August 8, 2012 6:46 pm
Americans need to face the harsh truth and pay more tax
One of the guiding principles of contemporary tax policy in the US is the notion that Americans are terribly overtaxed. Both candidates are running on not raising taxes for the middle classes and Mitt Romney wants to not only make the George W. Bush tax cuts permanent, he wants to cut income tax rates another 20 per cent across the board.
Yet, data from the non-partisan Congressional Budget Office reveal that, when it comes to federal taxation, US households are less taxed now than 30 years ago, and that is not just a function of the recession. The CBO data began in 1979 when the typical, or median, household paid 19 per cent of their income in federal taxes. In 2009, that share had fallen to 11 per cent.
Both economic and policy changes account for the decline in “effective tax rates”. In recessions, progressive tax systems provide automatic tax cuts as declining incomes push households into lower tax brackets. Middle-income households lost an average $6,000 in market-based income, an 11 per cent decline, between 2007 and 2009, but their federal tax bill fell $2,300, or 24 per cent. Thus their effective tax rate fell from 14 per cent to 11 per cent.
But policy changes also played a significant role and the Bush tax cuts have had a large impact on the fall of tax rates ever since. Over the 1980s and 1990s, the overall effective tax rate fluctuated within a narrow band of 20.2 per cent to 22.7 per cent – lower in the Ronald Reagan years, a bit higher in the Bill Clinton years. But from 2000-07, before the recession took hold, they fell by almost 3 percentage points, equal to about $300bn in revenue, or 2 per cent of gross domestic product.
Policy changes lowered taxes in the recession, too. That’s a perfectly legitimate use of tax cuts, but such cuts are supposed to be temporary and reset once the downturn has passed. Yet, every time a tax cut nears expiration, the deafening cry of “tax increase!” frightens politicians such that today’s tax policy is solidly asymmetric: rates can only go down. That makes it impossible to get on a sane fiscal path.
For Republicans who have signed the Grover Norquist pledge to never raise taxes, the misleading mantra that we are overtaxed serves two purposes. First, the wealthiest households get the biggest income boost from any across-the-board cuts.
Second, once the villainy of tax increases is widely accepted, the only way to achieve any deficit savings is through spending cuts. But this is very dangerous logic. The House Republican budget, for example, as authored by Mr Romney or Paul Ryan, would get virtually every government function outside of Social Security, healthcare and defence.
Barack Obama, backed by Senate Democrats, is calling for the upper-income Bush tax cuts to expire. But contrary to popular belief, Mr Obama has already been an aggressive tax cutter. His cuts have helped considerably in reducing recessionary damage to family incomes, but there needs to be a more robust plan to return to fiscal health.
That plan will have to include tax increases beyond just the wealthiest households, although that is the right place to start. But what should happen next? In Washington, the standard position is “comprehensive tax reform” where we “lower the rates and broaden the base”. While I agree with that in theory, in practice it has become a ruse. From the highly touted Bowles-Simpson plan to the Paul Ryan budget plan, we see many concrete ideas for lower rates, which is what got us into this mess in the first place, and precious few specifics on broadening the base.
The best thing to do, once the economic recovery is solidly under way, is to simply let the Bush tax cuts expire and return to the tax structure that prevailed under Bill Clinton. It cannot be plausibly argued, based on economic outcomes, that the rate structure in those years was counterproductive. Oh, and it also helped deliver a budget surplus.
While I understand and support the fairness argument, I’d urge Democrats to be forthright with the fact that we’re way below where we need to be in terms of revenue collection. We simply can’t begin to meet the challenges we face on the lowest effective tax rates in decades.
It may not be the conventional wisdom, but it is the truth.
The writer is the former chief economic adviser to US vice-president Joe Biden, and a senior fellow at the Center for Budget and Policy Priorities
Yet, data from the non-partisan Congressional Budget Office reveal that, when it comes to federal taxation, US households are less taxed now than 30 years ago, and that is not just a function of the recession. The CBO data began in 1979 when the typical, or median, household paid 19 per cent of their income in federal taxes. In 2009, that share had fallen to 11 per cent.
Both economic and policy changes account for the decline in “effective tax rates”. In recessions, progressive tax systems provide automatic tax cuts as declining incomes push households into lower tax brackets. Middle-income households lost an average $6,000 in market-based income, an 11 per cent decline, between 2007 and 2009, but their federal tax bill fell $2,300, or 24 per cent. Thus their effective tax rate fell from 14 per cent to 11 per cent.
But policy changes also played a significant role and the Bush tax cuts have had a large impact on the fall of tax rates ever since. Over the 1980s and 1990s, the overall effective tax rate fluctuated within a narrow band of 20.2 per cent to 22.7 per cent – lower in the Ronald Reagan years, a bit higher in the Bill Clinton years. But from 2000-07, before the recession took hold, they fell by almost 3 percentage points, equal to about $300bn in revenue, or 2 per cent of gross domestic product.
Policy changes lowered taxes in the recession, too. That’s a perfectly legitimate use of tax cuts, but such cuts are supposed to be temporary and reset once the downturn has passed. Yet, every time a tax cut nears expiration, the deafening cry of “tax increase!” frightens politicians such that today’s tax policy is solidly asymmetric: rates can only go down. That makes it impossible to get on a sane fiscal path.
For Republicans who have signed the Grover Norquist pledge to never raise taxes, the misleading mantra that we are overtaxed serves two purposes. First, the wealthiest households get the biggest income boost from any across-the-board cuts.
Second, once the villainy of tax increases is widely accepted, the only way to achieve any deficit savings is through spending cuts. But this is very dangerous logic. The House Republican budget, for example, as authored by Mr Romney or Paul Ryan, would get virtually every government function outside of Social Security, healthcare and defence.
Barack Obama, backed by Senate Democrats, is calling for the upper-income Bush tax cuts to expire. But contrary to popular belief, Mr Obama has already been an aggressive tax cutter. His cuts have helped considerably in reducing recessionary damage to family incomes, but there needs to be a more robust plan to return to fiscal health.
That plan will have to include tax increases beyond just the wealthiest households, although that is the right place to start. But what should happen next? In Washington, the standard position is “comprehensive tax reform” where we “lower the rates and broaden the base”. While I agree with that in theory, in practice it has become a ruse. From the highly touted Bowles-Simpson plan to the Paul Ryan budget plan, we see many concrete ideas for lower rates, which is what got us into this mess in the first place, and precious few specifics on broadening the base.
The best thing to do, once the economic recovery is solidly under way, is to simply let the Bush tax cuts expire and return to the tax structure that prevailed under Bill Clinton. It cannot be plausibly argued, based on economic outcomes, that the rate structure in those years was counterproductive. Oh, and it also helped deliver a budget surplus.
While I understand and support the fairness argument, I’d urge Democrats to be forthright with the fact that we’re way below where we need to be in terms of revenue collection. We simply can’t begin to meet the challenges we face on the lowest effective tax rates in decades.
It may not be the conventional wisdom, but it is the truth.
The writer is the former chief economic adviser to US vice-president Joe Biden, and a senior fellow at the Center for Budget and Policy Priorities
Copyright The Financial Times Limited 2012.
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