Salvaging a
Domestic Agenda:

Toward Bipartisan Tax Reform

By Andrew Ratzkin

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 ith a mixed record of legislative accomplishment in the 111th Congress despite strong Democratic majorities, what can be expected in the 112th?  After the surprisingly productive lame duck session ends– whatever one’s views of the content of the legislation, the output was impressive – can there be any further hope for a continued affirmative Democratic agenda, or will the Party’s options boil down to defending the enactments of the outgoing Congress or capitulating to the incoming Republican agenda?

Democrats should reject such a false choice and instead seize upon a Republican perennial favorite:  tax reform.  Much the way that Bill Clinton elevated welfare reform following the 1994 mid-terms, major tax reform is an area ripe with bipartisan appeal and the potential to improve the Administration's fortunes, whatever the Republican response.  The tax code presents a major opportunity for significant action on a domestic priority during the coming Congress.  Potentially, much of the energy to drive tax reforms to passage could stem from Tea Party supporters.

Tax reform should be built on two issues important to Republicans:  simplification and a shift from income and payroll taxes, which are predominately taxes on work, toward a national consumption tax, as many in the Tea Party have advocated.  However, these measures should be sculpted in such a way that they do not become figleaves for regressive taxation that falls disproportionately on the lower ranges of the income spectrumFor example, recently advanced simplification proposals – from the bipartisan deficit reduction commission and others – would generally close out various deductions and credits, such “tax expenditures” being the source of much of the complexity in the tax code; Democrats should ensure that these changes do not function as a device for further upward transfers of wealth.  Plainly, since the crash of ‘08, and even before, a strong undercurrent of anti-elite and anti-Wall Street anger has continued to reside among the Tea Party as well as the Democratic base; tax reform, in a bipartisan way, should give voice to those sentiments.  

Everybody (except accountants and tax lawyers) hates the tax code.  Beyond the economic merits of tax reform, that should be reason enough for Democrats to grab hold of this issue.  Democrats should therefore lead with a bold plan for simplification and strive for a grand compromise that would allow each side of the tax reform debate to reach key objectives.  Republicans would oppose at their peril—and may not even want to. 

What should be the key elements of reform?

  • Eliminate payroll taxes (Income tax, FICA, Medicare and unemployment insurance) – both employee and employer side – for low-wage earners. This elimination should apply only to the first, say, $20,000 in income of all earners.  Thus, all individuals, even upper income earners, would benefit from this tax cut.  Aside from the principal benefit of delivering tax relief to those most in need, this measure has the virtue of removing a significant tax burden on something we desperately want to create:  jobs.  Each job created, at whatever income level, would significantly and permanently cost employers less to fund.  Depending on results, successive legislation could extend the elimination of payroll taxes to higher income levels.  A tentative step in the direction of reducing payroll taxes (temporary, employee side only) was a feature of the Obama-Republican compromise over the Bush tax cuts.  If this proves popular, the stage is nicely set for farther-reaching measures.

  • Seize the idea, advanced by many Tea Partiers, of a national consumption tax and use it to replace – in a revenue neutral way – the receipts that would be lost by eliminating payroll and income tax for low earners.  (For the Tea Party, the consumption tax is conceptualized as a “fair tax”; for Democrats, the favored concept is the value added tax.  While there are key differences, the policy common ground, transferring burden from labor and production onto consumption, is fundamental.)  Once the economy is back on track, this tax or the financial transactions tax (see below) could be further increased to support deficit reduction over the long term.

  • Skew the national consumption tax in the direction of taxes on carbon-emitting energy sources.  After all, a carbon tax is essentially a consumption tax, but with a distinctive focus that would have several benefits.  Most significantly, taxing carbon-emitting goods would promote energy independence; improve the balance of trade; and internalize externalities such as carbon and other pollution associated with burning hydrocarbons, and thus shift the balance toward relatively clean forms of energy like natural gas, nuclear and renewables.  Like a sin tax, this tax would properly place its burden on activities we wish to discourage.

  • Agree to extend (or supersede) the Bush tax cuts permanently for all, except create two, or even three, new brackets at, say, $500,000, $1,000,000 and $10,000,000 per year or more to capture the exploding incomes within the top one percent.  Recognize, as Warren Buffet has, that $250,000 year is not, especially in high-cost areas, the dividing line between the middle class and the super rich, and that the upper middle class is feeling squeezed and economically destabilized.  Exempting top incomes from an extension of the Bush tax cuts has polled well, and the same logic should apply with greater force to new, higher brackets.  Any increase in tax receipts generated from tax expenditure reductions (or “deduction reductions”) pursued in the name of simplification should be directed to further reducing marginal rates, especially at the lower and middle income ranges, beyond the Bush cuts.

