The Reaganites and the Renegade

Conservative Republican strategists are hopping mad at Kevin Phillips. For years, they have embraced (with much success) the notion outlined by Phillips in his 1969 book, The Emerging Republican Majority, that middle-class voters could be wooed by running against the poor. But now, Phillips seems to have deserted his erstwhile allies. In his latest book, The Politics of Rich and Poor, Phillips advances an opposing populist theme that can be embraced only by Democrats: the idea of running against the rich.

Phillips's earlier book was based primarily on extensive polling results showing a deep-seated white voter reaction against Democrats after enactment of the 1966 Civil Rights Act (a reaction that Lyndon Johnson himself predicted when he signed the bill). In contrast, his new argument rests mainly on economic data. He relies especially on recent reports from the Congressional Budget Office (CBO) showing that over the past twelve years the rich have gotten much richer, while their taxes have been slashed, and conversely, that middle-income families have faced stagnant incomes combined with rising taxes.

So compelling does Phillips find this information that he believes even the Democrats -- who, he says, "have the political sensitivity of a fried clam," -- will eventually be able to exploit it for political gain. After all, he says, "Fairness is supposed to be what the Democratic Party gets elected on. That's what it's supposed to stand for."

One reason, of course, why the right is so angry at Phillips (and why liberals find him so attractive) is that he looks like a turncoat; "not a real conservative" is a frequent charge. Writing in the August 6 issue of Forbes, the conservative pundit Michael Novak fulminates that Phillips is "as conservative as Jesse Jackson" and that his populism is nothing but "hate of the rich."

But you don't have to hate the rich to see that the economic developments that Phillips cites have been bad for most families, and that they ought to be corrected. It is also somewhat amusing to hear conservatives condemning Phillips's appeal to populism. They certainly didn't complain about Phillips-style populism in its earlier incarnation, when it was directed against minorities and the poor.

To be sure, if populism means only doing the popular thing, it is not much of a lodestar for making public policy. But for most of the 1970s and much of the 1980s, the Democrats acted like anti-populists. It often seemed that they were only for things if they were not popular. As David Brockway, former chief of staff at the congressional Joint Committee on Taxation puts it, "Congressional Democrats ... appeared to think that it would be indulging in rabble-rousing and demagoguery to actually do what the broad general public would like." If Phillips's book gets the Democrats to bring the public's concerns back into their policy calculations, it's a useful tonic just for that.

* * *

Beyond their feelings of betrayal, conservative supporters of upward income redistribution clearly are very worried about the CBO data that Phillips relies on in his book. According to CBO's most recent update of its analysis (published after Phillips's book was at the printer), from the time President Ford left office to today, pretax incomes for the bottom three-fifths of family income groups have actually declined in constant dollars, and incomes have risen by only 2 percent for the next 20 percent. Thus, essentially all the gains in income since 1977 have accrued to the top fifth of all families, with most of the increase concentrated on the top 1 percent. For these 1 million highest earners, pretax income has risen by 86 percent in constant dollars, from an average of $296,000 in 1977 to $549,000 this year.

Taxes worked just the opposite. Compared to 1977's level of progressivity (adjusted for inflation), taxes have risen as a share of income for nine out of ten families. Only the best-off tenth got tax cuts and, again, the cuts are concentrated on the richest 1 percent. For this elite group, taxes have been reduced by 36 percent compared to the 1977 system -- a tax cut of $82,000 each in 1990 alone.

Put these two developments together, and you find that after-tax incomes have stagnated or declined for the bottom four-fifths of all families, while the after-tax income of the wealthiest 1 percent (in constant dollars) has risen by a staggering 110 percent.

Obviously, tax policy has mattered a great deal in the Reagan-era redistribution of income. Indeed, about two-thirds of the huge shift in total after-tax income in favor of the richest 1 percent over the past twelve years can be explained by the tax cuts (including their effects on pre-tax investment earnings).

All this looks like a pretty good explanation for public unhappiness -- and for the budget deficit. In fact, were the richest 1 percent today to pay taxes at their 1977 inflation-adjusted effective tax rate, then-federal tax bill would be some $84 billion higher this year, while the government would pay at least $73 billion less in interest, for a total reduction in the budget deficit of almost $160 billion in 1990 alone.

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Thus, for Republicans who oppose raising the minimum wage while calling for even more tax cuts for the wealthy, the information Phillips cites is a powderkeg. In trying to discredit that data substantively, conservatives essentially argue that (1) the supply-side tax cuts of 1978 and 1981 did not shift income toward and taxes away from the wealthy and (2) even if that did happen, it was a good thing. But these arguments don't hold water.

Much of the right's complaints about Phillips's (and CBO's) findings are based on arguments put forward by Lawrence Lindsey, a Harvard economist who published a book, The Growth Experiment, this year, slightly before Phillips's book came out, defending supply-side policies and calling for more of the same. (For a discussion of Lindsey's book see Alicia Munnell, The Growth Puzzle," TAP, Fall 1990.)

