Democrats miss the reform boat by ignoring this ubiquitous flat tax
You can forgive voters if they regard "Democratic tax reform" as an oxymoron right up there with George Carlin's oft-mocked "jumbo shrimp." While Republicans and conservatives have proposed major tax overhauls—including a flat income tax requiring only a postcard-sized return—Democrats and progressives have offered mostly small defenses of the current tax structure. This, in spite of the fact that they could point to a politically appealing reform of the tax code that fits well with their liberal ideology.
The fact is, more than 70 percent of U.S. families now pay more in payroll taxes than in the much-hated federal income tax. And payroll taxes are much more in need of reform.
As Ted Halstead writes in the Nation (April 20, 1998), payroll taxes are supposed to fund Social Security (that's FICA, for Federal Insurance Contributions Act), whose surpluses have covered budget deficits for nearly a generation. That means payroll taxes fund current government operations—just as the income tax does. But the payroll tax is the worst form of flat tax. Everyone, rich or poor, pays 7.65 percent (unless you're self-employed, then you pay a painful 15.3 percent)—until wages reach $68,400, after which they are not taxed at all. The payroll tax also exempts investment income, which the rich have and the poor don't. Since even the flat tax includes a healthy personal exemption, Halstead quips that "not even flat-tax proponents would be so devilish as to propose a tax that kicks in from the first dollars earned and sets a ceiling on the amount of wages to be taxed."
Democrats have long been the party of progressive taxation. So, if most families are hit harder by a flat tax than by a progressive one, it should be good politics to make the flat tax progressive. Halstead would do that by carving out a $10,000 payroll tax "personal exemption," similar to the one that already applies to income tax. This would protect a substantial portion of poor people's wages. Halstead then proposes that we plug the resulting $140 billion gap in Social Security funding by borrowing an ingenious British initiative: require businesses that emit greenhouse gases to purchase pollution permits. "Using this money would strengthen our economy, boost wages and job creation, fix our troubled tax system, and protect the environment, all without raising the deficit," he writes.
While a similar Clinton initiative to tax energy use sunk under the opposition of the energy industry and its unions a few years back, Halstead argues that linking such a plan to payroll tax cuts could unite environmentalists and labor, and win a lot of business support too. Employees may not realize it, but businesses also pay a payroll tax equal to what is deducted from worker paychecks. "Knowledge-based industries, which tend to be labor intensive but consume relatively little energy, now constitute 80 percent of the economy," Halstead calculates. "They would reap significant benefits from reduced labor costs, in exchange for increased pollution fees."
Linking pensions to pollution could have an unintended consequence, though, notes Left Business Observer editor Doug Henwood in his book Wall Street: How It Works and for Whom (Verso, 1997). "The government's interest would be to keep polluters polluting, much [as it] depends upon smokers for more and more revenue."
Joshua Micah Marshall offers another liberal tax reform idea in the American Prospect (May/June 1998), which lacks the environmental pluses and minuses, but is more sweeping and straightforward. He says the Democrats can win votes by making the payroll tax progressive—but still simple—and making the income tax simpler, but still progressive.
Marshall proposes progressive income tax brackets ranging from 10 to 34 percent, and he claims that most taxpayers would fall into the lowest bracket. That means flat-tax proponents would have a hard time making political hay with a 17 percent flat tax that would be more expensive for most voters. Then it's merely a matter of making the currently flat payroll tax more progressive. "If focus groups of downscale voters complain about the burden of taxes," Marshall reasons, "must we not conclude that their frustrations are tied to the payroll tax, of which they pay quite a lot, rather than income taxes, of which they pay very little?"
It's a good question: If payroll taxes are so huge, why hasn't the public gotten riled about them? In part, it's because the public believes that Social Security operates like a pension—you get out what you put in. But that's never been the case, Halstead maintains: "Current workers fund current retirees." And progressive payroll tax reformers risk bursting the "pension" myth and making Social Security seem more like a welfare program if they make the rich pay a greater share. But if the Donkey Party leads the charge to make those who can afford to pay help cash-strapped families breathe easier, there might be so many middle-class "welfare" beneficiaries that the party—and its principle—just might succeed.