POLITICS APRIL 19, 2012
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Democrats and Republicans agree that the federal income tax must be reformed. They even agree on some common goals. President Obama’s budget proposal calls for “fundamental reform” that would “simplify the tax code and lower tax rates” while eliminating “inefficient and unfair tax breaks.” House budget committee chairman Paul Ryan’s budget proposal, which the House passed in March, collapses the existing six tax brackets into two, both of them (10 and 25 percent) much lower than the current top rate (35 percent), and similarly pledges to eliminate “special-interest loopholes.” The Obama budget and the Ryan budget, a Bloomberg View editorial notes with approval, “aren’t as far apart as you might think.”
Granted, there’s virtually no chance the two sides will agree to comprehensive tax reform before the November election. But afterward, it seems quite possible that both parties will set aside their differences and reach a compromise. So why do I hope they don’t?
The beau ideal both sides have in mind is the 1986 tax reform bill crafted by Democratic Representative Dan Rostenkowski and Republican Senator Bob Packwood, which was signed into law by Ronald Reagan. Neither Rosty nor Packwood had a reputation as a reformer—TNR mocked Packwood as “Senator Hackwood”—and both legislators would eventually leave Congress tainted by scandal. Reagan, reportedly, had only the shakiest understanding of what the bill would do. Yet these three flawed politicians managed to shepherd a good-government bill through a maze of lobbyists and ideologues, achieving, briefly, a rare state of wonky grace.
The essence of the 1986 tax law was to combine conservatives’ desire for lower marginal tax rates and fewer tax brackets with liberals’ goal of reducing pro-business tax loopholes. The result was a tax code that was simpler and, on balance, fairer. But 2012 isn’t 1986 in a few underappreciated and, to my mind, crucial ways. Let’s review them:
Tax rates. If you want to swap lower tax rates for fewer tax loopholes, you should come to the table with high tax rates. In 1986, the top marginal rate was 50 percent. That wasn’t high by historic standards: For a decade and a half prior to Reagan’s 1980 victory, the top marginal rate never fell below 70 percent, and, during the 1950s and early ’60s, the top marginal rate exceeded 90 percent. By current standards, though, a top marginal rate of 50 percent is pretty high. The 1986 tax reform dropped it to 28 percent, and, since then, it has bounced between 30 and 40 percent. The current top marginal rate of 35 percent will, if no legislative action is taken, rise next year to 39.6 percent when George W. Bush’s tax cuts expire. To anyone who favors progressive taxation, bargaining down from 50 percent is much easier to stomach than bargaining down from 39.6 percent.
And that’s assuming the Republicans will consent to 39.6 percent as their starting point. They’ll push hard to bargain down from the current level of 35 percent. Baseline wars over whether to negotiate from 39.6 or 35 percent helped scuttle the supercommittee negotiations in November. In 1986, the starting point of 50 percent was never up for debate.
Tax complexity. Reducing the number of tax brackets follows a logic similar to that of lowering tax rates: It helps if you start out with a lot. In 1986, there were 15 different tax brackets for families and 16 for single people. Again, this was not high by historic standards: For most of the 1970s, the number of brackets never fell below 25. The 1986 tax reform swapped 15 or 16 tax brackets for two. Since then, that number has increased—but only to six.
Six brackets isn’t an ideal number, but not because it’s too many. It’s too few. Right now the top bracket (35 percent) kicks in for families at about $388,000. Obama wants to lower that threshold to $250,000. Everyone making this much money resides in the upper ranks of the top 5 percent. If your income exceeds a quarter of a million dollars, you are, by any sensible reckoning, rich, and you ought to pay more in taxes.
But there’s rich and then there’s rich. The higher you go up the income scale, the economists Emmanuel Saez and Thomas Piketty have found, the faster you’ll find rich people’s share of the nation’s income growing. The top 1 percent (everyone today making more than about $352,000) have doubled their income share since 1979; the top 0.1 percent (everyone today making more than about $1.5 million) have tripled their share; and the top 0.01 percent (everyone today making more than about $7.9 million) have more than tripled their share. Clearly these latter two groups merit brackets of their own. As James Surowiecki put it in a 2010 New Yorker column, the current system taxes LeBron James, who is super-rich, at the same rate as his dentist, who is merely rich.
