A Liberal Tax Revolt

Republicans think they've hit pay dirt with their crusade against the tax code and the Internal Revenue Service. And perhaps they have. But Democrats should pay particular attention to this irony: the political resonance of the flat tax is rooted in public concerns over simplicity and equity. And those should be Democratic issues. Liberals should be in a far better position to capitalize on them than conservatives. How is it that Dick Armey can exploit middle-class antitax resentments to support a proposal that would increase taxes for the lower 95 percent of taxpayers? How, indeed?

Many liberal programs and policies are simply a hard sell. We shouldn't expect it to be easy to get the electorate to pay for assistance to the poor, to support affirmative action, or to fund foreign aid. To gain support for these policies, politicians must appeal to our foresight and the better angels of our political nature. But progressive taxation simply does not fall into this category. Progressivity is not only good policy; it should also be good politics—since by its very nature it appeals to the self-interest of the overwhelming majority of the electorate. If Republicans can get Democrats on the defensive for their support of progressivity, then the Democrats are clearly doing something wrong.

The right is simply capitalizing on legitimate frustrations, taking advantage of the fact that liberals have had remarkably little to say about the tax burden on working- and middle-class families. That sort of indifference is perilous for liberals because it can invite the sort of antitax frenzy that makes progressive governance impossible. We need to engage conservatives on the politics of tax simplicity because doing so could do much more than simply defuse the momentum for the flat tax. We might also lay the groundwork for the critical task of reshaping the landscape of tax politics along lines favorable to progressive principles. For too long the politics of taxation have been contested on the narrow ground of income taxes. Payroll taxes, the most regressive taxes of all, remain off the table. On the capital gains tax, both parties have joined together in policies that plainly reward a tiny fraction of the electorate. Liberals need to open up the discussion about taxes. And, if liberals wake up to the opportunity, the politics of the flat tax may just point the way.


THE POLITICS OF THE FLAT TAX

The popular appeal of the flat tax is actually two appeals bundled up in one. The first is the allure of simplicity—the desire to do away with complicated rules, forms, and the lingering fear of breaking a rule without even knowing it. That's the appeal of the postcard tax returns. But beneath the attraction of simplicity resides the more compelling appeal of tax transparency—a tax code whose basic principles can be understood. Transparency speaks to deep-seated anxieties about fairness and equity, fears that whatever the tax code says on the surface, the wealthy may be paying little or no taxes because they can manipulate the maze of tax shelters and loopholes. Republican flat tax rhetoric frequently plays to these fears. Dick Armey and Bill Archer recently castigated the tax code for being "riddled with special-interest loopholes" and letting "some people earning more than $200,000 a year pay no taxes at all." That's the transparency appeal in its barest form.


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Statements like those cut to the heart of the dishonesty of contemporary flat tax rhetoric. Dig around in the pamphlets supporting Armey-Shelby, the GOP flat tax bill, and you'll find the standard lines about supply-side economics. But the bill's sponsors know that these make for very bad politics—because the flat tax would leave the rich paying less and the poor and middle class paying more. So they make the pitch on the basis of tax simplicity. Everybody pays one low, simple rate—no complicated forms, no special loopholes, and so forth. The aim here is to conflate progressivity with complexity, even though there is no real connection between the two. As countless Democrats rightly point out, it would be just as easy to "simplify" the tax code by creating four or five graduated tax brackets and eliminating most, or all, deductions. That's simple, straightforward, and progressive.

But if this is true, then why do Democrats always have to get stuck saying "Me, too" when Republicans push tax simplicity? Why, indeed? For Republicans, the political allure of the flat tax is clear enough. It not only cuts taxes for the wealthy; it allows the GOP to put Democrats on the wrong side of the simplicity issue and identifies them with taxes in general. It's not surprising that Democrats instinctively resisted the GOP onslaught against the IRS and the tax code in last year's Senate Finance Committee hearings on IRS abuses. They knew after all that the real objective was to delegitimize and gut government. But this is only because Democrats have allowed Republicans to define the tax simplicity debate on their terms. Democrats, after all, have no ideological commitment to the tax code's complexity. Their interest is in a tax code that raises revenue in a progressive fashion. Democrats have simply let themselves get outmaneuvered—as they did when Republicans attacked IRS abuses that were plainly outrageous, and Democrats belatedly said, "Me, too." As it turns out, tax simplicity is far more in the long-term interests of Democrats than Republicans.

