Political Hay

Take the Tax Debate to Obama

The election may be over, but the fight over tax policies is just beginning -- and it's one that Republicans and conservatives can't afford to pull a McCain on.

By 11.19.08

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The election may be over, but the same is not true for the tax debate. The tax debate is just beginning, with Congress soon to be considering sweeping tax legislation proposed by President Obama.

Conservatives and Republicans need to be much smarter and more aggressive about how they deal with Obama on this issue. We are no longer bound by the intellectual weaknesses of John McCain on economics and taxes and his inability to articulate the basic arguments. In fact, we must stop now thinking of McCain as the Republican leader. McCain is already indicating that he wants to be a wooden puppet for Obama on many issues, in "a spirit of bipartisanship." For Republicans and conservatives, the man whose political failures and confusions put the Far Left in charge of our government should now be an afterthought.


Smearing Reaganomics

The debate for Obama and the Democrats begins with a smear of the tax policies adopted by Reagan and the Republicans going back 30 years. A good example of this is found in Obama's discussion with Joe the Plumber. During that discussion, Obama said, "We've cut taxes a lot for folks like me who make a lot more, but we haven't given a break to folks who make less."

That was not an offhand remark. That was a central theme of Obama and the Democrats all year. In his standard stump speech, Obama would say, "We've given more and more to those with the most and hoped that prosperity would trickle down to everyone else. And guess what? It didn't. So it's time to try something new. It's time to grow this economy from the bottom up. It's time to invest in the middle-class again."

In other words, Republicans cut taxes only for the rich, and forgot about the middle class and lower income workers. Hillary's version of this was even more dramatic. She would say, "Republicans have cut taxes for the rich so much that it is now actually hurting the middle class."

This is a completely false smear of Reagan Republican tax policy. If we let them stick us with this false tag, they will use it politically against us for a generation. The official U.S. government data from the IRS and the Congressional Budget Office now show that the top 1% of income earners, the true rich, pay 40% of all federal income taxes, almost twice their share of national income. The top 20% of income earners pay 86.7% of federal income taxes. The federal income tax burden today is basically borne by these top 20% of income earners.

By contrast, the bottom 40% of income earners as a group pay negative 3.8% of all income taxes. That means instead of paying taxes into the system, on net they draw payments out of the income tax system equal to 3.8% of all federal income tax revenues. The middle 20% of income earners, the true middle class, pay just 4.7% of all federal income taxes.

This is the result of Reagan Republican supply-side economics that began with Reagan and Jack Kemp in the 1970s and 1980s, through Newt Gingrich and his Contract with America, to the Bush tax cuts of 2001 and 2003. Reagan and his Republicans have abolished federal income taxes on the working class. Moreover, they have almost abolished federal income taxes on the actual middle class (the middle 20%).

Here are the changes that produced this result. Ronald Reagan first proposed the Earned Income Tax Credit (EITC) in his historic welfare reform testimony before the Senate Finance Committee in 1974. The EITC has now abolished federal income taxes for the working poor, and cut federal income taxes sharply for lower income workers. As President, Reagan cut federal income tax rates across the board for all taxpayers by 25%. He also indexed the tax brackets for all taxpayers to prevent inflation from pushing workers into higher tax brackets. In the Tax Reform Act of 1986, he reduced the federal income tax rate for "folks who make less" all the way down to 15%. That Act also doubled the personal exemption, shielding more income from taxation altogether for everybody.

Newt Gingrich's Contract with America adopted a child tax credit of $500 per child that reduced the tax liabilities of lower income people by a higher percentage than for higher income people. President Bush doubled that credit to $1,000 per child, and made it refundable so that low income people who do not even pay $1,000 in federal income taxes could still get the full credit. Bush also adopted a new lower tax bracket for the lowest income workers of 10%, reducing their federal income tax rate by 33%. He cut the top rate for the highest income workers by just 11.6%, from 39.6% to 35%.