  • Pay for the Bush tax cuts, as modified, with a modest financial transactions tax.  According to The World Federation of Exchanges, the total volume of trades on the NYSE and NASDAQ for the first half on 2010 was approximately $16.6 trillion.  Imposing a 1 percent tax on trades (say, half percent each on buyer and seller) would generate roughly $320 billion annually, nearly enough to pay for extending the Bush tax credits for all income levels (Treasury has estimated the cost of doing so to be $3.7 trillion over 10 years).  Such a tax would pale next to some brokerage fees and would not be highly visible.  Including in the tax base trades of bonds, derivatives, commodities, and securities traded on other domestic exchanges would further increase the revenue derived from this tax.  Transactions taxes are already common, at the state and local level, most notably on retail and real estate sales, where they land disproportionately on lower-income and middle class families.  Imposing a financial transactions tax would reduce that disparity.  The logic of all transaction taxes, of course, is to impose the tax when money is already “on the table,” and a tax on financial transactions would squarely do just that.  (Indeed, that is precisely the logic of typical Wall Street fee structures.)

Singling out financial transactions for taxation would deliver the added benefit of burdening what we want to discourage, such as day trading and the financial sector generally, relative to “real” economic activity, such as manufacturing, agriculture, services, etc., which would not be subject to such a tax.  As many commentators have observed, over the last several decades, the size of the financial sector – whose only functional justification is to efficiently allocate resources to productive uses in the rest of the economy – has grown steadily until reaching record levels today, from 2.5% of gross domestic product in 1947, to 8% by 2006.  As Robert Creamer has observed, of every 12.5 dollars earned today in the United States, one goes to the financial sector.  Lastly, a financial transactions tax would extract resources from the sector of the economy that did so much to cause the Great Recession, and yet received outsized assistance in the heat of the crisis from taxpayers under duress.

  • Consider trimming or eliminating the corporate income tax, which is imposed at one of the highest nominal rates of any industrial economy.  Make up for the lost income through the national consumption tax and the financial transactions tax.  Even many liberal economists have acknowledged that it makes no sense to tax business enterprises, which we want to thrive.  If we are concerned about fairness and excessive income inequality, then we should tax earnings when they reach the individual.  Eliminating the corporate income tax also would remove the rationale for taxing dividends at the reduced rate of 15%, because the problem of double taxation of corporate earnings—at the enterprise and the individual level—would no longer exist.  Thus, high income earners, who derive a greater portion of their income from dividends than low-income earners, would no longer enjoy a lower tax rate based on such sources of income.

  • Eliminate federal subsidies for fossil fuels from the tax code.  Recent estimates of the extent of U.S. fossil fuel subsidies range from $5.5 billion (EIA 2008) to $49 billion per year (OECD 2007), the lion’s share of which is attributed to tax breaks.  (Estimates vary widely in part because subsidies taking the form or tax expenditures, such as foreign tax credits for oil producers, are generally opaque.  Unlike budget items, such subsidies are not enacted with an attached dollar value and the impact to Treasury is not readily transparent.)  This proposal should in theory be attractive to libertarian-oriented members of the Tea Party, who presumably disfavor government thumbs on the scales of free enterprise. 

Championing tax reform should not be a very heavy lift for the Democrats; that is one of its prime benefits politically.  To the contrary, in the current political and ideological environment, tax reform, once unleashed, could prove hard to stop.  But Democrats are in a strong position to exact a policy price – preserving progressivity, capturing some environmental externalities, and checking Wall Street – in exchange for support.  The trick is to let the genie out of the bottle and guide it while Democrats are still in a position to do so during the coming Congress.  Not acting now has risks for both sides—Democrats could become weaker and lose further control, while Republicans may find by 2012 that 2010 was their high water mark.

Some commentators have suggested that possible areas of cooperation in the 112th Congress are limited to issues such as trade and small bore items like earmark reform.  Instead, the President can still and should strive for bold action that would be a base pleaser – both for Democrats and for the Tea Party.  Tax reform presents Democrats with a chance to show that they “get it,” align with popular anger, and get out in front of a debate over major, even systemic, reform.  They should not let the opportunity pass.
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Andrew Ratzkin is General Counsel of a major engineering and construction company specializing in electric generation projects.  He was trained as an environmental lawyer.  
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