The deficit. The 1986 tax bill was designed deliberately to be revenue-neutral—not because the budget was balanced (the deficit that year was $221 billion, which in those days was considered a lot), but because there wasn’t much chance of getting bipartisan agreement otherwise. In 2012, the deficit exceeds $1 trillion. We don’t need tax reform; we need a tax increase.
One seldom-acknowledged reason for the 1986 tax reform’s long-term “success” was that its revenue-neutral bargain was shredded a mere four years later when President George H.W. Bush agreed to increase the number of brackets from two to three and to raise the top rate to 31 percent. President Bill Clinton shredded tax reform a second time in 1993, increasing three brackets to five and raising the top rate to 39.6 percent. It was these tax increases that made it possible for Clinton eventually to balance the budget (before President George W. Bush unbalanced it again).
The sword of Damocles. President Obama has something in 2012 that Rosty would have killed for in 1986: an automatic tax increase should no agreement be reached. It isn’t clear how much Obama will use this as leverage, because he doesn’t want to cancel all the Bush tax cuts, just those for the wealthiest families. But why not let all the Bush tax cuts lapse, if deficit reduction is the true goal? At the very least, Obama ought to convince his GOP adversaries that he views the prospect with equanimity. Whatever tax reform is achieved in 2012 must prove itself better than doing nothing at all. And doing nothing looks to me like a hard-to-beat outcome.
Timothy Noah is a senior editor at The New Republic. This article appeared in the May 10, 2012 issue of the magazine.
30 comments
A great post, as always, Timothy. However--and this is a singular experience for me when reading your columns--this time I had a couple qualms, one minor, one major. First, as a technical matter, this is incorrect: "Right now the top bracket (35 percent) kicks in for families at about $388,000. Obama wants to lower that threshold to $250,000." In fact, the $250,000 figure actually falls roughly in the middle of the second-highest bracket, currently 33%, which applies to income earned in the $217,000-$388,000 range for couples. That second-highest bracket of 33% will rise to 36% when the Bush tax cuts expire. The highest bracket, currently 35%, will rise to 39.6% when the Bush tax cuts expire. The President is not seeking to lower the 35% bracket to apply to income between $250k and $388k. Instead, the Administration would allow the current Bush tax cut rates to expire for any couple earning above the $250k threshold. In other words, the President's position is to split the second-highest bracket in two. Income in the $217k-$250 range would retain the current 33% bracket; income in the $250k-$388k range would see a tax increase to 36%. Only those earning more than $388k would see an increase to 39.6%. The 35% rate would no longer exist, and Obama would allow the top TWO (not just the very top) rate go up, making the quoted text above incorrect. Second, the section in your post on "Tax complexity" wasn't actually about complexity. Rates and brackets have almost nothing to do with tax complexity, although one wouldn't know it given all the press attention on rates (cough*WSJ*cough). The rate schedule takes up only a couple pages among the many thousands of pages of the Internal Revenue Code. And, in any case, the bracket calculation is quite a simple one that mostly pre-calculated by IRS in each year's tax tables. E.g., the 10% rate on the first $17,000 in income is the same for all taxpayers, whether you're a millionaire or a minimum wager: $1,700 in tax liability. The IRS (or TurboTax) figure all that out for taxpayers anyway. Instead, the true sources of complexity is tax expenditures. Right now, the Federal income tax takes in about $1.2 a year in revenue; it also offers about $1.2 trillion in tax breaks. There are literally hundreds of tax exclusions, exemptions, deductions, and credits--these tax expenditures are what make the Tax Code (thousands of pages' worth) and tax compliance (thousands of hours' worth) so complicated. In addition, to harken back to the broader point of your post above, many of these tax expenditures--particularly the largest and most costly deductions and exclusions--are also the most regressive. Deductions and exclusions are particularly egregious: they're government spending programs that provide a higher tax reimbursement the higher your income tax rate is. I'm ballparking it here, but roughly, for every $1 in Federal revenue lost because of something the two biggest tax benefits provided to low-income earners (EITC and child tax credit), more than $6 in revenues is lost in the two largest deductions subsidizing the top quintile of income earners. So, tax reform done right--admittedly an open question--would be a fantastic opportunity to reexamine this "spending (much of it for rich people) through the tax code." It also would give the country an opportunity to reexamine whether some of the more market-distorting tax breaks might be eliminated or better-designed. Imagine, for example, a homeownership tax incentive delivered as a refundable tax credit (which provides the same dollar-for-dollar tax benefit to all taxpayers, regardless of income) rather than the current interest deduction that essentially cuts a bigger check to taxpayers with higher incomes and more expensive houses. In any case, to the extent that many deductions and exclusions are curtailed or reformed, we can (1) reduce "tax complexity," (2) make the tax code more progressive, and (3) not incidentally, raise additional revenue (provided that only some, but not ALL, of the savings are used to lower rates) -- all of which sort of cuts against the argument made in your post about complexity. Just thought that was a point worth mentioning. In any case, my apologies for harping on only two aspects of your post. Your larger point is well-taken and one that is, to my way of thinking, impossible to legitimately disagree with.
