WASHINGTON — Most middle-income voters will be more than a little cynical when they hear politicians in Washington debating "tax fairness." After 10 years of illusory tax "cuts" and phantom tax "simplification," many understandably think that, whatever the politicians do, middle-class taxpayers will be left holding the bag.
The problem is that Washington in the 1980s abandoned the idea of tax progressivity--the concept that people should pay taxes according to their ability to pay.
Of course, it's easy to see why poor people prefer progressivity. Progressive taxes take a larger share of income from those who make more. And self-interest suggests that rich people might like regressive taxes--which hit the poor hardest and the rich least.
But what about the majority of us in the middle?
Those in the beleaguered middle have a large dollars-and-cents stake in fair taxes. For the federal government's sharp move away from tax progressivity over the last 12 years hit average families hard.
To illustrate this in stark terms, take the 1977 federal tax system as a benchmark. That was the year President Jimmy Carter took office--after a campaign during which he called the tax system a "disgrace." But 1977 was the last year before the "supply-side" tax changes of 1978 and 1981, that promised--but didn't deliver--relief from a system perceived as increasingly unfair to average families.
The 1977 system wasn't perfect. But if the progressivity of the 1977 tax system--including the entire range of personal and corporate income taxes, payroll taxes and excise taxes--were applied to today's incomes (after adjusting for inflation), effective tax rates would range from 8.1% on the poor, to 18.9% on families in the middle fifth, to 42.2% on the richest 1%.
If we'd kept the ability-to-pay principle, that's what our tax system would look like today. The problem is: Supply-side tax theory swept through, giving us a tax system that burdens the middle class and doesn't raise enough revenue to pay the country's bills.
To illustrate supply-side logic at its worst, imagine abandonment of the ability-to-pay principle. It would turn the 1977 structure upside down, so the poor would pay at the rate of the rich, the near-poor at the rate of the near-rich and so forth. Since soaking the poor doesn't bring in much--call it the you-can't-squeeze-blood-from-a-stone principle--all rates would have to be adjusted upward by 15% to raise the same revenues as a progressive system would.
The bottom line? Nine of 10 families would pay higher taxes--about $3,000 more each, on average--under the regressive system than under the 1977 rules. The richest 1%, in contrast, would pay an average of $180,600 less in taxes.
Implausible? This would be the result if, as some ardent supply-siders recommend, the government did away with the income tax and raised all federal revenue from sales and excise taxes.
Many people fed up with the income tax's complexity wonder why we don't just have a flat tax--where everyone pays the same rate. Wonder no more. If we were to raise the same amount of revenue through a flat tax, everyone would pay a flat 24.4% of income in federal taxes--and nine of 10 families would pay more than under a system as progressive as 1977's. The average tax hike would be close to $1,500 per family. Meanwhile, the richest 1% would pay an average of almost $100,000 less in taxes.
The worst thing about these hypotheticals is that they're not all that far from the situation today. Because of the decline in progressivity since 1977, nine of 10 families pay higher federal taxes than if progressivity had remained in place. Poor families now pay 21% more, and middle-income families about 7% more. But the richest 1% pays 36% less, and the federal government collects almost $70 billion less in net revenues.
Some of the tax cuts for the rich translated into increased interest, dividends and other capital income, helping fuel an astonishing 110% increase in real after-tax income for the wealthiest 1%. Meanwhile, tax hikes on average families ate into savings and any income those savings would have generated. The bottom line is that the move away from progressivity will cost middle-income families from $15,000 to $75,000 of earnings, an average of $1,100 each in 1990 after-tax income. Poor families are out an average of about $500 each. And there is nothing hypothetical about the average 1990 after-tax increase of $113,000 in the incomes of the richest 1%.