The greatest challenge in politics is to understand when a political era is closing and the door to a new one is ready to be opened. Thirty years ago, a small band of conservatives understood that what they called the era of tax and spendin which government grew inexorably on a tide of invisible tax increases through Republican and Democratic administrationswas ready to be challenged.
In 1977, Rep. Jack Kemp and Sen. Bill Roth introduced a bill to cut tax rates by a third and index them to inflation. They were radicals even within their party; this was the plan that George H. W. Bush called voodoo economics. A year later, California passed Proposition 13 capping property taxes, and Time magazine almost ran out of extreme metaphorsavalanche, earthquake, revolutionaryto describe it. By 1981, a Proposition 13 supporter, Ronald Reagan, was president, and Kemp-Roth was the law.
Everyone active in politics todayvirtually every elected official, every speechwriter, every strategist and pollstercame of age in the 30-year era of tax revolt. It is so deep in our blood that it is surprising to be reminded that there was a time when you could raise taxes and not lose elections. For 30 years, we have seen what happens to people who try straight talk on taxes: Mr. Reagan will raise taxes, and so will I. He wont tell you. I just did. Those were admirable words, but the Democratic nominee who spoke them in 1984, Walter Mondale, went on to lose 49 states and the presidency. The casual dishonesty of George H. W. Bushs Read my lipsno new taxes was more politically successful in 1988, but when he inevitably broke the promise, he, too, lost the presidency. Thats a lesson his sonand every Democrathas learned well.
Just as the tax revolt era had a beginning, so will it have an end. And there are indications that the end might be approaching. In 2006, New Jersey governor Jon Corzine raised taxes. Many expected him to face the backlash that his ill-fated predecessor Jim Florio encountered in the 1990s. Instead, his approval ratings actually went up from the mid-30s to above 50 percent. In 2004, Gov. Mark Warner of Virginia formed a bipartisan coalition to raise taxes and left office in 2005 as one of the most popular governors in state history. This year, the movement to impose limits on state taxes using ballot initiatives (known as Taxpayer Bill of Rights or TABOR), failed in three states once voters who appear to have become skeptical of tax-cut gimmicks and free-lunch promisesunderstood the consequences. Perhaps most tellingly, when Bush and the Republicans led a last-ditch defense of their congressional majority with millions of dollars in ads charging that Democrats would raise taxes, it had no impact. In fact, shortly before the election, voters said they trusted Democrats over Republicans on the issue of taxes by 12 percenta result almost as unlikely as preferring Democrats on national securityeven though they fully expected Democrats to raise taxes.
Still, few if any Democrats seem willing to bet much on that evidence that the tax revolt is ending. Almost all of the Democrats elected in 2006 talked much more about the Bush tax cuts they would vote to extend than those they would allow to expire, and when they did talk about allowing any of them to expire in 2010, it was always with a caveat such as only for the top 1 percent, or only for those with incomes over $300,000. Whether the public is more willing to accept taxes or not, Democrats are warywith good reasonof carelessly reigniting the tax revolt.
But the truth is that we are heading down a path toward fiscal crisis that will inevitably require a major increase in revenues. In case that sounds like a euphemism, Ill say it plainly: Taxes must go up. If Democrats try to avoid that fact, theyll become mired in trench warfare with Republicans over small-bore increases that will cost them political support and wont really address the problem. But if Democrats seize the opportunity to define a new era of the politics of taxes, as Republicans did 30 years ago, they can shape the debate in a way that may actually help them to achieve some of their most-cherished policy goals.
Payback time
Everyone who looks at the numbers knows that taxes must go up. If we do nothing at all, the years 2007 through 2016 will bring deficits of $3.5 trillion outside of the surplus in Social Security. But doing nothing assumes that all the Bush tax cuts will be allowed to expire as scheduled in 2010 and subsequently. If the tax cuts are extended, and spending remains generally unchanged, the 10-year deficit will total $7.8 trillion. To balance the budget under these conditions would require cutting defense spending by 67 percent, Medicare by 54 percent, or every other program by a third, something that no one in politics has shown any willingness to do. The current path leads straight into a severe economic crisis.
Then consider the platform on which the newly elected Democrats campaigned: For almost all of them, fiscal responsibilitynot necessarily a balanced budget, but an end to runaway deficitswas a key theme. Symbolizing an end to Washingtons corruption and recklessness, fiscal responsibility is embodied in the Democrats promise to restore pay-as-you-go budget rules, in which any new entitlement spending or tax cuts would have to be paid for by equivalent spending cuts or tax increases elsewhere.