- chrisprend
April 19, 2012 at 1:21am
My comment to Noah's post: Yes! Short and no complexity.
- rayward
April 19, 2012 at 7:00am
Only vaguely related, but Timothy Noah, if I have any power at all as a commenter, can you please write a considered response to the following short video of a Charles Murray AMA? See http://andrewsullivan.thedailybeast.com/2012/04/ask-charles-murray-anything-why-not-just-redistribute-income-to-fix-inequality.html Honestly. It's the most transparent piece of BS dressed up in a patina of concern for the poor and unsubstantiated by actual data since ... the Ryan budget, I guess. Also, if you happened to read the Ed Luce FT interview with Murray, this should be a very pleasing softball to lob out of the park. (I just like fireworks. Especially when they find deserving people.)
- chaitless
April 19, 2012 at 7:50am
I agree with chrisprend that tax rates are a single line on the tax return, require no interpretation and are a simple calculation. The Code's complexity, I believe, stems from the infusion of social and economic policy into the tax code (i.e. government influence over our affairs,) weighing it down with costly inefficiency that requires more government force and the most collective pain for taxpayers, as those who behave accordingly pay too little and others pay too much. People can argue over fairness, but progressive rates are the most efficient way to collect revenue.
- Nusholtz
April 19, 2012 at 7:50am
Sadly, Obama and his supply-side advisors (apparently he has quite a few, Geithner comes to mind) are SO afraid of expiring the Bush Tax-Cuts, that he'll do almost anything to avoid it. Extend them, allow himself (and America) to be held hostage, negotiate cuts in Social Security and Medicare, anything. He keeps hoping he can use renewing the Bush Tax-Cuts on salaries below 100K/150K/200K/250K -- whatever the proposal is this week -- as a negotiating chip to get them to expire on salaries above that. What he doesn't realize is it would be a GOOD THING if the entire Bush tax-cuts were allowed to expire. The Supply-Side doom-and-gloom predictions of economic collapse should taxes go back up are just that -- predictions. And from our history, really inaccurate predictions at that. He also doesn't realize the Republicans are quite a bit less interested in true negotiations than he is. They're WAY more devoted to being able to claim "We Never Raised Taxes!" -- despite the impact on entitlements. Probably BECAUSE of the impact on entitlements. His best move, especially after he gets re-elected, would be to negotiate in good faith, the Republicans will block, then let the tax-cuts expire. HE can't get elected again, and in 4 years the effect on the deficit and our economy of actually PAYING for our Government will be enormously positive. Sadly, I doubt he'll do this. Nor would Geithneer let him.
- AllanL5
April 19, 2012 at 8:51am
Two comments: First, the tax code isn't complex, certainly not for the roughly 70% of taxpayers who use the standard deduction, and hardly at all for most of the rest whose only deductions are for mortgage interest and state and local taxes. Business/corporate tax returns, however, can be complex, especially for multinational corporations and those engaged in extraction of natural resources (oil and the like). Of course, when Republicans talk about complexity and simplifying the tax code, what they actually mean is lowering the tax rates for high income individuals. Second, God is too busy these days to approve an increase in tax rates (tax expenditures grow like kudzu but an increase in tax rates requires special dispensation from God), so the only potential for an increase in tax rates is the one that has already been approved.
