The Tax Debate We Want and Need

President Obama has now given the Congressional “super committee” his plan for “Economic Growth and Deficit Reduction” that would trim $3 trillion from projected deficits over the next decade.

But whether one believes the plan is “fair and balanced,” a modern version of a “Class Warfare Manifesto – or something else entirely- let’s get real.

The increasingly tiresome and predictable “Tax Cuts (or Hikes) vs. Government Spending and Deficits” debate has been Washington’s longest running kabuki dance for decades. The odds that a 67-page plan, with more than 100 discreet proposals, will un-muddy these turbid waters, especially in a presidential election year, are virtually nil.

As Chief Executive, Obama certainly had to submit a plan. But with that behind him, what’s desperately needed is a whole new framing of this tired, predictable debate, that at least has some potential to unite and engage a broad swath of citizens and force both Congress and the President to act responsibly.

What he needs to say – clearly, relentlessly, and with so much repetition he’ll doubtless earn the brickbats of many annoyed editorial pages and raging talk show hosts – is that for the next 100 days, the “Tax Cuts/Hikes” vs “Budget Cuts” debate is quite irrelevant. What’s really facing America is an immediate and stark choice between two different tax cuts – and it’s imperative to educate Americans so they can weigh in on what kind of tax cut they’d prefer.

Here’s why.

In less than 100 days – on January 1, 2012 to be exact – the vast majority of Americans are scheduled to receive the single largest tax hike in their working lifetimes.

A single parent, working full time as a janitor or fast food worker at federal minimum wage of just $7.25/hr, will be hit with a $290 annual tax increase. A teacher, nurse, construction worker, or factory supervisor earning $50,000 will pay another $1000. And a two-income, professional family, with each spouse making about $106,500? They’ll get whacked with a whopping additional $4,240 during 2012.

That’s because, in stark contrast to federal income taxes, the payroll tax -clunkily known as the Federal Insurance Contribution Act (FICA) – is levied on the very first dollar of earnings. Employees have long paid 6.2 percent for Social Security, and another 1.45 percent for Medicare. Employers then must match these amounts, for a combined 15.3 percent. (Self employed Americans must pay both halves).

To date, the government spending provisions in the 2009 Obama Stimulus plan have received the most attention from critics on both the Right (“Too much!”) and Left (“Too little!). But a major part of the stimulus package was a temporary decrease in the Social Security payroll taxes paid by virtually all employees and self-employed business people.

A 2009 FICA decrease temporarily deprived a government program (Social Security) of $120 billion in annual cash flow. (Or, in the traditional Republican world view, it allowed taxpayers keep $120 billion of their money.)

This tax break was then renewed in the December 2010 tax deal, that also temporarily extended the Bush-era federal income tax cuts (then set to expire on January 1, 2011). The Bush tax cuts were extended two years, through December 31, 2012.

But a very interesting – and again, little noticed at the time – thing happened during all the strum und drang of last summer’s debt ceiling/budget balance debate. Congress kept the December 31, 2012 (post November election) expiration date for the temporary income tax cuts.

But it failed to change the December 31, 2011 expiration date for the FICA tax cut. (Had it extended this “cut,” Congress would have needed to cut an additional $120 billion a year — something for which both Democrats and Republicans had little appetite.)

Arguably, not since Lyndon Johnson convinced Congress to enact a broad, 10 percent income tax surcharge to help pay for the Vietnam war will such a large, annual tax increase so dramatically affect the vast majority of Americans.

It’s one thing to argue that income taxes should be raised for the top 1 percent of wealthiest Americans – not to mention oil companies and corporate jet owners – in order to pay for this or that government program, or to avoid certain “cuts” in popular benefit programs. Obama and his Democratic allies – not to mention countless editorial boards and commentators – have been vigorously making this argument for years. And yes, polls do show most Americans prefer a combination of targeted tax increases along with budget cuts.

But such formulations are also decidedly abstract. Most Americans — conservatives and liberals — also believe there’s still significant “waste,” “stupidity” and even “fraud” in current federal government spending.

As long as Republicans can still credibly raise the three-decades old Reagan era formulation – “Does Government have a Taxing problem, or a Spending problem?” – this debate quickly becomes a muddle. “Hmm,” many voters muse to themselves. “Maybe we can have it both ways – no bad budget cuts but also no tax hikes!”

This “Tax hikes! Budget Cuts!” shouting match has long echoed (with the volume increasingly turned up, especially with Tea Party activists in the room) that famous Miller Lite commercial “Tastes Great!” “Less Filling!”). Meanwhile, fierce partisans on each side hunker down, WWI-like, in their respective ideological trenches.