Consider how different the politics of the flat tax would be if, instead of the current tax code, we had a tax code with minimal deductions and five brackets at 10 percent, 20 percent, 26 percent, 32 percent, and 34 percent. Let us further assume that 75 percent of the population fell into the lowest bracket at 10 percent. How much political traction would Dick Armey get if he proposed cutting the three upper brackets down to 20 percent and making up the shortfall by raising the lowest bracket from 10 percent to 20 percent? Probably not much. But that just makes the point: the complexity of the tax code is the enemy of progressive taxation. The fact that so much of it remains hidden in a murky netherworld of complex deductions, payroll taxes, and differential rates of taxation on various forms of investment allows Republican politicians to campaign against taxes in general while actually shifting the tax burden from the wealthy to middle- and lower-income taxpayers.

The problem is that Democrats tend to see the tax simplicity issue too much in tactical terms. If the Republicans have their proposal for tax simplicity, the Democrats have one too—and they can do it while maintaining tax equity. There is, in fact, a Democratic proposal that does just this: the hypothetical progressive tax I set forth above is actually House Minority Leader Richard Gephardt's "10% Plan." But even the plan's backers recognize that it is essentially a counterproposal to Armey-Shelby. The GOP bill was formally introduced in 1994, and Dick Armey has been pushing the plan nonstop ever since. Gephardt's plan, while first proposed in 1995, is only now being written into an actual bill. And even its supporters concede that its real purpose is to put the lie to the GOP's flat tax arguments and stake out a progressive position in the coming debate.

Gephardt deserves real credit for putting his plan on the table. But fundamentally he is still playing catch-up. And that's the problem. Tax simplicity should be more than a rhetorical dodge Democrats use to outflank the Republicans in their drive for the flat tax. It should be central to all Democratic strategy on taxes. As countless political battles have shown, Democrats can do no better than fight Republicans to a draw when the subject is taxes as such, yes or no. But when debates turn on tax equity, they are in a strong and even commanding position. Liberals need to make this issue their own. Not only does tax simplicity generate short-term political benefits. It also produces long-term political advantages by shaping the terrain of tax politics in ways favorable to progressive principles. Democrats need to get out ahead of the GOP on tax simplification and focus the debate not on taxes in general but on just who pays and in what amounts. That kind of tax policy debate would be a fight on Democratic turf, a battle Democrats could win.


FLAT TAX, FLAT TACTICS

Alas, the Clinton administration has a long history of playing defense on tax politics and is actually quite good at it. When the debate over the flat tax does heat up, the White House will stand back and let the Republicans take their best shot. That's a classic Clinton stratagem, and it's not necessarily ill conceived. The Clintonites have an exceptional record of tactically outflanking the GOP with a combination of measured retreats and focused attacks on Republican policies that favor the rich. And the flat tax debate will be particularly amenable to that strategy. According to Citizens for Tax Justice, the Armey-Shelby bill would mean a tax hike for the vast majority of families making less than $150,000 annually—and mammoth tax cuts for everyone above. Those are the kind of numbers that 30-second attack ads are made of. The Republicans could find themselves walking into just the sort of political disaster they made for themselves in the government shutdowns of 1995 and 1996.

But let's recognize the limitations of victories achieved on these terms. Whatever the cunning of Clintonite tactics, they remain just that: tactics. Good tactics win debates. But good strategy is about shaping the terms on which debates will take place. Good strategy determines whether a political victory will mean simply preventing harm or producing meaningful reform. Democrats can trip up Republicans by charging that GOP tax cutting endangers programs, balloons the deficit, or creates giveaways for the wealthy. But that's all. There is no strategy here for transforming the very landscape of tax politics, no strategy for getting off defense and on the offensive.

Victories like these also have hidden costs. Even a legislative victory could prove to be a strategic defeat if a mishandled defense of the current tax code served only to further identify the Democrats as the party of taxation. Sometimes in the politics of taxation the whys and wherefores of particular policies become less important than the overall motion of the debate. The libretto of tax politics often tells us much less than the deeper rhythms. Republicans are great at capturing their pet grievances with the tax code with cutting phrases like the "marriage penalty" and the "death tax." And they chant these lines like mantras everywhere they can. It does not even make a difference really whether Democrats have some counterargument to each individual point. Nor does it really matter to Republicans whether many of their proposals ever get off the ground. The real aim is to corner Democrats into looking like defenders of the status quo, defenders of taxation for taxation's sake.