- rayward
April 19, 2012 at 9:07am
Combine a lottery system with submitting your federal income taxes. Two types of lottery "tickets." Category one -- simply by submitting your federal taxes you are elgible to win lottery prizes. (This provides equality regardless of status/class). Category two -- the larger the amount you pay, the greater your prize. (This encourages the rich to pay their taxes in full instead of cheating/pursuing tax breaks.) For all, this makes taxes a game and form of entertainment and a wholesome sporting event variation of class war. I am so brilliant (and conceited) I can hardly stand it. Fortunately, my idea will be either ignored completely or rejected out of hand. Oh, Fubar.
- skahn
April 19, 2012 at 9:09am
"His best move, especially after he gets re-elected, would be to negotiate in good faith, the Republicans will block, then let the tax-cuts expire. HE can't get elected again, and in 4 years the effect on the deficit and our economy of actually PAYING for our Government will be enormously positive. Sadly, I doubt he'll do this. Nor would Geithneer let him." Allan5, You have a good plan, and you're probably right that Obama/Geithner will not implement it. But even if it were put in place, and the economy is ravaged even more than it was under Bush, the average American wouldn't realize what's going on. When it comes to macroeconomics, most Americans, including business titans, are dumb as dirt. That's why they keep periodically electing Republicans, most of whom immediately go to work crashing some part or all of the economy with their as-long-as-renegade-sociopaths-are making-huge-profits-everything's-fine philosophy. But that's life. We're all dumb in some area of out lives. Republicans are just stupid in the area they treasure most--economics.
- magboy47.
April 19, 2012 at 11:33am
Here is an example of Republican Reform from Romney. We already have a $1 million cap on acquisition debt for home mortgages, which also limits the combined mortgage deduction for two homes to that amount. Romney mentioned, privately but overheard, that he plans to reduce the second home deduction for high income taxpayers and he claims this will offset his cutting the tax rates. One home with a mortgage for Romney is already capped. He will be unaffected by the change. That's an example how Duplicitous Mitt will cut his own tax rate and pretend otherwise.
- Nusholtz
April 19, 2012 at 11:38am
We need higher revenue to fund our government. Why do proponents of tax reform always claim that lowering rates must be part of the process? I say, keep the rates where they are after the Bush tax cuts expire again, and then eliminate deductions for mortgage interest, charitable donations, preferred treatment of capital gains and dividends, etc. But keep the EITC. And make child care expenses fully deductible above the line.
- subterran
April 19, 2012 at 12:13pm
If it were up for a vote, a line item veto for a sitting President of the United States should be passed. I understand the Supreme Court has stated in no uncertain terms that this idea belongs in a lawn trash bag along with grass cuttings. However, Congress could revisit this question sometime before the elections in November.
- Doug12
April 19, 2012 at 12:14pm
I say go for Jim Cooper's bill, which is essentially the Deficit Commission's recommendations. Why does everyone, including Obama, treat the coimmission and its ideas as if they were radioactive? I don't think you can take one small piece of Ryan's bill and say hey, this doesn't sound so unreasonable. You have to look at the big picture, and why that supposedly sane item was included. And when you do, the bill quickly becomes unthinkable as a basis for compromise, which of course was the intention. Even the Republicans don't want this abomination to become law.
- mlottman
April 19, 2012 at 12:17pm
We agree - in fact the do nothing strategy is what I thought Obama should have done back before he agreed to extend the "irresponsible" Bush tax cuts. The ability to bargain from higher tax rates would greatly increase Obama's leverage in any negotiations. DMcMahon
- NR138704
April 19, 2012 at 1:04pm
Sad but true. The best one chan hope for from BHO on Progressive economic policies in the next 1- 5 years is "do nothing". Care to bet he'll eventually "do worse than nothing"?
- drofnats1
April 19, 2012 at 2:08pm
Letting all the Bush tax cuts expire would, I agree, be an excellent outcome. I would hope that President Obama would use that as a positive alternative to caving into Republican demands to extend all or some of them yet again. The thing that concerns me is the automatic budget cuts. We could do better than letting the draconian cuts from the debt limit ceiling deal go into effect. I'm hopeful, though, that Congress will find a way around them.
- Erik_S
April 19, 2012 at 2:26pm
Nary a note about effective tax rates from Noah. All he seems to really care about is super high rates that look good on paper, but nobody really pays. The fact is, if you look at effective tax rates for the top 1%, they are relatively unchanged from the late 50's and 1960's.
