The "trickle down" theory of prosperity lives and breathes on Capitol Hill.
There is no other way to interpret the new tax bill passed recently by the House. It repudiates traditional "tax reform" and endorses the idea that helping high-income groups - the people with money to risk and invest - will ultimately help everybody through faster economic growth.
"Tax reform," of course, is one of those glib phrases that can mean anything to anybody. But, as preached and practiced for the past decade, it signified closing "loopholes" and dishing out disporportionately large tax cuts to the poor and the lower middle class. Reform found expression in political rhetoric - candidate Jimmy Carter damned the tax system as a "disgrace" in 1976 - and books such as Philip M. Stern's Rape of the Taxpayer: Why You Pay More While the Rich Pay Less.
The conflict between this type of "reform" and "trickle down" is almost unavoidable. About 1 percent of the population owns about half of the individually controlled common stock. If the government wants to stimulate investment by making it more profitable, this group inevitably benefits.
That may help account for the astounding turnabout in congressional attitude embodied in the House-passed tax bill. Unlike previous tax bills, it doesn't favor the poor and lower middle classes. Moreover, the bill substantially enlarges the "loophole" considered most offensive by reformers: the taxation of capital gains.
You can judge the extent of the congressional change by studying the table below. It shows that individual tax rate reductions in the House bill benefit different income classes roughly in proportion to the amount of taxes they now pay. For example, taxpayers in the $15,000 to $20,000 bracket now pay 13.1 percent of all individual taxes. They would receive 12.5 percent of the benefits provided by the House bill, compared with 20.7 per cent of the benefits under President Carter's proposal.
The capital gains changes twist the bill's impact even further in the same direction.
Capital gains are the profits on the sale of financial assets such as common stock, bonds, homes, farms and small businesses. The bill's most significant provision would "index" these gains to inflation beginning in 1980. Suppose, for example, that someone bought stock for $100 on Jan. 1, 1980, and sold it a year later for $110. Under current law, a capital gain of $10 would occur. If, however, inflation were 6 per cent in 1980, the House bill would treat only $4 as a capital gain. Inflationary price gains (it's argued) shouldn't be counted as profits.
Not only would capital gains be indexed, but the ultimate tax rate also would be cut. According to the Joint Committee on Taxation, about half of the combined benefits of these changes would go to taxpayers with $100,000 or more in income. The Senate may change the details of the tax till, but probably won't alter the basic thrust.
It's a good guess that Congress's new-found sympathy for the upper middle class and the wealthy reflects an intuitive sense that these groups - believe it or not - are being squeezed hard by inflation. Indeed, most Members of Congress are well entrenched in these brackets (annual salary of $57,500, plus outside income) and know that the stock market is still about 10 percent below its 1973 peak.
But more than intuition supports this view. Inflation works to redistribute income, and, arguably, the rich and upper middle class have been hurt the most. A paper written by Joseph J. Minarik, an economist at the Brookings Institution, make just this point.
Most salaries, he argues, are crudely linked to inflation, rising as prices rise. Many government transfer programs (such as social security) are similarity indexed. These devices, Minark contends, families from relative income losses resulting from inflation.
But the upper middle class and the rich - whose income depends more on stock dividends and bond interest - lack similar protection, Minarik believes. Consider stocks. Current tax depreciation isn't adequate to allow equipment with new machinery at sharply higher prices. Consequently, companies must either reinvest more of their profits (at the expense of dividends) or skimp on future investment. Either option impairs a company's value and depresses its stock price.
Congress's sympathetic reaction to this squeeze also reflects a deep disenchantment with the old-time tax reform. People wanted tax relief more than tax reform. If the rich substantially escaped taxes, then let them be taxed. The trouble was that the rich didn't escape taxation. After all loopholes, deductions and exemptions are considered, a taxpayer in the $100,000 bracket still had an effective tax rate of about 30 per cent against 10 per cent for hte $20,000 bracket and 6 per cent for the $10,000.
So Congress had no great pot of gold to redistribute. "Reform" involved ending provisions that encouraged wrong with that kind of reform, but in the end, Congress found it a tedious and thankless job.
But Congress may discover its new tax reform is no more a panacea than the old. Economically, Treasury Secretary W. Michael Blumenthal has argued, the money spent on capital gains cuts won't spur investment nearly as much as other measures (such as a cut in the corporate tax rate). Politically, it will be hard to justify more large tax cuts for high-income taxpayers without giving more to those at the lower end. The likely outcome: tax cut will get bigger and the pressures to restrain new spending will grow stronger.