Read My Lips: We Need These Taxes

By Roger Lowenstein
Sunday, June 15, 2008

Let's imagine an alternate universe. The U.S. government is running a large and growing deficit. Not far down the road it faces huge increases in Social Security and Medicare costs. Naturally, the candidates for president want to remedy this by raising revenue. They don't want us to bequeath bigger deficits to our children or stake our future on foreigners' willingness to keep lending us money.

But have you heard this speech? "My fellow Americans, I have a plan to raise taxes so that the budget will be closer to balance and future Americans won't have to worry about their retirement security." Neither have I.

Somebody, though, should be giving it. The U.S. budget deficit will be $400 billion -- or 3 percent of the gross domestic product -- this year, according to the Center on Budget and Policy Priorities. And it's growing. A gas-tax "holiday" (as advocated by John McCain) or a middle-class cut in the payroll tax (candy from Barack Obama) are pandering and will only make things worse. How would a conscientious president deal with the deficit and also make the system fairer? Here are five relatively painless ways.

1. End preferential treatment for private equity fund managers.

When you and I earn ordinary income, we pay a maximum rate of 35 percent in taxes. The max for private equity fund managers is 15 percent. This includes folks like Stephen Schwarzman, the head of Blackstone, whose net worth has been estimated at $7.8 billion and who (when he's not in St. Tropez or sundry other vacation digs) lives in the former Park Avenue apartment of John D. Rockefeller Jr.

Why do fund managers pay less? To encourage investment, the tax system charges a lower rate -- 15 percent -- on capital gains. No one objects to fund managers paying that rate on the profits they earn on their own capital. But here's the rub: Most of their profits come from investing other people's money. Typically, for every dollar their investors earn, the managers take a 20 percent cut. This is, in effect, a fee -- or ordinary income. Why shouldn't a Schwarzman or a Henry Kravis of Kohlberg Kravis Roberts & Co. be assessed the same rate on their fee income as anyone else? And since this wouldn't affect the people putting up the money, it would have no effect on total investment or economic growth. This change would raise only $3 billion a year, but on simple fairness, it's a must.

2. Raise the cap on the payroll tax.

Social Security is financed by a 12.4 percent tax, but it's assessed only on the first $102,000 of income. So people who earn more than that amount pay a lesser share of their total income. Warren Buffett, currently the richest American, has noted that his secretary is taxed at a higher effective rate than he is. Since income disparities are growing (the top 1 percent of earners took home 23 percent of all income in 2006, the highest total since just before the 1929 stock market crash), more and more income is escaping the tax. And Social Security needs the money: Its benefits will eclipse payroll tax revenues by 2017 (after that, the system will have to reclaim money it has lent to the rest of the government; eventually it won't have enough). Raising the cap would help preserve benefits. There are many ways to do this. Obama favors extending the tax on the wealthy -- perhaps on incomes above $200,000. More simply, we could raise the current ceiling.

3. Reinstate a meaningful

inheritance tax.

The Republicans won a rhetorical debate by labeling the inheritance tax a "death tax" -- the very phrase conjures up an image of heartless bureaucrats dragging the elderly from their beds to settle up, depriving them of their final moments of peace. In reality, the tax is paid not by the dying but by their living heirs. Prior to President Bush's tax cuts, which called for a gradual phaseout, the inheritance tax was levied only on estates worth more than $600,000, or 2 percent of the total. By next year, the floor will rise to $3.5 million -- at which point only one-third of 1 percent of estates will be taxed.

The tax is due to be repealed in 2010 -- and then restored in 2011 (a gimmicky flip-flop that Congress approved so that the projected deficit wouldn't seem astronomical). Congress is certain to revise the inheritance tax during the next administration. Reverting to half the pre-Bush level, as compared with total repeal, would net the government $40 billion a year.

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