Second, the new Democrats promised to retain those portions of the Bush tax cuts that benefit the middle class, as well as to fix the Alternative Minimum Tax (AMT), which increasingly takes the value of those tax cuts away from the upper-middle class.
And most significantly, all the new Democrats embraced an economic populism that is, so far, more of an attitude than a policy agenda but is reminiscent in some ways of President Clintons early Putting People First agenda of investment in human capital.
These positions are not entirely incompatible, but there is only one way to fit them together: To avoid an economic crisis or massive cuts to existing programs, taxes will have to increase by at least the amount of the 2001 and 2003 tax cuts that are scheduled to expire. And if we are to restore the promise of activist government that can solve problems and help families make it in a difficult, dynamic economy, then taxes are going up even more, beyond what can be raised by letting the tax cuts expire.
Well before the election, budget expert Stanley Collender wrote, Whether it is fear, resignation, or just reality setting in, an attitude adjustment in the federal budget world is now definitely palpable: there is a growing likelihood that taxes will have to be increased to reduce the deficit.
But between inevitability and action falls the shadow. No one will say it. No one, Democrat or Republican, wants the responsibility for making the connection between taxes and the security, stability, and services we expect from government.
So to make it possible to talk about revenues when the opportunity arrives to actually do something about revenues, Democrats and anyone else who is serious about avoiding economic crisis must spend the next two years thinking and planning how to condition the political environment so that politicians can move with courage. That will require, first, establishing the idea that taxes must increase as a non-debatable fact; second, fixing the political process that has greased the way for tax cuts; and, third, setting the framework in which we talk about taxes.
Joining the Pigou Club
The first step will be to establish an acute sense of fiscal and economic crisis. That wont be difficult, since its true. The difficulty is in expressing it the right way. The deficit is an abstraction. As long as we accept that balanced budgets every year are not a realistic goal, the difference between a deficit of $150 billion and $600 billion is meaningless. Instead, Democrats should emphasize tangible consequencessuch as a choice between cuts to vital services and a devastating economic shock versus manageable tax increases.
Corzines success in raising taxes is a good example of using a crisis to create some political room. To force a reluctant legislature to act on the budget, Corzine let more than half of state government shut down for a week. The alternative to a tax-raising deal was visible chaos. Theres also a parallel in the Iraq War: As recently as spring of 2006, stay the course was a positive idea; anyone who questioned it was seen as weak. But over the course of just a few months, stay the course became synonymous with rolling disaster, and everyone disowned the term. Staying the course with regard to fiscal policy needs to be regarded as equally negligent.
Connecting tax decisions to their consequences depends first on repairing some of the abuses of the political process that keep them separate. Eugene Steuerle, a Treasury official in the Reagan years who is now at the Urban Institute, often points out that, the problem is process, not policy. And theres nothing accidental about the process. A centerpiece of Karl Roves design for government, which lives on even after his electoral strategy has been buried, is the radical separation of tax decisions from spending decisions, so that tax choices are always viewed in isolation from their consequences. In the past, every three or four years, Congress would enact one large budget bill under the special anti-democratic process known as reconciliation, which limits debate and amendment. Almost always, these bills incorporated both spending and tax changes, and without exception, they reduced the deficit. That was, after all, the point. But starting in 2001, Congress has passed reconciliation bills every year, usually containing only tax cuts, and last year, it passed twoone with tax cuts and another with spending cuts, carefully separating them in time so that it could never be said that the tax cuts were forcing the spending cuts.
This particular abuse of the process is possible only when one party controls both houses of Congress and the White House, so it will be thwarted for now. But Democrats could change the budget rules to require that bills pushed through under the reconciliation process lead, on balance, to a reduction in the deficit. (This change, which would not require a presidential signature, is included in Rep. Barney Franks (D-Mass.) plan for congressional reform.) And the pay-as-you-go rules, which many liberals are wary of, thinking that they would hold back investment in public services, are absolutely central to breaking the racket of cheap tax-cut politics. Without pay-as-you-go, Republicans would be free to propose tax cut after tax cut, starting with permanent repeal of the estate tax and extension of all the Bush tax cuts, and some Democrats would balk at voting against them. But with pay-as-you-go, every such proposal would have to be linked directly to a consequence, and those consequences will not be popular. With pay-as-you-go in place, the dishonest politics of tax cuts comes to an end.