The other result of the tax policies of Reagan, Gingrich, and Bush is that they were the centerpiece of the economic policies that produced a 25-year economic boom, from 1982 to 2007, what Art Laffer and Steve Moore have called "the greatest period of wealth creation in the history of the planet." In their recent book, The End of Prosperity, they also write, "Adjusting for inflation, more wealth was created in America in the twenty-five year boom than in the previous two hundred years."

I will not recount here again how Reagan's economic policies so dramatically reversed what was a collapsing economy by the end of the 1970s, and how the continuation and expansion of those policies produced the 25-year boom. But conservatives must note that they cannot allow the economic turmoil of 2008 to erase the public memory of that enormous, historic, astounding achievement. They cannot allow Obama and his Democrats to say, "It didn't work." And that is going to require a sustained public education campaign as to what did happen, and why.


Economic Growth

During his campaign, Obama successfully focused on a theme of rebuilding the middle class, particularly through his supposed middle-class tax cut. This is classic Saul Alinsky strategy, which called for radical reformers to appeal to the middle class, rather than scaring them away with overt radicalism.

One key way for conservatives and Republicans to counter this theme and appeal to the middle class in the future is the issue of economic growth. This was central to the political success of Reagan and the Republicans in the 1980s, embracing the policies and rhetoric developed by Jack Kemp in particular. The economic growth theme is what takes conservatives from the mid-40s in public support to the mid-50s. This theme is also essential to appealing to the Hispanics and other minorities that strongly supported Obama and the Democrats this time. This is why it is so important to set the record straight on the Reagan economic boom.

The Obama tax plan is vulnerable on this score, because it is so anti-growth. As I have recounted before as well, Obama's plan calls for raising the marginal tax rates on virtually every federal tax -- individual income taxes, capital gains taxes, dividend taxes, payroll taxes, death taxes. It effectively calls for raising corporate income taxes by 25% by closing loopholes and tax havens, even though America's corporations already suffer the second highest corporate tax rates in the industrialized world. Obama ridiculed McCain's proposals to reduce those excessive rates as still more tax cuts for the rich and corporate fat cats.

Raising all of these marginal tax rates together amounts to a vigorous assault on the incentives for saving, investment, entrepreneurship, business creation and expansion, job creation, risk taking, work, and overall economic growth. This argument is not hard for the average voter to understand, and polls and focus groups show that they do respond to it. With the current weak economy, this argument may be successful in derailing most or even all of these tax increases.

A second chapter of the Obama tax plan is 9 or 10 or more new or expanded refundable income tax credits for various social purposes, such as child care, welfare, health care, education, housing, retirement, and others. Refundable means that if a worker has little or no income tax liability, the government will send him a check for the full amount of the tax credit anyway. In these cases, the tax credits are not tax cuts reducing any tax liability, but new government spending programs hidden in the tax code. Because Reagan and the Republicans have already cut taxes so much for the middle class and lower income workers, Obama is quite wrong in calling them tax cuts for these workers.

Tax credits do not promote economic growth as reductions in marginal tax rates do because they do not promote incentives to any significant degree. A tax credit is like a cash grant, and a cash grant for child care does nothing to promote the economy. At best, a tax credit affects incentives only up to the amount of the credit, in general a few hundred or a couple of thousand dollars. But the incentives from a reduced tax rate affect all economic decisions and resources, including those from abroad.

Indeed, the tax credits negatively affect economic growth because they are phased out over various middle and higher income levels, effectively increasing marginal tax rates for those incomes. Removing a tax credit as income rises has the same effect on incentives as imposing a tax as income rises.

This is not to argue that all tax credits are always a bad idea, even refundable ones. Rather, the argument is that, first, refundable income tax credits for those with no income tax liability are not tax cuts. They are income redistribution, which is basically the opposite of tax cuts. And, secondly, income tax credits do not promote economic growth.

Liberals and Democrats will help to make the economic growth issue work for conservatives and Republicans because they will assuredly trash the economy, not only through bad tax policies, but also through hare-brained energy policies that will cause energy and gas prices to soar and leave supplies unreliable, through renewed inflation, through costly regulatory burdens, and through other soft-headed fallacies. Cap and trade global warming policies will wreck the economy by imposing huge additional costs. Obama seems to think he can promote economic growth based on increased government spending. Reality will show that to be disastrously wrong.