Lindsey gained the attention of conservatives in the fall of 1987, with an article in the National Tax Journal. In it, he confidently predicted that, due to the 1986 Tax Reform Act, rich people would go on strike when it came to cashing in their capital gains. Using what he called "sophisticated computer analysis," Lindsey said that because of the increase in the top tax rate on capital gains from 20 percent to 28 percent, reported capital gains would be permanently cut in half.

As it happened, Lindsey's prognostication was a bit off the mark. His prediction that 1987 taxable capital gains would be $83.6 billion was almost 40 percent below the $137 billion in gains that were actually reported that year (even though 1987 was actually a depressed year for capital gains reporting, not only because of the stock market crash, but also because many taxpayers had cashed in gains early in 1986 to take advantage of the expiring capital gains loophole). Reported gains are expected to be more than $200 billion in 1990, about double Lindsey's long-term prediction.

As a reward for his clear thinking, Lindsey was hired by President Bush to analyze Bush's plan to restore a capital gains loophole, specifically to cut the capital gains tax almost in half. True to form, Lindsey predicted such a surge in capital gains realizations -- more than a doubling -- that tax revenues actually would go up under the Bush plan, a finding that more neutral analysts found incredible. Testifying before the Senate Finance Committee in March, 1989, Ronald Pearlman, a former Reagan Treasury official and now head of the Joint Committee on Taxation, called Lindsey's conclusions "sufficiently inconsistent with history to lead our staff to discount them when arriving at a revenue estimate."

Lindsey's defense of Reaganomics is also "sufficiently inconsistent with history" that it ought to be discounted. For example, unlike any reputable economist, he thinks that personal savings went up in the 1980s (due to IRAs and other tax breaks). He reaches this bizarre conclusion by redefining "savings." No longer, according to Lindsey, should savings be perceived as deferred consumption (the portion of our national output mat ends up being available for investment). Instead, for Lindsey, savings is simply the increase in value of financial assets, including speculative gains. Under this theory, Holland was awash in savings during the famous tulip craze, even though national consumption actually exceeded output.

Despite (or because of) his economic eccentricity, Lindsey is a favorite of the Right. In an article in the October 1990 issue of Commentary that relies heavily on Lindsey, James Q. Wilson puts forth the most extensive conservative argument about why Phillips, and CBO, are wrong about the redistribution of income over the past decade. Let's examine those arguments at some length.

* * *

At the outset, Wilson admits, as he must, that the rich have gotten a lot richer. But relying on Lindsey, he argues that neither the Reagan tax cuts of 1981 nor the 1978 capital gains tax cut, played a role in this development.

Wilson notes that "tax rates were cut, and the percentage of that cut was greatest for the high-income brackets. But... a cut in tax rates is a meaningless assertion; what we really want to know is how, if at all, tax payments changed. ... One effect is indisputable: by 1986 the rich ... were paying a far bigger share of total personal income taxes than they had... earlier. By contrast,... the poor were taken off the federal income-tax rolls altogether."

Unfortunately for Wilson, each of these statements is either hopelessly misleading or simply wrong. In 1979, the poor did pay no federal income tax. In fact, they got a tax credit that offset most of their Social Security payroll tax as well. As a result, for families of four at the poverty line, combined income and payroll tax liability came to only 1.8 percent of their income. But by 1986, families at the poverty line paid 3.4 percent of their incomes in income tax, and their combined income and payroll taxes were 10.5 percent of their income -- a sextupling in these combined taxes since 1979. Only after the Tax Reform Act of 1986 (which Lindsey calls "one step sideways") took effect in 1987, were taxes on the poor reduced to their pre-Reagan level.

As for the rich, from 1977 to 1985, their share of the nation's total income increased by a third, but their share of total federal taxes actually fell. Again, only after tax reform did the tax share of the wealthy rise slightly. Overall, from 1977 to 1990, the share of pretax income going to the top 1 percent rose by 51 percent, but this group's share of total taxes went up by only 15 percent. The richest 1 percent's share of after-tax income rose from 7.2 percent to 12.5 percent -- an increase of 71 percent.

Again following Lindsey, however, Wilson argues that the increase in income going to the wealthy is merely a statistical aberration. "There is no doubt that the reported income on which the rich paid taxes did go up," Wilson admits. "But Phillips doesn't ask why; instead, he implies that Reagan changed the rules somehow so that the rich were allowed to keep more money."

"There is a different explanation, one set forth in some detail by Lawrence Lindsey," says Wilson. "Lowered marginal tax rates induced the rich to report income that they had once either hidden from view or sheltered in various loopholes. If this is the case ..., then the rich did not get richer because Reaganite policies bent the tax rules in their favor."

This is an intriguing idea, but it turns out to be perfect nonsense. Of course, some rich people are outright tax criminals, as the recent tax fraud conviction of Leona Helmsley illustrates. But it would be hard to conclude that Reagan policies so improved the moral atmosphere that these cheats have been reformed en masse. That leaves us with legal tax dodges -- tax avoidance, if you will, as opposed to tax evasion. Those legal devices, however, generally show up on tax returns (or can be extrapolated from other data sources). And the figures that CBO and the congressional Joint Committee on Taxation use to measure real income take account of the various tax shelters employed by the rich.