That was the case in last year's Senate Finance Committee hearings on IRS abuses. With only a few carefully choreographed public hearings, GOP lawmakers stoked up resentments against taxes and tax collectors and filled the nation's print weeklies and news magazines with horror stories about abusive IRS agents. The effort was so successful that they quickly steamrolled the White House into accepting a stack of GOP-authored reforms of the IRS. But the reforms were really only an added bonus. The real aim was to make the abusive IRS agent the poster boy of the Democratic Party.


MISSING THE POINT

Unfortunately the Democrats' own history of defeat sometimes makes them overlook opportunities they might more fully exploit. Liberals sometimes become so used to grappling with antitax agitprop that they lose touch with the fact that certain taxes really are burdensome to middle-income wage earners. Partly because of this, they place far too much emphasis on how conservative policies inordinately help the wealthy. That's a crucial part of the story; but it leaves the story half untold. It may be clear to tax policy analysts that every dollar not paid by corporation X or wealthy individual Y must be made up either in more revenue from lower-income taxpayers or by cuts in government programs. But that's a distant logic for the average taxpayer. Democrats are at their strongest when they demonstrate the connection between breaks for the wealthy and added burdens on the middle class in the form of benefit cuts or tax hikes—and vice versa. In the titanic budget battle of 1995-96, Democrats made Republicans suffer at the polls only when they demonstrated convincingly that the proposed tax cuts equaled cuts in valued benefits for the middle class. The point is even more clear in two recent political battles—the minimum-wage increase in 1996 and the capital gains tax decrease in 1997. The campaign to raise the minimum wage was obviously a move to support working Americans, but only a relatively small percentage of Americans work at the minimum wage, and only a minority of those head households. Yet the minimum-wage increase had a profound political resonance not simply because of what it meant to be for it, but what it meant to be against it. Being opposed to even a modest increase in the wages of America's lowest-paid workers exposed Republicans as basically unconcerned with the struggles of working Americans. And opposition to the bill quickly became politically deadly.

The debate over a capital gains tax cut had an altogether different character. The capital gains tax itself is simply not politicized to anything like the degree that marginal income tax rates are. Even the term "capital gains" seems perfectly designed to obscure exactly what is being talked about. In last year's tax debate, there was a well-mobilized constituency—investors, brokers, and their intellectual allies—who cared passionately about capital gains cuts. There was no mobilized constituency on the other side and the White House simply rolled over for most of the Republican plan.

As long as capital gains taxation remains distant from the concerns and everyday experience of ordinary Americans, it will never truly resonate for Democrats as a political issue. It shouldn't surprise Democrats that they lost this fight.

Perhaps Democrats should borrow a page from the GOP playbook and come up with their own version of the "marriage penalty" or the "death tax." The rate of taxation on capital gains is, after all, the rate of income tax on a certain kind of investment income. So it's really an investment income tax rate. The differential between the rate of tax on investment income (less) and wage and salary income (more) amounts to a penalty on wage and salary income. In fact, it is doubly penalized if we consider that wage and salary income is taxed by the income tax and the payroll tax. Liberals might get more political traction if they reframed the debate about capital gains taxes around the "wage earners' tax penalty."


POLITICS AND THE PAYROLL TAX

But rather than getting caught up in debates over how much to cut the capital gains tax, liberals should be focusing on providing relief from those taxes that are most burdensome to working- and middle-class families. It is an open secret that the payroll tax is the most regressive portion of the federal tax code, and yet it remains curiously nonpoliticized. To contest tax policy on the narrow ground of the income tax while ignoring the payroll tax is craziness. Liberals need to put the payroll tax on the table.

Of all the statistics that tax policy analysts quote today, none is more significant than this one: 72 percent of American households pay more of their income in payroll taxes than income taxes. That's a shocking statistic. So shocking in fact that it's worthwhile to reflect for a moment on just what it means. The progressivity of the tax structure is quickly becoming no more than a statistical illusion for the vast majority of Americans. If middle-class and lower-middle-class taxpayers are receptive to antitax politics, it's not only because their wages have stagnated. It's also because they have been saddled with an increasing proportion of the tax burden when they are least able to afford it.

Senator Edward M. Kennedy has recently proposed a modest reform of the payroll tax. As it now stands, the Social Security portion of the payroll tax combines contributions of 6.2 percent each from employee and employer. But the tax only applies to the first $68,400 of income. So the higher your income goes over $68,400 the lower the effective rate of payroll tax you pay. The Kennedy proposal would remove the $68,400 cap and use the additional revenue to fund a rate reduction from 6.2 percent to 5.3 percent. That's a modest but important step. The amount of dollars returned to wage earners' paychecks would not be great. But it would make a difference. And the political resistance to removing the cap would expose Republican priorities much as it did in the fight over raising the minimum wage.