Conservatives and Republicans should continue to advance pro-growth tax policies, such as reductions in the most damaging top marginal tax rates, and excessive corporate tax rates, as well as reduced tax burdens on savings and capital, such as reduced capital gains tax rates and expensing for business investment. These policies will not be achieved in the current political environment. But they will work politically as liberal Democrat policies fail on the economy, and voters start to look elsewhere.

The tax issue will also work politically for Republicans and conservatives, to a spectacular degree, the minute Democrats try to raise taxes on anyone earning less than $250,000, breaking the central Obama campaign promise. Be prepared for a grassroots firestorm as soon as that happens.

Moreover, conservatives and Republicans should advance other pro-growth economic policies, such as increased energy and gas production to provide reliable supplies at lower prices, anti-inflation monetary policies, and reductions in runaway government spending. These pro-growth policies together will be central in restoring political success.


Conservative Income Redistribution?

To counter Obama's middle class tax cut rhetoric, some conservatives have argued for the idea of a $5,000 child tax credit. They would not make the credit refundable, to avoid effective new welfare checks from the government for most workers, recognizing the dramatic cuts in income taxes for the middle class and lower-income workers already adopted by Reagan and the Republicans. But they would allow the credit to be taken against the payroll taxes funding Social Security and Medicare.

But with one or two children, such a credit would quickly eliminate payroll tax liability for most workers at middle-class and lower incomes. Since Social Security and Medicare already suffer from deep long-term deficits, how will we replace the revenue lost to these credits? And why should families with children pay little or no payroll taxes for much or most of their lives, yet receive full Social Security and Medicare benefits? This would just be another redistributionist policy, only focused on favored conservative beneficiaries, which should be even easier to see in the context of the Obama tax credit policy discussed above. Indeed, focusing the redistribution solely on families with children, who already vote mostly Republican, would weaken its political benefit as an alternative to the Obama tax plan.

Moreover, this child tax credit would not promote economic growth, for the reasons discussed above. It does not promote incentives for saving, investment, business creation and expansion, job creation, etc. The $5,000 credit loses too much revenue for no pop on the economy. There are much better alternatives, both economically and politically.

For income taxes, Republicans and conservatives should focus on cutting middle-class income tax rates. If the 25% middle-class tax rate were reduced to 15%, the result would be a flat rate tax of 15% for close to 90% of workers. The lower rates would promote economic growth as discussed above. Indeed, it would likely lead to renewed middle-class income growth. It could be combined with an increase in the personal exemption, which would apply to children, to ensure that all taxpayers would get a tax cut from the package. Such a proposal would be politically competitive with the Obama tax plan right away, and could even potentially displace his tax credit scheme next year.

For payroll taxes, personal accounts should be adopted and expanded over time to eventually phase out the payroll tax entirely, and replace the programs now financed by that tax. This would produce a truly massive reduction in the size of government, with an equivalent increase in the personal resources of families. That would do more than anything to strengthen families. Advancing such accounts will be difficult in the current political and economic climate, with liberal/left Democrats vigorously opposing them currently in complete control at the federal level. But such accounts have long been overwhelmingly popular in polls and focus groups, and their strong political appeal will recover with the economy. Because of the massive, historic reduction in government potentially involved in such accounts, conservatives should greatly favor them over a simple redistributionist giveaway.

These are truly exciting middle-class tax cut opportunities, both politically and economically.

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About the Author
Peter Ferrara is Director of Entitlement and Budget Policy at the Heartland Institute, General Counsel of the American Civil Rights Union, Senior Fellow at the National Center for Policy Analysis, and Senior Policy Advisor on Entitlements and Budget Policy at the National Tax Limitation Foundation. He served in the White House Office of Policy Development under President Reagan, and as Associate Deputy Attorney General of the United States under President George H.W. Bush.