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But right now, the choice is much different: Which tax cut do we choose to keep – albeit, temporarily — in place as the economy tries to claw its way back to prosperity?

In addition to making for some interesting politics in the coming months, such a conversation might also – finally – provide a teachable moment as to how America’s tax system really works. On this subject, the pools of seeming ignorance seem vast, even among supposedly thoughtful commentators and journalists.

What’s the single biggest tax, that the vast majority of Americans now pay? Hint: it’s definitely not the federal income tax – though you’d certainly think it was given all the obsessive talk about it.

Indeed, in 2010 almost 50 percent of all Americans paid nothing – zero, nada, zilch – in federal income taxes, after taking all the various deductions and exemptions to which they’re entitled. For households making between $50,000 to $75,000, the actual “tax bite” from the IRS settles out at around 6 percent, according to recent IRS figures.

In defense of making the Bush-era income tax cuts permanent – especially for more affluent Americans – conservatives often cite this reality. They also note – quite correctly – that about 38 percent of total personal income tax receipts come from just the top 1 percent of taxpayers.

But these facts mask an underlying reality about Americans’ incomes – and the kind of taxes they pay. The median income of an American household is only about $50,000 a year. About 75 percent of all American households, have an Adjusted Gross income of $70,000 or less.

Most Americans are paying little or nothing in income taxes – and the poorest workers in our economy actually get money back from the Treasury, courtesy of a Reagan-supported Earned Income Tax Credit – for a simple reasons. They just didn’t make all that much money.

So what is the biggest tax for most of us? It’s FICA, for a profoundly important reason. Unlike the federal income tax, with its various deductions and exemptions designed to help workers and their families, FICA’s tax bite starts on the very first dollar we all earn. Exemptions, schmexemptions – it’s all taxable.

Politicians of both stripes like to avoid this decidedly inconvenient truth, through several ruses. First, they insist that there’s a profound difference between these types of levies since FICA only finances two programs that are also widely considered “politically untouchable” – Social Security and Medicare. Accordingly, many argue that FICA isn’t really a “tax” – but a “contribution” to Social Security and Medicare.

But even if one prefers such semantics, this is a distinction without any meaningful difference. Both parties include these programs, on an equal basis, with all other federal government spending programs in keeping score with their respective deficit reduction plans. FICA payroll taxes and federal income taxes are both taxes, pure and simple — and both Social Security and Medicare are “government spending programs,” just like defense, Medicaid, farm subsidies, etc.

Critics of the FICA tax reduction strategy – on both sides of the aisle – have also expressed concern that this “temporary” tax reduction will prove anything but -thus threatening the ultimate solvency of entitlement programs.

To be sure, there is genuine danger that even in good times, politicians will be loathe to muster the political courage to end any “temporary” cut. (Exhibit A: the “temporary” Bush-era tax cuts enacted during the 2001 recession, that were originally slated to end on December 31, 2010).

As for the threat to Social Security and Medicare, remember that this reduction is only on the Social Security side of the equation. As budget geeks also know, in the last few decades the 12.4 percent combined Social Security FICA tax has resulted in mutli-trillion surpluses.

Sure, just recently the Treasury began paying out more in Social Security benefits than the system is taking in. Yet even with a few more years of 4.2 percent employee payroll rates, Social Security’s day of reckoning isn’t scheduled to arrive until well into the 2030s.

Matching the widespread ignorance about FICA are similar misunderstandings about the federal income tax system. Let’s start with the current debate about what to do about the Bush-era tax cuts, starting with the fact that the precise policy issue isn’t about enacting new tax increases. Rather, it’s whether (and when) to let the “temporary reduction ” of income tax rates enacted under the Bush Administration in 2001 to expire, returning these income tax brackets to pre-2001 levels.

To date, Obama has proposed continuing the vast majority of these cuts, on a permanent basis. Unlike the Republicans, however, Obama has long advocated one exception with the Bush-era tax cuts. He would let the system’s two top tax brackets “revert” to their 2001 levels – and it’s this insistence that has led his Republican critics to fulminate about “class warfare.”

What Obama has proposed is that for income above the $250,000 Adjusted Gross Income level for households ($200,000 for single filers), the tax rate should be increased from 33 percent back to 36 percent. Whether you view this as a 3 percent increase in the nominal tax rate – or an overall 9 percent increase in taxes levied on income above this threshold – the key point is this. This rate hike would affect only that portion of income above the threshold. All income, below this threshold, would keep getting taxed at the Bush-era tax cut rates.

