As long as there are taxes there will be debates about the fair distribution of the tax burden. In principle, a national political campaign offers a forum for achieving a national consensus on the issue. In practice, though, campaign rhetoric may frustrate that goal by obscuring the facts. We think that's been happening already in this political year in the discussions of the fairness of the 1981 Reagan tax cuts.
Four years ago candidate Reagan repeatedly pledged that he would seek an across-the- board 30 percent reduction in all income tax rates. Such a proportional reduction in tax rates would leave the distribution of tax liabilities unchanged. If the Jones family would pay twice as much tax as the Smiths without the proposed across-the-board tax cut, the Joneses would still pay twice as much tax as the Smiths after the proposed tax cut. If all taxpayers with incomes over $50,000 would pay 33 percent of the total tax payments with no change in tax rates, they would still pay 33 percent with the proposed across-the-board tax cut.
Candidate Reagan's assumption in the 1980 campaign was that the American public viewed an equal percentage tax cut for everyone as a fair and desirable way to reduce taxes. Reagan's election and the subsequent overwhelming congressional vote for his tax legislation reflected the very widespread popular support for the idea of an across-the-board tax cut.
But now the Mondale campaign and many of its supporters are attacking the Reagan tax reductions for being "unfair." The essence of their argument seems to be that somehow the tax cut favored the wealthy and shifted the tax burden toward lower-and middle-income taxpayers.
This vote-seeking attack simply isn't backed up by the facts. As everyone knows, the centerpiece of the 1981 tax legislation was a gradually phased-in 23 percent cut in all tax rates, which in itself left the distribution of taxes unchanged. Some additional complexities in the 1981 tax legislation meant that the net effect of the tax cut was a smaller tax reduction for high earners and a bigger proportional tax cut for families around the middle of the income distribution.
High earners at the top of the income distribution benefitted relatively less from the tax cut because of a special feature of the tax law that had been enacted in 1969. To reduce the adverse incentive effects of high marginal tax rates, Congress had then voted to limit the maximum marginal tax rate on wages and salaries to 50 percent, even if the individual's income put him into the highest 70 percent tax bracket. When the 1981 tax bill lowered the top rate from 70 percent to 50 percen, it did nothing to reduce the marginal tax rate of these very high earning individuals.
Someone with the good fortune to earn a taxable income of $250,000 would have paid about $115,000 in taxes before the Reagan tax cut. Although a full 23 percent cut would reduce this tax bill by $26,000, the previously enacted 50 percent maximum limited the impact of the rate cut for such an individual to about $8,300, or just 7 percent. Indeed, the tax cut for someone who earned a million dollars would also be limited to $8,300, a tax reduction of just about 2 percent.
Two of the special features of the 1981 tax act substantially increased the proportional tax cut for middle-income families. That legislation improved the overall equity of the tax system by reducing the so-called "marriage penalty" feature that causes a working couple to pay more in taxes than two unmarried individuals with the same incomes. The law also extended the availability of Individual Retirement Accounts to every employee who was previously ineligible and raised the amount that low-income and middle-income employees could contribute. For a middle-income working couple with $25,000 in earnings, the cumulative effect of the cut in tax rates, the IRA extension and the reduced marriage penalty could easily add up to a tax cut of over 35 percent. Although the changes in the IRA rules and marriage penalty also benefit high-income taxpayers, those extra benefits represent a much smaller percentage tax cut at high incomes.
All of this means that the tax cut left higher income groups with a larger share of the total tax burden, even before taking account of the way in which the tax cut reduced the use of tax shelters by high-income individuals and increased their pretax earnings. But it's also true that an important group didn't benefit directly from the tax cut. The tax bill couldn't cut taxes for those whose incomes are too low to pay income tax at all. However, contrary to the implications of Mondale's critique, no one was made worse off by the Reagan tax bill.
But what about the claim that statistics show that the federal income taxes paid by some low- income families have actually increased during the past three years? That is true, but it is easily misunderstood. It's crucial to note that changes in the tax law have not been responsible for those increased tax liabilities. Instead, rising real incomes and inflation combined to bring some families onto the tax rolls and to push others into higher tax brackets. Without the Reagan tax reduction, those low-income individuals would be paying even more tax. To assess the impact of the Reagan tax act, the effect of the changes in the tax law must be separated from the effects of rising incomes, and that's just what Reagan's critics have failed to do.
Much of the increase in the number of taxpayers and in the tax paid by lower-income individuals would have been avoided if the tax brackets had been indexed for inflation. It's ironic, therefore, that Mondale criticizes the Reagan administration for the consequences of an unindexed tax system at the same time Mondale proposes that tax indexing should not start as scheduled in January 1985.
In addition to the federal income tax, individuals also pay a Social Security payroll tax and state income taxes. For some families, increases in these other taxes during the past three years have outweighed the Reagan tax cuts. The Mondale campaign sometimes lumps these other tax increases together with the Reagan tax cuts in an attempt to criticize Reagan tax policy. But the Social Security tax hikes had already been enacted during the Carter administration and were advanced in time by Congress at the recommendation of the bipartisan National Commission on Social Security Reform -- with the explicit endorsement of Tip O'Neill as well as Ronald Reagan. And those with a complaint about higher state tax rates should look to their state capitals and not to Washington.
In light of all of these facts, what's left of the fairness critique? There may be some who feel that, to be fair, any change in tax rates must achieve a substantial narrowing of the distribution of after-tax income. But no one should claim that the Reagan tax legislation shifted the burden of taxation away from high-income earners and toward those with lower incomes.
When all of the pieces are added together the Reagan tax cut clearly benefited middle- and lower-income taxpayers. And that's an important reason why President Reagan and his 1981 tax cut continue to be so popular today.