- seattleeng
April 19, 2012 at 2:56pm
seattleOink! cite?
- Nusholtz
April 19, 2012 at 7:20pm
Nutz writes: "oink oink" en.wikipedia.org/wiki/File:Average_Tax_Rates_for_Selected_income_groups_Under_a_fixed_Income_Distribution,_1960-2010.jpg As I've noted before, dems spend the most time making the most hay out of nothing. Buffett rule will not change the outcome of our economy one bit. And yet that's all we hear about. CBO says it will raise $4B a year. Yawn. "Raising" rates back to where they were in the 60's will not change the outcome of our economic end game one bit. And similar amounts of breathless bleating are spent there too. Except that the top 1% didn't pay big taxes back then either. Noah et al: Complain about something that matters. Write about changes that will actually change the end game. This relentless pursuit of fairness that is driven by greed just clouds your thinking. Do you want to fix a problem, or do you want to bleat about in an echo chamber about how unfair things are? Engineering school is very, very good about training you to quickly figure out what matters and what doesn't when something is broken. Buffett rule and tax rates on the wealthy...just don't matter. Listen to Ryan. He gets it.
- seattleeng
April 19, 2012 at 8:15pm
SeattleOINK! "if you look at effective tax rates for the top 1%, they are relatively unchanged from the late 50's and 1960's." Your statement is false or misleading. The wealthiest 1-in-1,000 taxpayers pay barely a quarter of their income in Federal taxes today—half of what they would have contributed in 1960. Effective tax rates for the top 1 percent have varied moderately over the past five decades, peaking in about 1980 before falling back to lower levels between the late 1980s and the present. In stark contrast, the wealthiest taxpayers have seen their effective tax rate plummet over the past five decades because of changes in Federal tax policies.
- Nusholtz
April 19, 2012 at 10:05pm
But you do agree the top 1% have seen their tax effective tax rates relatively unchanged since at least 1960. And presumably, in the 1950's they were lower. They definitely lower in the 30's and 40's. The data is plain. After you answer this, we can peel back the onion.
- seattleeng
April 20, 2012 at 1:01am
OINK! No. The rates have not been unchanged since the 60's. The rates have changed. They went up and down and up and down after Bush. Besides, the data is not about the rates, the data is about average effective rates, which means deductions are included. The 1986 Act got rid of shelters and brought down rates. There is no onion.
- Nusholtz
April 20, 2012 at 8:44am
Nutz, do you know what "effective tax rates" means? I think you are avoiding the question. From the graph I linked to, you can clearly see the top 1% have paid at or under 30% effective for most of the last 50 years. The rates went above 30% from the late 60's to the mid 80's. But overall, the effective tax rates on the top 1% have never been higher than about 38%, and have generally been at or below 30% for for the entire history of our country. Do you agree?
- seattleeng
April 20, 2012 at 11:30am
OINK! "Effective tax rates" means you take the tax and divide it by adjusted gross income. The fact is that effective tax rates have changed. They have gone up and down on your graph, but the effective top rates on the top .1% have gone only down. If your point is that effective rates don't change for the top 1%, that is not true.
- Nusholtz
April 20, 2012 at 12:11pm
Back in the 1990s, I was often puzzled by the way the personable, mild Bill Clinton induced such maniacal hatred from conservatives. Quite aside from the impeachment-lynching party in Congress, led by Clinton's counterpart philanderers, there was a foaming-at-the-mouth virulence observable in ordinary people. Remember? This article, in passing, explains it all: "President Bill Clinton shredded tax reform a second time in 1993, increasing three brackets to five AND RAISING THE TOP RATE to 39.6 percent." The capitalized words are what induce clinical hysteria in dyed-in-the-wool Republicans. Ironically, as the article goes on to note, "It was these tax increases that made it possible for Clinton eventually to balance the budget (before President George W. Bush unbalanced it again)."
- jgallant
April 20, 2012 at 12:46pm
Nutz writes: "They have gone up and down on your graph, but the effective top rates on the top .1% have gone only down. If your point is that effective rates don't change for the top 1%, that is not true. That's not my point. My point is 1) Prior to the 60's, the top 1% paid less quite a bit less than they pay today 2) We've about about 15, maybe 20 years, in the entire history of the country that the top 1% have paid over 30% effective 3) The top 1% have never paid more than 38%, and that was for a fairly short duration in time. Are any of these statements false?
