A Tax Plan for Kerry
By Ted Halstead and Maya MacGuineas
Monday, May 24, 2004; Page A23
John Kerry not only has a message problem, he seems to have conflicting economic priorities. Kerry wants to make job creation and helping the middle class the central theme of his campaign, but he has yet to offer any bold or compelling ideas to back up the rhetoric. At the same time, he has been unable to find a way to square his broader jobs agenda with his commitment to fiscal prudence. Allow us to suggest a solution to both problems: abolishing the payroll tax.
Although you'd never know it from listening to our political leaders, the largest tax now paid by over 70 percent of working American families is not the income tax but the payroll tax. No tax does more to discourage job creation or to reduce take-home pay for low- and middle-income workers. Likewise, nothing could do more to boost both than repealing it outright.
Unlike income taxes, the payroll tax kicks in from the first dollar earned and applies only to wages. It is split equally between employers and employees (except in the case of independent contractors, who bear both parts of the burden). While income taxes have been cut many times in recent decades, payroll taxes have risen steadily: from a tenth of the federal budget in the 1950s to over a third today.
A basic premise of economics is that the more you tax something, the less of it you get. By taxing labor so heavily, we are in effect choosing to have fewer jobs and to drive employment into the informal sector, where workers receive no benefits and often try to hide their wages. The payroll tax is particularly painful for small businesses, which we depend on for job creation. Not surprisingly, the National Federation of Independent Business routinely cites payroll tax relief as one of its top priorities.
As if retarding job growth weren't bad enough, the payroll tax is also highly regressive, meaning that it falls disproportionately on low-income workers. Not only is its rate structure flat, but its largest component (which funds Social Security) applies only to wages up to $87,900 a year. In other words, the fastest-growing tax just happens to fall hardest on those who can least afford to pay it.
Kerry has flirted with the idea of payroll tax relief in the past. During the economic downturn, he suggested a "payroll tax holiday" to stimulate consumer spending and help lower-wage earners. More recently he proposed a temporary income tax credit to offset the cost of payroll taxes incurred by businesses for hiring new workers. But these proposals amount to little more than tinkering at the margins of the problem. If the payroll tax hinders job creation (which it does) and is highly regressive (which it is), why stop at half-measures? Any candidate who is serious about stimulating employment and helping working-class families should propose repealing the payroll tax permanently.
Of course, the roughly $750 billion a year generated by the payroll tax would need to be replaced with a new source of revenue earmarked for Social Security and Medicare. As it is, Kerry's existing proposals are already at odds with his desire to cut the deficit in half. Thus any new funding stream will not only have to generate sufficient revenue, it will also have to avoid the numerous pitfalls of the payroll tax. Better yet, it should be structured to encourage economic growth. The ideal candidate is a national consumption tax.
Conservatives have been championing consumption taxes for decades on the grounds that they would encourage saving -- and, hence, long-term growth -- without discouraging work and enterprise. These are very important benefits. Traditional types of consumption taxes such as sales taxes or the "flat tax," however, are extremely regressive and therefore would be no improvement over the payroll tax on that front.
A better alternative would be a progressive consumption tax, levied not on individual purchases but rather on total spending. Each year, taxpayers would calculate their total income, subtract their total savings and pay taxes on the difference. The first, say, $25,000 of consumption would be tax-free, and from there the tax rates would be progressive rather than flat. The more you spent and the less you saved, the higher your tax rate would be.
Phased in gradually, a progressive national consumption tax could replace the entire revenue stream of the payroll tax. And it would be a far better funding stream for Social Security and Medicare, insofar as a consumption tax would encourage exactly what we most need as the retirement of the baby-boom generation approaches: higher rates of personal savings. Over time, higher saving rates would also boost economic growth and living standards.
By replacing payroll taxes with consumption taxes, Kerry (or his rival) could claim the ultimate policy hat trick: more jobs, higher take-home pay and more personal savings. On top of that, embracing this idea would help Kerry reconcile two strands of his own thinking that have so far been in near-constant tension: his commitment to fiscal rectitude and his penchant for populism.
One can almost hear the new campaign slogans: "balanced-budget populism," "pro-growth populism" -- or both.
Ted Halstead is president and chief executive of the New America Foundation. Maya MacGuineas is director of the foundation's Fiscal Policy Program. They will answer questions at 11 a.m. tomorrow on www.washingtonpost.com.
© 2004 The Washington Post Company