suboptimal,” Fratto — a deputy press secretary to President George W. Bush — thinks a reversion would make it easier to eventually accomplish major tax reform.
The Obama plan of only raising the top two rates on the wealthiest Americans kills any chance of income tax reform. This is important to understand: tax reform was always going to be a long shot.
The forces arrayed against reform are numerous, well-organised, well-financed, dispersed across the country, and are often sympathetic groups: charities, state and local governments, the housing industry, and homeowners, just to name a few.
But tax reform becomes practically and politically impossible if the tax burden is skewed to the top as the Obama plan intends. In fact, the wealthiest Americans will face an even higher top marginal tax rate than under the Clinton years due to the increased Medicare payroll and investment taxes in Obamacare.
Tax reform requires creating winners, and the pool of winners has to come from people paying taxes. Those not paying taxes today have absolutely nothing to gain from tax reform. In fact, if we only raise the top two rates, the only people who would gain from income tax reform would be the wealthy. And we can’t help the wealthy, so…no tax reform.
The Clinton tax rates create a much better basis for tax reform because more Americans will actually be paying taxes and can benefit from reform.
Now let me see if I understand this clever bit of political strategy. In other words, you have to give a critical mass of voters some skin in the game. By raising middle-class income taxes today, you could then cut them tomorrow as part of reform that would lower tax rates (at least for them) and broaden the tax base to create a more efficient, pro-growth tax code.
“Yes, I am scaling back your housing/healthcare/state and local tax break, but I am also lowering your marginal tax rate.”
Now Tony is right that the current makeup of the tax code does make it tough to do CBO-approved, revenue-neutral tax reform, as Mitt Romney found out. But I have some concerns/questions/observations (beyond concerns about a nasty 2013 recession):
1. What if Democrats decide to keep the money with no tax reform? All else equal, letting the Bush tax cuts expire would, according to the CBO, give government a gusher of money, an additional $5.1 trillion over a decade.Tax revenue as a share of GDP would average 20.6% from 2013-2012 vs.18.1% if we keep the Bush tax cuts (or about the post-WWII average).
2. With higher tax revenues, wouldn’t any near- or medium-term pressure to do entitlement reform evaporate? While annual deficits might be lower, the Medicare-Medicaid-Social Security debt bomb would still be ticking, and the longer we wait to act, the more dramatic reform will need to be.
3. If you are looking for middle-class, tax-reform sweetener, what about cutting payroll and investment taxes?
I will continue to think about this …
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