begemot

  Political Taboos, pt. 2: Payroll Tax Reform

[reposted from my diary at dKos]

Part two of my series on "taboos" in American political discourse will argue for the need to reshift the tax debate from income to payroll taxes. Previously I have posted an introduction to the series and an entry on the need to eliminate agricultural subsidies. All posts in this series will also be reposted on my occasional blog begemot. The topics in this series are taboos not in the sense that they cannot be discussed at all, but that they are not currently the subject of serious legislative initiatives (as far as I'm aware). The series, for the most part, does not blame Democrats for not raising these issues, some of which are more politically feasible than others, but does argue that these issues should be considered more seriously -- at least after November's elections if not before. The usual caveat applies that I am not a specialist in any of the subjects I am posting on but have attempted to research it more or less thoroughly in order to produce an informed argument.

I will argue in the current entry that shifting the tax debate to reforming payroll taxes is both a moral imperative and in the best interests of the Democratic Party in both the short and long run. Payroll taxes are regressive taxes which affect lower income Americans to a far greater extent than upper income Americans. Most lower income Americans pay more (sometimes significantly more) in payroll taxes than in income taxes. While the Republicans have made cutting income taxes, repeatedly, incessantly, and without regard for the consequences, one of the centerpieces (if not the centerpiece) of their political program, the have, unsurprisingly, entirely ignored payroll taxes.

As Paul Krugman (who else?) argued way back at the beginning of the Bush mal-administration,

When it comes to tax cuts, however, Mr. Bush's people ignore the payroll tax — that is, they propose no cut in the tax that is most of what most families pay, while demanding a large cut in the income tax, which falls mainly on the affluent. And they want to eliminate the inheritance tax, which is overwhelmingly a tax on the downright wealthy.

Moreover, as Krugman has argued more recently (the NY Times, annoyingly and pointlessly makes their archived version of this article for pay only), the recent tax cuts for the wealthy are possible in part because of the increase in payroll taxes foisted on us 20 years ago at the behest, among others, of Alan Greenspan.

The payroll tax is regressive: it falls much more heavily on middle- and lower-income families than it does on the rich. In fact, according to Congressional Budget Office estimates, families near the middle of the income distribution pay almost twice as much in payroll taxes as in income taxes. Yet people were willing to accept a regressive tax increase to sustain Social Security.

Now the joke's on them. Mr. Greenspan pushed through an increase in taxes on working Americans, generating a Social Security surplus. Then he used that surplus to argue for tax cuts that deliver very little relief to most people, but are worth a lot to those making more than $300,000 a year. And now that those tax cuts have contributed to a soaring deficit, he wants to cut Social Security benefits.

The point, of course, is that if anyone had tried to sell this package honestly — "Let's raise taxes and cut benefits for working families so we can give big tax cuts to the rich!" — voters would have been outraged. So the class warriors of the right engaged in bait-and-switch.

This represents an enormous opportunity for progressives to wrest the tax issue away from those who would use it to benefit the very wealthy and to show how it should be used instead to help out the hard working middle class.

In a recent issue of Atlantic Monthly, Maya MacGuineas, director of the Fiscal Policy Program at the New America Foundation, argued extensively and persuasively for the need for radical tax reform.

Social Security and Medicare payroll taxes, also regressive, have grown to the point where they are the largest federal taxes that most American families pay. Though the basic structure of the federal payroll tax has hardly changed in fifty years, its rate has been raised repeatedly. Today it is 15.3 percent, and all earners, whether they make $25,000 a year or $250,000, pay it on the very first dollar of earnings. But the 12.4 percent Social Security tax applies only to wage earnings below $87,900—meaning that the $25,000-a-year earner (every dollar of whose income is taxed at 15.3 percent) pays a higher effective tax rate than the $250,000-a-year earner (most of whose income is exempt). And investment income and employer benefits—which accrue disproportionately to high-income earners—go completely untaxed, making the system still more regressive. People who live entirely off inherited wealth pay no payroll taxes at all.