While process changes might slow down the rush to cut taxes, however, process alone will not be sufficient to change the political calculus around the tax increases that will be necessary. To force a broad discussion of taxes and revenues, and one that could be bipartisan, it should begin with the term tax reform. Fairness and simplification should be the first goal. The 1986 tax-reform bill, which lowered rates, eliminated loopholes and simplified the system, stands to this day as one of the last great landmarks of bipartisan, problem-solving government.
At least one observer thinks a similar breakthrough is possible even in the next two years. Bruce Bartlett, a Reagan advisor who fell out with the current Bush administration over its betrayal of small-government conservatism, argues that the circumstances that led to reform in the 1980s were similar to todays: The Republicans saw that their strategy of cutting tax rates had reached its limits, while Democrats since the 1950s had been interested in closing tax shelters and loopholes. If they were to continue lowering marginal rates, Republicans would have to find common ground with Democrats interested in broadening the base, as they did in 1986. (The opposition came from those who liked the system of nominally high rates, which gave politicians the power to cut them selectively for favored constituents.) Similarly, Bartlett believes, Republicans will soon recognize that extension of all the Bush tax cuts is impossible. When paired with a Democratic desire to make good on promises such as extension of a few tax cuts, along with AMT relief, that realization might produce a similar moment of compromise.
This is, to be sure, by far the most optimistic scenario I heard from either Democrats or Republicans, and the only one that foresaw significant action between now and the 2008 election. Even Bartlett admitted, however, that its quite possible that Rove will do some polls and tell the Republicans to let the Democrats deal with the problem and then well come back and beat them in 2012.
Thats probably more than possible, which means that the moment for real tax reform will come after the election of a new president, though not necessarily a Democrat, in 2008. In that case, the project of the next two years is to define what reform means, much as the early proponents of tax reform in the 1980s, former Sen. Bill Bradley and Rep. Dick Gephardt, did with their Fair Tax proposal of 1982. (I worked for Bradley several years later, so Im deeply steeped in the legend of tax reform.) For conservatives, tax reform has recently been synonymous with a single-rate flat tax, which is neither fair nor simple, since most of the complexity of the tax code derives not from the number of rates but from the different definitions of income. As an alternative, another tall, smart Democrat, Sen. Ron Wyden of Oregon, has emerged into the Bradley role, with a proposal that would redefine simplification and fairness by taking as its central idea that all income, from whatever source, should be taxed the same. In particular, this means ending the favorable treatment of capital gains and dividend income.
Public opinion polls suggest that making the system fairer and simpler might be far more appealing than tax cuts ever were. A poll by Greenberg Quinlan Rosner Research in 2003 found that when people were asked, What bothers you most? about the tax system, 77 percent said it was either complexity or the feeling that wealthy individuals and corporations dont pay their fair share, while only 14 percent said what bothered them was the amount they themselves pay in taxes. Nonetheless, people are notoriously averse to tax the rich proposals if they see them as punitive. The idea of treating investment income and income from work identically, which was a centerpiece of John Edwardss 2004 campaign, would seem to finesse that paradox by establishing a neutral principle that applies to rich and poor alike.
But while fairness should be the main goal of reform, fairness alone will not raise revenues adequate to meet governments needs. One of the brilliant tactical moves of the mid-80s tax reformers was to first agree that reform would be revenue-neutral, so that issues of raising or lowering taxes would not get in the way. At a recent press conference with Bradley, Wyden sounded nostalgic for those days, answering questions about revenues with a promise that reform would do no more than lower rates and close loopholes. But revenue neutrality is not a luxury that 21st-century reformers can afford. In place of revenue neutrality, they will have to adopt some predetermined target level of revenues that will keep pace with the natural growth of entitlement programs because of the aging population and health-care inflationthe main drivers of the so-called entitlement crisis. Even with a target level of revenues much higher than todays 17 percent, they will still be unable to avoid significant cuts to the two fast-growing entitlements, Medicare and Medicaid, or a wholesale revision of the health system. This, too, creates an opportunity for bipartisanship.
If the tax reformers of the future are to make good on the promise of lower rates, as well as surrendering the revenues from the AMT, as well as paying for an aging population, they will have to go well beyond the boundaries of the income tax. And here is where the greatest opportunities for an entirely new political configuration may be found. Conservatives have always been interested in taxing consumption as a way of encouraging savings and investment, and liberals in need of revenue will have no alternative but to reconsider their historical aversion to consumption taxes as regressive.