For income above the $370,000 threshold (single and joint), the rates would go from 35 percent back to 39.4 percent — a 4.4 percent rate increase and 13 percent overall increase in taxes paid on this portion of income. But again – this bracket hike would only be on the income above this even higher threshold.

Remember, too, that all income taxpayers – even those earning income in these relatively rarified brackets – are able to take advantage of various tax deductions and exemptions. (Many deductions, like charitable giving and the mortgage deduction for first and second homes, actually benefit wealthier taxpayers disproportionately, since they itemize their deductions).

That’s why the precise term in these federal income tax discussions is Adjusted Gross Income (AGI). To get to an AGI of about $370,000, many taxpayers actually start with an overall annual income of $500,000 or even higher.

The looming FICA rate hike – from 4.2 percent of wages and self-employed income currently back to 6.2 percent on January 1 – may look a lot smaller. It’s “only” a 2 percent rate increase – but it packs an actual 30 percent “tax increase” wallop.

Even the wealthiest taxpayers – as long as they’re working and earning money from wages – will also benefit from the FICA payroll cut extension. Indeed, many of them will get the maximum benefit — $2,120 for single taxpayers, and $4,240 for couples (Though FICA taxes on Medicare are levied on all wages, for Social Security they’re only levied on the first $106,500 of individual income).

In other words, a reversion to pre-2001 levels in the top two federal income tax brackets, would actually be offset, for many more affluent taxpayers, by their FICA tax savings. (This does assume that these taxpayers are earning money through wages – not through investments, pensions, or other means). By a rough calculation, single wage-earners making up to $260,000 – and remember, that’s AGI; actual incomes would be higher – would still be “net winners.” Joint filers would still be net winners up through about $340,000 AGI.

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To date, this “tax cut vs. tax cut” debate has been poorly understood, much less well-defined – not to mention more than a bit lost among all the shouting and details of competing budget plans.

Still, are Congressional Republicans — and their loyal apologists in the conservative ranks of the journalistic commentariat — getting a bit nervous? How could they not be?

Indeed, some of this is already showing in some floundering around and stammering that Speaker John Boehner and his allies are doing in criticizing Obama’s proposal to extend the 4.2 percent percent employee rate for Social Security. Earlier this month, Boehner criticized the strategy by claiming that funding a temporary tax decrease (FICA) by a permanent hike in income tax rates for the wealthy was typical of tax-happy Democrats.

Well then, fine, Obama can say. “We can make both the FICA tax cut and the income tax hike temporary — through, say, December 31, 2012 or even 2013. We can then decide, after either I or one of you is elected President, what to do with one, or both of these.” Next objection?

In a letter they sent to Republican caucus members last week detailing their objections to President Obama’s payroll tax cut proposals, Boehner and House Majority Leader Eric Cantor now are all hot and bothered that when the payroll tax cuts expire at some point in the future, the large tax increase will then be too risky for the economy. “There may be significant unforeseen downsides to large temporary tax cuts immediately followed by large tax increases,” they wrote.

Well, well, well – Let’s see if we can get this one right. An abrupt and immediate tax increase beginning this January, totaling about $120 billion a year, on the vast majority of working Americans, amidst 9 percent unemployment and the real danger of a sliding back into a “double dip” recession – is now a good idea?

In a nutshell, Boehner’s and Cantor’s position now devolves to this: Large, immediate tax increases for most Americans, right now, is preferable to letting any current, temporary tax cuts on the wealthiest 1 percent of Americans expire even a year early. Any jobs lost – by 99 percent of working Americans and self-employed business people and their families by having their taxes go up $300, $1000, even $4000 more a year – is an acceptable price to pay, because of the greater number of jobs that would be presumably be lost should the top two brackets of the federal income tax system expire a year earlier (this January, not January 2013), reverting back to their levels of the 1990s (when the economy largely boomed, during the Clinton years).

Of course, there’s another choice: keep in place, for at least another year, just the current tax cut, for virtually all working Americans. And pay for it, dollar for dollar, by – a temporary tax hike (of the same duration), targeted to the most affluent 1 percent of Americans, earning well north of $250,000 or even $350,000.

This is the choice Obama should frame – and encourage Americans to weigh in on with their elected officials. Yes, in the long run, such a tax cut is arguably not “great public policy.” Though at this point even “good policy” considerations seems largely absent from the choices Washington D.C. seems to be giving voters, period.

Phil Keisling

Phil Keisling, a Washington Monthly contributing editor, served as Oregon secretary of state (1991–99) and is currently the director of the Center for Public Service at Portland State University.