In a recent op-ed piece, MacGuineas and New America Foundation president Ted Halstead urge Kerry to consider making abolishing the payroll tax one of his fiscal priorities:

Although you'd never know it from listening to our political leaders, the largest tax now paid by over 70 percent of working American families is not the income tax but the payroll tax. No tax does more to discourage job creation or to reduce take-home pay for low- and middle-income workers. Likewise, nothing could do more to boost both than repealing it outright.

Unlike income taxes, the payroll tax kicks in from the first dollar earned and applies only to wages. It is split equally between employers and employees (except in the case of independent contractors, who bear both parts of the burden). While income taxes have been cut many times in recent decades, payroll taxes have risen steadily: from a tenth of the federal budget in the 1950s to over a third today.

The New America Foundation is not the only progressive group arguing along these lines. An organization called "Get America Working!", which includes Robert Reich on its board, is equally vocal on this issue:

Payroll taxes do more damage than any other tax -- to the economy, social well being, the environment and income distribution. Payroll taxes have grown from 2 to 34 percent of Federal revenues, a gigantic accidental national increase in the price of hiring people. Now 80 percent of American taxpayers pay more in payroll taxes than in income tax.

{snip}

The payroll tax is far more regressive even than it appears. The Social Security (largest) component applies only to wages up to $80,400 but not beyond. A family with two $50,000 earners pays more than another with one salary of $300,000 and investment income of $650,000.

Less obvious is the fact that low wage (i.e. little bargaining power) workers usually pay the "employer's" half of the tax. Their employers simply hold down wage increases until they have shifted the tax's cost to the workers. The opposite is true for highly skilled workers. The result: low wage workers pay the full tax and highly paid workers effectively pay little or nothing. That today's over $550 billion payroll taxes are so perfectly regressive – twice over – helps explain America's worsening income inequality.

[See also this GAW Chart on the rising U.S. reliance on payroll taxes.]

The possibility has not escaped Democrats, although they have so far not made it the centerpiece of their fiscal agenda. Of the Democratic candidates for president only Carol Mosley Braun, as far as I'm aware, addressed the issue on a consistent basis. (See for example her comments last summer on the News Hour.) Howard Dean flirted with the idea in January, but, to the disappointment of some of us supporters, never officially announced a plan including payroll tax reduction. Kerry has included payroll tax relief for new hires for small business in his extremely sophisticated plan for job creation but has, as far as I can tell, not addressed the issue of payroll tax relief more directly and comprehensively.

The main issue, of course, is how to make up the income that would be lost in cutting or eliminating payroll taxes. MacGuineas and Halstead propose a progressive national consumption tax which would also encourage savings. However, the idea of instituting an entirely new federal tax strikes me as particularly politically impossible. More realistic would be the possibility of extending tax credits or relief for social security taxes and making this up by repealing some of Bush's income tax and inheritance tax cuts for the very wealthy. This idea was proposed by Robert Reich who imagined the following scenario:

Starting as soon as possible, you'll be relieved of payroll taxes on the first $20,000 of your annual income. The tax holiday will last two years. Ballpark cost to the government: $700 billion. We'll pay for it by repealing Bush's estate tax cut, which will also cost around $700 billion. Are you with me? All we have to do is convince Democrats it's a smart move and strike fear in the hearts of enough Republicans to get it passed and signed

John Mattar of Democratic Underground proposed a very similar plan and also added the necessity (I would say moral imperative) of repealing the cap on contributions in order to make the social security tax less regressive:

Citizens for Tax Justice estimates that the elimination of the "earnings cap" would generate an estimated $52.8 billion in additional annual revenue (year 2000). That could pay for a full rebate of the payroll tax for up to 34.4 million workers earning $20,000 each year .

Can it be done? As with my previous post, this is an issue that I think truly can be drawn into the national political discourse. It is one that is both morally and fiscally imperative and also could provide potential enormous political advantage to the Democratic Party. Let's work to get this one on the table.