Taxing consumption is usually synonymous with some version of a Value-Added Tax, (VAT) which is slowly gaining acceptance among liberals. (See Value Added, by Jeffrey Birnbaum) An alternative would be a tax either on gasoline (always unpopular) or more broadly on energy use, which could be built with incentives and subsidies for clean-energy technology and thus help address climate change as well as ameliorate dependence on the Middle East. Broad energy taxes have an unfortunate political history (old-timers in Congress will not soon forget the phrase we got BTUd from 1993, when House Democrats voted for a politically risky energy tax based on BTU usage, only to see the Senate drop the plan). But the politics of an energy tax today would be very different, offering the potential to reconfigure our relationships in the Middle East, address climate change, and create jobs in cleaner, more efficient innovations, a field that many believe will be the next driver of the American economy. Washington insiders will also note that when the BTU was killed, it was because Democrats from oil states such as Louisiana, Texas, and Oklahoma dominated the Finance and Energy Committees, as they always had. Soon afterwards, those states threw their lot in with the Republican right. Today, the oil industry has lost its influence in the Democratic Party and is unrepresented on the Finance Committee. Oil companies are a ripe, unprotected target.
There is also renewed interest in energy taxes on the moderate right. A former Bush economic advisor, Greg Mankiw, recently announced the formation of the Pigou Club (named for the British economist Arthur Pigou, a colleague of John Maynard Keynes), an informal and involuntary alliance of economists and commentators who advocate carbon or energy taxes, or other Pigovian taxes that have the simultaneous effect of raising revenues and reducing consumption of something undesirable. Pigou Club members are deemed by Mankiw to have signed up when they say something in public favoring such taxes, and range from Alan Greenspan and Martin Feldstein to Al Gore and Paul Krugman.
While consumption taxes are inherently less fair than a progressive tax on income, there are ways to moderate its unfairness, and if a consumption tax were directly linked to a positive social goodsuch as a VAT that pays for universal health carethe entire package, taken together, would be enormously progressive.
Think big
As one tries to game out what might happen on taxes in the years ahead, the strategy seems to get bigger and bigger: We start by revisiting the Bush tax cuts but move to comprehensive tax reform, and from reform of the income tax, we move to a more sweeping change that would balance taxation of consumption and income. Steuerle, the former Reagan administration Treasury official, argues that reformers of the future should go bigger still and put everything on the table, including cuts to entitlement spending and increases in other spending. A veteran of the 1986 reform, he argues that it is a bad model specifically because its scope was limited to taxes. As a result, provisions added to win votes were added to the tax code rather than provided through direct spending.
A giant showdown with all revenues and spending on the table would certainly call the bluff of Republican conservatives who say they want to cut spending but have never been willing to take the political consequences of doing so. At the same time, it might allow Democrats to put on the table some of the tangible benefits of additional revenues, such as funding for expanded health coverage or for real economic security programs to help workers manage the risks of the economy.
The risk here is of putting too little on the table rather than too much. If the fight is just about extension of a particular tax provision, it will be hard to win. And if politicians arent willing to talk honestly about the magnitude of the changes necessary, the default will be excruciating: In a few years, we will enter a period of chronic crisis, scraping by each year with a painful series of budget gimmicks, fee increases, and disguised tax hikesjust enough to get by for the year before the dreary cycle begins again. After a few years, the public impression would be of a government that is constantly raising taxes, constantly cutting services, yet never solving either the fiscal crisis or other problems. And the grinding obsession with that abstraction called the deficit would continue to make it impossible to reconnect taxes with the benefits and security people expect from government.
With so much on the table, there is the potential for a complete transformation of government, one that would restore a platform on which to rebuild a role for an active, problem-solving government and a fresh-thinking ambitious politics. It would be the ultimate act of reconnecting taxes, public responsibilities, and public goods, replacing the era of invisible tax increases before 1981, and the tax-cut revolt that has prevailed since then, with a new era of clarity and informed choice.
And while there might be a great political risk, a new president might choose to absorb all the costs of raising taxes at once, early, then build from that stable foundation. Grand moves in policy often occur quickly in a presidents first year, taking no more than a few months of intense legislative and political maneuvering to resolve. Reagans budget and tax cuts were finished by August, as was Clintons vast budget package. But the ideas and assumptions that make such moves possible can always be traced to work and thought over the several years preceding them. If politicians begin to think and talk about the need to raise taxes now, there might be an alternative to denial and desperation.
