TO WEIGH the effect of the Reagan tax cut plan on your own taxes, you have to remember that it all depends on the future inflation. The Reagan plan would cut the tax rate for each bracket, but inflation will keep bumping you through the brackets. The size of your tax cut -- if any -- would be determined by the speed of inflation. The Treasury Department has avoided that sensitive point in all its calculations so far, for the very good reason that it fatally undermines the supply-side rationale for the tax cut. The point comes to mind again because yesterday a large industrial company, W. R. Grace and Company, took an advertisement in this paper and others to describe previous comments in this space as "confused."
A couple of people have called, anxiously, to ask whether we were "confused" -- that is, wrong. No, we weren't wrong.
The figures in the Grace ad were based on the assumption that inflation over the next four years will be zero. Do you assume that inflation over the next four years will be zero? The Reagan administration assumes that it will be 35 percent.
Upon inquiry, spokesman for Grace said that the assumption of zero inflation kept the figures simpler and was not misleading because their calculations showed a similar pattern at higher inflation rates. There Grace is simply and flatly incorrect.
Grace's computations are based on a definition of income that excludes exemptions, deductions, the earned income credit and the tax-free bottom bracket -- all the buffers built in to lighten the load at the lower end of the scale. Most of them are being rapidly eroded by inflation. That's why the Grace anaysis doesn't show the Reagan plan imposing a real tax increase on the working poor. But the Reagan plan does.
For most taxpayers in the middle ranges, the Reagan plan promises only a very minor tax cut -- with little or no change in the marginal rate. And for this reason the whole subject is a matter of some considerable embarrassment to the administration. The marginal rate is the tax on the last dollar that you got, and the supply-side theory holds that the whole powerful and invigorating effect of this tax cut lies in the incentives provided by the reductions in the marginal rates. Under the Reagan plan, with even moderate inflation, there wouldn't be any reduction in marginal rates for the vast majority of taxpayers.
Under the Reagan plan, to repeat ourselves, the largest real tax cuts would go to taxpayers now in the 54 percent to 70 percent brackets. Here the Grace ad makes an important point that we had missed. Only so-called unearned-income -- dividends and interest, for example -- is taxed at more than 50 percent. Among high-income taxpayers, all the benefit of the Reagan plan would go to those with unearned income, and none to those with only earned income. That's clearly unfair. The whole distinction between earned and unearned income is harmful, and should be abolished.
Perhaps Congress ought to drop the top rate from 70 percent to 50 percent. A good case can be made for it -- particularly if it is accompanied by the abolition of some of the more egregious tax shelters. It is a good enough case that it does not require the support of disingenuous arithmetic.