But if Social Security is the "third rail" of American politics, then the payroll tax is the third rail of liberal tax policy analysts. It is a widely held point of orthodoxy that any departure from the current payroll tax regime would endanger the program's long-term political viability by threatening its character as a universal entitlement. This is an important concern, but the argument has serious shortcomings. It is reasonable to assume that the public perception of Social Security would change quite dramatically if it changed from a program of social insurance to one of cash assistance to the elderly poor. But it's not at all clear that the same argument should apply to the funding structure of universal entitlements.

We shouldn't play fast and loose with Social Security's future. But neither should we let our fears paralyze us—particularly when doing so erodes the overall progressivity of the tax code. The reality is that Social Security is quite popular. To maintain the current system or even increase payroll taxes (as some propose) would put Democrats in the anomalous position of using something for which they are very unpopular (taxes) to protect something else (Social Security) that is already quite popular and seems likely to remain so. That simply makes no sense. A touch of progressivity is far less likely to damage Social Security than the increasingly burdensome taxes that are required to fund it.

In fact letting progressivity erode can, paradoxically, generate political momentum for lower and more regressive methods of taxation like the flat tax. The classic case of this odd double movement happened in the California tax revolt of the late 1970s that culminated in the notorious Proposition 13, which placed strict and quite low limits on property taxes. What is often overlooked in Proposition 13 is that middle-income homeowners really were getting socked with rapidly rising property taxes. Through a combination of changes in the mechanisms of assessment and explosive growth in housing prices, real rates of taxation were in fact rising quickly. It was only after state government failed to provide any relief that these same taxpayers became the shock-troops for Proposition 13.

This pattern is so common, in fact, that it almost amounts to a law of tax politics. Call it the middle-class tax vise. It goes something like this:

  1. Over time the burden of taxation is redistributed down the income scale until most of the progressivity is squeezed out.
  2. With middle-income wage earners shouldering an increasing level of taxation (and likely receiving less back in government programs), the electorate becomes soured on the tax structure and receptive to antitax politics.
  3. To remove the burden of middle-class taxes, taxes are reduced but on a regressive basis.

Over the last 30 years the federal tax code has followed a similar pattern. Through a combination of rising payroll taxes and declining marginal rates of taxation on income the overall degree of progressivity in the tax code has been steadily declining. In the late 1970s California Democrats failed to tend to the needs of middle-income homeowners, and they reaped the whirlwind. Democrats today are making much the same mistake. If focus groups of downscale voters complain about the burden of taxes, must we not conclude that their frustrations are tied to payroll taxes, of which they pay quite a lot, rather than income taxes, of which they pay very little?

Progressive tax reform is good politics, but not easy politics. Giving middle-income wage earners a break on payroll taxes would require rethinking some important orthodoxies about Social Security and universal entitlements. Radically simplifying the tax code would raise howls from countless constituencies who would lose their pet deductions and preferences. But vibrant political movements find creative ways to transcend problems such as these. Only moribund movements allow themselves to become so hobbled that they become easy marks for their political adversaries. Liberals need to shake their political timidity on taxes and start widening the debate to encompass those areas of tax policy where they have natural advantages.

It's important not to overestimate the importance of such marginal changes in the tax code. The most important determinants of wage inequality are based in pretax rates of income. Tax equity is a start, not a solution. The solutions to rising economic inequality and social insecurity will be found in broader structural reforms—reforms in labor laws, in universal health care, in a new generation of social investments. But if Democrats cannot solve the problems of America's working families by changing the tax code, they can at least avoid the blame for working against their interests. If a regressive tax system keeps generating antigovernment revolts, there will neither be the means to finance social outlay nor legitimacy for government intervention. Democrats should never be left holding the bag for the IRS or defending the payroll tax. The liberal failure to speak for the frustrations of the common American on tax policy tarnishes liberal credibility on other issues, and it impeaches government as an agent of popular change.

When it comes to taxes, the problem is not that Democrats lack a story to tell—they have one. The problem is that Republicans are telling it for them. And they are telling it not, of course, in the interests of progressive taxation but in the cause of regressive taxation and gutted government. The Republicans are, after all, only seizing the opportunity to push their agenda. The culprits are Democrats who have neglected their own work for much too long.

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