Voodoo Economics: The Sequel

September 25, 1994 02:37 PM | | Bookmark and Share

By Robert S. McIntyre

Remember a decade and a half ago, when supply-side Republicans promised they would cut everybody’s taxes and balance the budget at the same time? Remember how, as it turned out, most people’s taxes went up and the deficit skyrocketed–while the only thing that went down were taxes on the very rich?

Well, here they go again.

The Republican plan, due to be formally announced with much fanfare this week, is familiar in its cynicism. It promises large, unfunded income tax cuts–targeted to the well off–and enormous corporate tax reductions, bundled together with a constitutional amendment that will magically (and by implication painlessly) balance the budget. All across the country, Republicans are campaigning on this incongruous combination. The danger is not just that voters may respond favorably, but that President Clinton may let himself be pushed into a 1995 tax-cut bidding war that could undermine his hard-fought deficit reduction victory of 1993.

The collection of tax cut proposals to be unveiled on Tuesday could, when fully implemented, add $120 billion a year or more to the budget deficit. An even more radical plan, proposed by unreconstructed supply-sider Rep. Dick Armey (R-Tex.) and endorsed by numerous GOP candidates, could cost in excess of $200 billion annually.

Let’s start with the more far-out plan, Armey’s “Freedom and Fairness Restoration Act.” The plan would replace the progressive personal and corporate income taxes with what amounts to a 17 percent flat-rate national consumption tax.

To be sure, the part of Armey’s plan that calls for wiping out all loopholes and taxing all income equally has some surface attraction. But that’s not what his plan actually entails. Far from eliminating tax breaks that benefit the well-off at the expense of the rest of us, Armey would institute a giant loophole by exempting most capital income–interest, dividends, capital gains–from taxation entirely.

Under Armey’s plan, businesses would be taxed on their gross receipts minus the cost of the goods and services they buy from other producers who have already paid tax on them. But unlike a standard value-added tax, which taxes payments to workers at the employer level, Armey would allow businesses to deduct the cash wages and pensions they pay. Instead, such payments would be taxed as they are received by workers and retirees. This feature allows Armey to mitigate the regressivity of a standard sales tax by exempting the first $12,350 in wages for single people, $21,200 for a single parent with one child, and $34,700 for couples with two children. (Under current law, couples with two kids start paying income taxes when they make more than $23,200 in total income.) In effect, this feature offers families a rebate against their sales tax equal to 17 percent of their wages up to the exemption amounts.

That may sound generous, but in fact current law, thanks to the expanded earned-income tax credit, is already more generous for many low- and moderate-income families, who would face substantial tax hikes under the Armey plan. Still, Armey’s wage tax rebates would end up exempting over half of total wages from his new tax.

Which brings up the still larger flaw in the Armey scheme: it would add massively to the federal budget deficit. In fact, a reasonable estimate–just confirmed by the Joint Committee on Taxation–is that Armey’s proposal would cost the Treasury over $200 billion a year. That would multiply annual government borrowing as a share of the economy back to Reaganesque levels.

Look at it this way. According to the Congressional Budget Office, the best-off one percent of the population now pays just under a third of the total federal personal and corporate income tax bill–at a rate of about 31 percent of that group’s total income. Even if Armey’s tax applied to all of their income, they would still see their income taxes cut almost in half with his flat rate of 17 percent. But since Armey would exempt investment income from taxation, the tax cut for the well-off would be much, much larger.

Now, if Armey wants to cut income taxes on the wealthy by about three-quarters–and purports to cut taxes for the middle class as well–how does he expect to raise enough money to avoid skyrocketing deficits? The answer is, he doesn’t.

Armey’s mentors are Hoover Institution economists Robert Hall and Alvin Rabushka. Back in 1983, they calculated that for their plan to break even, it would need a rate of 19 percent and wage-tax exemptions only a third as large as Armey proposes (and far below those provided by the current income tax). In that case, they admitted, their plan would “be a tremendous boon to the economic elite”–while producing much “higher taxes on average people.”

