Democracy Dies in Darkness

Wonkblog | Perspective

The middle class doesn't want a tax cut. It wants better government.

By Steven Pearlstein

September 27, 2017 at 9:51 AM

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During a speech in Indianapolis, Sept. 27, President Trump said the GOP tax plan is a “once-in-a-generation opportunity” to lower taxes on the middle class and businesses. (Bastien Inzaurralde/The Washington Post)

One of the great canards of American politics these days is that the "struggling" middle class needs and wants a tax cut. It doesn't. What it needs and wants after years of tax and spending cuts is more and better government services for the taxes it already pays.

According to the nonpartisan Tax Policy Center, the average rate of income tax paid by the American middle class — the 20 percent of households in the exact middle of the income ladder — has been going down for decades, and was at 2.6 percent of gross income in 2013, the last year for which statistics are available. For the 40 percent of household below them — what you might call the working class — the average household not only paid no tax, but because of refundable tax credits actually got money back from the government equal to 1.2 percent of income, helping to offset payroll taxes (Social Security and Medicare) that averaged around 8 percent. To whatever extent the middle class is struggling, it ain't because of income taxes.

Indeed, when Gallup asked Americans in April about the taxes they pay, a majority — 61 percent — said they felt the income tax they paid this year was fair. A Pew study found that only 26 percent of Americans felt they paid too much in taxes, in contrast to the 60 percent who felt corporations and the wealthy paid too little. A poll by Bloomberg found that taxes were well down on the list of Americans' public policy priorities, with only 4 percent claiming it was their top concern.

Obviously, there's nobody who wouldn't enjoy the extra spending or saving that a tax cut would bring, but as the researchers at Pew found in April, what Americans would like even better is for government to spend more to educate their children, rebuild infrastructure, and provide health care and an income safety net for the elderly, veterans and the deserving poor. Despite years of politicians railing against "big government," Pew found that as many Americans today wanted government to be bigger as to be smaller.

Like the campaign to repeal and replace Obamacare, the middle-class tax cut is a solution looking for a problem. It's nothing more than a political totem, an expensive exercise in political pandering. Moreover, at a time when the U.S. economy is running pretty much at full capacity, a tax cut is more likely to lead to price and asset inflation than sustainable growth in incomes and employment.

If Democrats had the courage of their pro-government convictions, they'd be saying all that. But because they've spent the past decade reflexively adding the words "middle class" to every talking point, they've badly boxed themselves in. Democrats can rail all they want about the skewed nature of Republican tax cuts, but in framing this and every other economic issue in terms of the greedy rich vs. the struggling middle class, they've implicitly forfeited the ability to declare that there's no need for a tax cut at all, including one for the sainted middle class.

Are rising costs of health care, housing and college education putting strains on some households, particularly those that haven't had a decent raise in years? Sure. But the solution to those problems is to reform the health care and education systems and increase the supply of housing, not to jeopardize the government's ability to make the public investments needed for sustained economic growth, which is what cutting government revenue would do.

Everyone, of course, is for tax reform. Genuine tax reform would make the tax code fairer by treating people with similar incomes in similar ways. It also would make the economy bigger by eliminating tax breaks that distort economic behavior. But what Republicans propose is a whole lot of old-fashioned tax cutting wrapped in a thin cloak of reform. Genuine reform would raise the same amount of money in a fairer, simpler and more efficient manner. Republican tax reform needs $1.5 trillion in fiscal fairy dust over the next decade to make it appear that their plan won't reduce government revenue and increase the federal debt.

Another myth driving this year's so-called reform effort is that the American economy has become uncompetitive because business taxes are sky high. For starters, the American economy remains one of the two most competitive in the world, according to the last rankings of the World Economic Forum, not exactly a bastion of socialist thinking.

And one reason the United States has remained so competitive is that the effective tax rate for U.S.-based corporations — not the statutory rate bandied about by the business lobby — is just 24 percent, about the average for all industrialized countries, according to a report this year by the Treasury. At the same time, more than half of business profits now avoid the corporate tax altogether as more and more large businesses have organized themselves as partnerships and limited liability corporations — what are known, in tax parlance, as "pass-throughs."

According to a recent Brookings Institution monograph, if the proliferation of "pass-through" entities had not been allowed to occur — and with it all manner of tax avoidance — American businesses would be paying $100 billion a year more in taxes on profits than they are now. And that's not counting the billions more in payroll taxes they avoid, further weakening the financial foundations of Social Security and Medicare.

Real tax reform would put an end to the pass-through scam by requiring all businesses of the same size to pay the same tax on business profits, irrespective of corporate structure. When you hear Republicans and business boosters talking about lowering the tax rate for "small businesses," that's just a ruse. What they really are talking about is making this pass-through tax loophole even bigger for hedge funds, oil drillers, law firms, private-equity firms and real estate partnerships, most of which are quite large.

You'll also hear this week about making the tax code more "pro-growth" by allowing businesses to deduct the full cost of new investments (buildings, equipment, research, advertising and brand development) rather than depreciating it over the useful life of those investments. The credible-sounding argument is that this will increase investment. In fact, all it really will do is encourage firms to invest more today and less tomorrow while lowering taxes paid in the short term and increasing them by roughly the same amount over the longer term.

It's all a shell game whose only purpose is to lower business taxes by giving businesses rather than the government the time value of their money as taxes are pushed into the future. It will do little or nothing to increase long-term economic growth. What it will do is increase corporate profits, share prices and executive bonuses over the next few years.

Real tax reform would also ensure that when rich people die, their estates would be required to pay the deferred tax on the appreciated value of the stocks, real estate and other investments sitting in their portfolios. The tax on that appreciation has been deferred because the investments have never been sold and the capital gains never realized — and for most billionaires, this usually accounts for most of the money they leave to their heirs.

The fake news about the inheritance tax is that it represents an unfair "double tax" on entrepreneurial success. In reality, thanks to loopholes in both the capital gains and inheritance taxes, the wealth of the super-rich now passes from one generation to the next without being taxed even once. Any tax plan that doesn't close this glaring inequity doesn't deserve to be called reform.

Read more:

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It took the worst of Trump to bring out the best in Corporate America

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Related: Mark this date: Donald Trump is now a lame-duck president

Related: Now is the time for business leaders to dump Trump — for the good of the country


Steven Pearlstein is a Post business and economics writer. He is also Robinson Professor of Public Affairs at George Mason University.

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