- seattleeng
April 20, 2012 at 1:50pm
Gallant writes: "The capitalized words are what induce clinical hysteria in dyed-in-the-wool Republicans." Clinton did increase top rates, but also slashed cap gains taxes. As a result, a wealthy person paid just 2% more in effective tax rates under Clinton compared to Bush II. But that 2% was easily offset by the increase income they received in the late 90's. From the raw numbers, it appears it was a truly wondering time to be wealthy. Almost unprecendented. What rubs the right the wrong way is raising taxes as part of a larger plan to bludgeon the economy, especially when the gov is becoming increasingly wasteful.
- seattleeng
April 20, 2012 at 1:58pm
In addition to the reasons that Tim mentions, another reason that 2012 is not 1986 is that much of the business complexity of the code was eliminated in 1986 and the majority of the current deductions (in $) that might be eliminated are more broadly distributed (like medical costs, local and state taxes and mortgage interest) and would be difficult to eliminate. Also it is worth thinking about what would happen to the real estate market in 2013 if the mortgage interest deduction were eliminated. So tax reform is not a sensible goal now. The only tax expenditure that could sensibly be eliminated is the lower rate for capital gains and dividends. Second, I don't know or care much where Wikipedia gets its graphs, but if one looks at a recent refereed article: http://elsa.berkeley.edu/%7Esaez/piketty-saezJEP07taxprog.pdf at 16, one can see that the effective tax rates for the top .1% were much higher in the 60's and 70's than thereafter, varying from a high of 60% to a low of less than 40% after 1986, increasing under Clinton and decreasing under Bush. There is literally no historical evidence that these higher (marginal or effective) rates had any negative effect on growth. So the question really is what is the level of government that the populace demands and how will it be paid for? It is hard to imagine that one can cut much out of domestic spending without significantly affecting the well-being of ordinary Americans. I cannot figure out what Seattle could possibly mean by government becoming increasingly wasteful while it is becomes a smaller and smaller share of the economy.
- krvogel49
April 20, 2012 at 4:54pm
krvogel, see Table 2 in the paper you referenced. Again for the top 1%, they are similar. krvogel writes: "There is literally no historical evidence that these higher (marginal or effective) rates had any negative effect on growth." The contrary is true, too.
- seattleeng
April 20, 2012 at 5:48pm
Tax complexity has nothing to do with the number of tax brackets. If we have 2 tax brackets or 2 million, everyone will either look up the final number in tax tables or use tax software. Functionally, for tax preparers or individuals, reducing the number of tax brackets doesn't make the tax code simpler. I can't imagine that the current House of Representatives could possible agree to any tax reform proposal that would be in America's best interest so I agree that letting all the Bush tax cuts expire looks to be the best tax reform we'll get with the Congress we have. Real tax reform should start with the question, what do we want government to do and how do we want to pay for it. For instance, eliminating the cap on income subject to the Social Security tax would extend the solvency of the Social Security Trust Fund till 2083. A financial transactions tax of 0.1% would raise about 100 billion a year which is about how much additional revenue we need to fund our national infrastructure. The re-clogging of the tax code with tax expenditures since the 1986 Tax Reform Act points to a different approach to tax reform. The best tax reform would eliminate all deductions, exemptions, credits and loopholes in the tax code. All tax brackets would be replaced with a sliding scale percentage that incrementally increases as income increases. Income from investment and wages from work would be taxed exactly the same. The hidden government programs concealed in the tax code that have merit should be re-written as stand-alone spending programs. The brilliant spotlight directed towards discretionary spending will separate the wheat from the chaff.
- Earlybird1
April 21, 2012 at 6:05am
earlybird writes: "The best tax reform would eliminate all deductions, exemptions, credits and loopholes in the tax code. All tax brackets would be replaced with a sliding scale percentage that incrementally increases as income increases. Income from investment and wages from work would be taxed exactly the same." Amen. If corp income taxes are eliminated, then cap gains should be taxed EXACTLY as income. And get rid of every deduction and and credit. Take all your income, subtract a baseline cost of living from it, multiply by a tax. Simple progressive as hell.
- seattleeng
April 21, 2012 at 11:34am