Did the rich decide to shelter less of their income as a result of the 1981 Reagan tax cuts, as Wilson and Lindsey assert? That would be a hugely surprising result, given that reported tax shelter "losses" skyrocketed after 1981. In fact, data from the Joint Committee on Taxation show that from 1981 to 1985, adjusted gross income (that is, income after various tax shelters) as a share of total income for the top 0.5 percent of all returns (about a half million families) fell by 8 percent. In other words, after the 1981 Reagan tax cut, the rich sheltered more, not less, of their incomes due to all the tax-shelter opportunities created by the 1981 Tax Act's plethora of new loopholes.

Wilson goes on to argue that the poor did not lose under Reagan spending policies either. Phillips "is quite misleading" about the effects of budget cuts, Wilson maintains. The net effect on the lives of the poor is hard to state, but Phillips gives no evidence (and I know of none) that [cuts in] these spending programs" hurt the poor.

* * *

Here is some evidence that Wilson overlooks. According to the CBO, from 1977 to 1990, the average income of the poorest fifth of the population fell by 14 percent (in constant dollars), and that drop was entirely due to a decline in transfer payments received from government. More generally, from 1980 to 1989, federal spending on everything except Social Security, defense, and interest on the national debt fell by more than a quarter as a share of the gross national product. To conclude that these budget cuts had no impact on the incomes of the poor is quite preposterous.

Wilson also attacks Phillips on his contention that the deficit itself, with its resulting higher interest rates, "made for widening income disparities." While admitting that there is "no doubt" that "the federal deficit contributes to the existence of high interest rates," Wilson says that Phillips "gives no evidence" that high interest rates either hurt the poor and the middle class or helped the rich. Indeed, Wilson maintains, because the rich now "work harder" due to their tax cuts, the share of their income in the form of interest and dividends has been cut in half.

In truth, Phillips's point, that high interest rates hurt debtors and help large owners of capital, is so apparent that it hardly needs elaboration. Even Lindsey admits in his book that "[w]hen interest rates go up, lenders get richer and borrowers get poorer."

As for Wilson's claim that the rich now work harder, well, it is certainly true that the labor income of the rich kept pace with their overall income growth -- not hard to understand given the 25-30 percent annual hikes in top executive pay in the 1980s (while other wages stagnated). But CBO reports that the share of total income of the top 1 percent coming from labor income was exactly the same 45 percent in 1984 as in 1977. Almost all the rest (53 percent in both years) came from capital income, that is, interest, dividends, profits, and capital gains.

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Over the years, Phillips has been lucky or smart enough to have his books appear when the stage was already set for their broader political acceptance. This year, his latest populist message was already pretty much the conventional wisdom among Washington Democrats by the time his book was published in June. At a press conference last March, for example, House Majority Leader Richard Gephardt and a number of his Democratic colleagues joined Citizens for Tax Justice in releasing a report based on an updated version of the same Congressional Budget Office data that Phillips relies on in his book. Gephardt and his fellow Democrats promised to make restoring tax fairness and redressing income inequities their main political theme for 1990 and beyond.

But Phillips certainly has helped extend the debate about Reagan-era income redistribution to a wider audience. Of course, whether he is right about the likely effects on future elections can be debated. Michael Novak is dismissive: "populists usually lose," he asserts. "Envy doesn't inspire." Writing in The New Republic, Thomas Edsall argues that the racial element of the tax-and-income shift -- which hurt blacks more than whites -- may blunt its political impact.

On the other hand, the debate over this year's deficit reduction bill -- where Democrats gained considerable advantage by successfully painting the President and the Republicans as lap dogs for the wealthy -- and numerous polls showing three-and four-to-one public support for raising taxes on the rich suggest that speaking out against the class war that has been waged against the middle class and the poor over the past decade may have considerable political resonance. In last fall's elections, Democrats such as Tom Harkin of Iowa used the tax fairness argument to considerable advantage. And the two challengers who took up the issue most vigorously, Paul Wellstone of Minnesota and Bernie Sanders of Vermont, succeeded in ousting Republican incumbents thought to have been well entrenched.

The Republicans took over federal tax policy in 1978 and the presidency in 1980 by offering the middle class a plausible explanation for the economy's problems. It relied heavily on Phillips's original populist theme -- that the government was doing too much for the poor and minorities at the expense of middle-income taxpayers. As it turned out, however, that explanation was wrong, and $1.5 trillion in federal borrowing later, the public is looking for an alternative. With most people now wanting more, not less, from government in such areas as education, environmental protection, and health care, the stage is already set for the positive side of Democratic campaigns. If the Democrats also are willing to place the blame for high deficits and increased middle-class taxes where it belongs -- on Republican tax cuts for the very rich -- Phillips's newest political theme might just be their ticket back to the presidency.

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