The obvious problems with the Armey flat tax have not stopped many Republican political hopefuls from endorsing it. For instance, GOP Senate candidates from Michael Huffington in California to Chuck Haytaian in New Jersey have signed onto the plan. (Haytaian’s confusing platform combines a purportedly loophole-free flat tax with a call for keeping many existing tax breaks and adding a new one for health insurance.) Massachusetts’s Republican Gov. William Weld also has praised the Armey plan, as has conservative pundit George Will. Weirdly, Will is particularly fond of the fact that Armey’s plan would repeal tax withholding. Although this would require wage-earners to file 12 tax returns each year rather than one. Will see this as beneficial because it would make people angrier at government. So much, one might say, for tax simplification.

Perhaps recognizing that the Armey plan looks remarkably like the much-criticized flat tax proposed by Democratic presidential candidate Jerry Brown in 1992, GOP leaders in Congress have settled on a different set of tax cut proposals. The leadership plan includes these costly features:

  • A $500 per child tax credit that would cost more than $26 billion per year.
  • Repeal of the 1993 change that includes 85 percent of Social Security benefits in adjusted gross income at higher income levels. Under the GOP plan, at most half of Social Security would be subject to tax. This would cost about $5 billion a year.
  • Reduced tax rates for married couples by widening the tax brackets and increasing the standard deduction for joint filers. The cost would be $30 billion a year.
  • A huge capital gains tax cut. By excluding 50 percent of capital gains from taxation (on top of the current 30 percent exclusion for top bracket taxpayers) and by indexing gains for inflation, the Republicans would make about three-quarters of all capital gains tax-exempt–a $25 billion a year tax break mostly for the wealthiest people.
  • Restoration of Individual Retirement Account tax breaks for upper-income people, with a long-term cost exceeding $12 billion a year.
  • Eliminating all taxes on new corporate investments by allowing an immediate tax writeoff. The cost would quickly be tens of billions of dollars annually, and far more as time goes by.

The total losses of more than $120 billion a year would far more than wipe out the deficit-reducing benefits of the tax hikes adopted in President Clinton’s 1993 budget plan. How would Republicans make up the losses? Unsurprisingly, a GOP congressional aide told the Daily Tax Report that the Republican plan “will not be in the form of a fully funded, comprehensive package.” In other words, this is election-year pandering, pure and simple.

Voters may or may not be gulled by the GOP promises this fall, but Clinton–who has said he still would like to deliver on his 1992 campaign pledge of a middle-class tax reduction–may feel he has to match the Republicans’ promises. If he tries, one GOP House aide says, “the level [of the Republican middle-class tax cut plan] could increase to match or exceed any middle-class tax cut proposal President Clinton decides to offer.” The GOP promises may not be paid for; they may violate all the budget rules; but if Clinton tries to compete, he will find himself in a bidding war that, politically, he can’t possibly win.

Back in 1981, when President Reagan and Ways and Means Chairman Dan Rostenkowski locked horns over tax cuts, their back-and-forth competition for congressional votes quickly got out of control. As Rostenkowski sadly learned, trying to out-Reagan Reagan was futile. In 1981, there was simply no tax cut–whether breaks for oil companies, utilities, railroads or real-estate moguls–that Reagan and his supply-side-crazy Treasury Department wouldn’t cheerfully match and graft onto their own already excessive plan.

It took the hard fight for the loophole-closing Tax Reform Act of 1986 to curb the tax shelters and abuses that the 1981 act created. And it took the bitter battle for Bill Clinton’s 1993 budget act to bring taxes on the rich more in line with their ability to pay. The Republicans apparently think that they can attract voters by promising costless tax relief Maybe so. But if you’re one of those potential voters, keep in mind that unfunded tax reductions virtually guarantee higher taxes in the future. And when the two parties start trying to outdo one another in handing out tax breaks, in the end only the special interests really win.

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