Taxing the middle class.

WALTER MONDALE'S promise to raise our taxes and thereby relieve us of our supposed anxiety about budget deficits was one of the strangest and most unexpected developments in recent political life. It is, surely, unprecedented for a major political party to campaign on a promise to intercept a greater proportion of our paychecks and spend it for us. Mondale further suggested that President Reagan had a secret plan to raise our taxes. This too was strange. How can you accuse someone of planning to do what you are promising to do?

Mondale was in a muddle here, no doubt accounting for the momentary stunned silence in the San Francisco convention hall after said, "I just did." His aides had undoubtedly been spending too much time reading New York Times and Washington Post editorials. In the past three years the two papers combined have published several hundred editorials calling for tax increases--always for "pragmatic," never ideological, reasons. (Oh, the economy would function so much better, inflation would be lower, employment would be higher, interest rates lower, and so on.) I suppose the Mondale aides must simply have believed all this nonsense, and perhaps really do imagine that the American people are looking forward to a lower deficit courtesy of lower take-home pay.

Several of Reagan's top aides have seen things very much the same way, of course, having repeatedly pressed their boss to raise taxes in the past three years. (And he has proven malleable: There have been four tax increases in the past two and a half years.) When Mondale gave his acceptance speech, Budget Director David Stockman and Chief of Staff James Baker were laying the groundwork for a fifth tax hike next year, according to more than one report.

Time magazine in its August 20 issue recorded the following reaction by an anonymous "White House aide" to Mondale's remarks about taxes: "He really stuck it to us. It was brilliant. We look terrible." Now, does that sound like the reaction of someone who intends to lower taxes? Or is it the reaction of someone caught in flagrante? The point to notice about Mondale's remarks is that they were half right. But Reagan didn't have a secret plan to raise taxes. His aides did. And the secret was being kept, not from the American people, but from Reagan himself.

Supply-Siders' Delight

THAT IS why the supply-siders on Capitol Hill were so delighted with Mondale's comments. They knew that in the ensuing uproar, the tax-increase ambitions of Reagan's underlings would unavoidably be brought to the President's attention. He would promptly repudiate them (it was hoped) and even reverse them promising a tax cut.

In the event, this latter promise did not fully materialize, but Reagan did disavow any secret plan. The Detroit News reported the following response on Capitol hill to the disavowal:

House Speaker Tip O'Neill is enraged by President Reagan's denial that he has a secret plan to raise taxes next year. Why, the President's own aides have been running all over the place these last few months suggesting just the opposite. They didn't exactly come right out and say a tax increase would be necessary, concedes Speaker O'Neill, but you could tell what they meant by the "winks and nods" they were giving out when the question came up.

One of the main reasons why there has been so much enthusiasm for raising taxes is that the 1981 tax cut has repeatedly been misrepresented as "massive," and even "irresponsible," when in truth it was neither. And this in turn has fed the widespread misperception that the current budget deficit was caused by the tax cut. (In fact spending rose rapidly as a percentage of GNP in fiscal years 1981 to 1984, and that was the true culprit.)

The sad truth is that for the entire middle class, the income-tax-rate reductions enacted in 1981 have been completely offset by bracket creep and the Social Security tax increases signed into law by Presidents Carter (1977) and Reagan (1983): Both measures included phased-in tax-increase provisions. Despite the indexing of tax brackets due to take effect in January 1985, these phased-in Social security tax increases ensure that, under current law, a full eight-year Reagan Presidency will have been a period of tax increases for middle-class Americans.

My source for this is an October 1983 Treasury Department study of recent tax changes. In view of its principal finding, it is not surprising that neither President Reagan nor the Secretary of the Treasury has said anything about it. The study compared the 1981 to 1988 federal tax liability of a family of four (at income levels ranging from $15,000 to $40,000) with its 1980 tax liability, that liability expressed as a percentage of income. Assume, in other words, that a family paid a certain percentage of its income in taxes in 1980. Then adjust that income upward each year for inflation, and add into your calculations a) the 1981 tax cut, b) subsequent Social Security tax increases, and c) bracket creep. Question: Does that family end up paying a lower percentage of its income in taxes than it paid in 1980, or a higher percentage? Answer, in the words of the Treasury Study:

Bracket creep, due to inflation, and payroll-tax increases scheduled under the 1977 and 1983 Social Security amendments wipe out all of the personal-income-tax reductions in the Economic Recovery Tax Act across a wide range of income families. Even the full three years of marginal-tax-rate reductions followed by indexing are not enough to provide tax relief. . . . Under current law, families end up paying a higher percentage of their income to the government than in 1980. Without the third year and indexing, the tax increases would be much sharper.

In 1985, for example, the tax burden of a $15,000 family will be up by $80, and that of a $40,000 family will be up by $168.

What Tax Cut?

INDEPENDENT AND methodologically quite different studies by the Tax Foundation and the Urban Institute show similar results. According to the Tax Foundation, the after-tax income of the median-income family declined from $10,282 in 1980 to an estimated $10,175 in 1984. (Both figures are expressed in 1974 dollars, when the median after-tax income was $10,976.) Moreover, direct federal taxes on the median-income family increased (in current dollars) from $3,405 in 1980 to $4,150 in 1984.

According to the Urban Institute report, which was released shortly before the Republican National Convention in August, increases in social Security taxes, tracket creep, and state and local taxes left the average family paying out out 26.3 per cent of its income in taxes in 1984 compared with 25.9 per cent in 1980.

The August 16 Washington Post book time out from its persistent editorializing against the "massive" Reagan tax cut to comment on the Urban Institute data: "The hard-working, wage-earning middle-middle class--statistically the middle fifth of all American families ranked by income--has drawn no visible benefit from Reagan economic policy. Average family income in that middle fifth, after inflation and after taxes, has risen less than 1 per cent since 1983." Yet on the same day, on the Op-Ed page, the misleading Hobart Rowen complained once more about Reagan's "huge tax cuts"--no doubt out of habit.

In his acceptance speech in Dallas, Reagan seemed to contradict these unpalatable findings when he said: "Today, a working family earning $25,000 has about $2,900 more in purchasing power than if tax and inflation rates were still at the 1980 level." It is the last few words there that are misleading. They posit the high inflation rate of 1980 (12.4 per cent) continuing unchecked for four years. This would indeed have produced a rate of bracket creep that the country fortunately was spared. In fact, according to the Treasury study, a family currently earning $22,000 will by next year enjoy a net tax cut of one dollar, compared with 1980.

Of course, we should not in all of this lose sight of the important point that the income-tax cut we really did experience in 1981--the reduction of the top rate on "unearned" income from 70 to 50 per cent--was extremely important: It encouraged dynamic effects not captured by the above statistics. It permitted the current recovery, and in particular it encouraged upward mobility--the movement from one job to a better (higher-paying) one. But for those who stayed in the same job, with their incomes adjusted only for inflation, the 1981 tax cut and the subsequent tax increases were the fiscal equivalent of treading water.

There is thus an uncomfortable kernel of truth to the charge that the Reagan tax cut "helped the rich." In one important sense it did help all, because it encouraged everyone to become rich. But for those with no such ambition, or no such capacity, their tax burden has not been reduced in the Reagan years.

As the Post Counsels . . .

IT FOLLOWS that if he is re-elected, the most important domestic-policy task facing Reagan will reform of the tax code, with particular reference to alleviating the tax burden (by lowering the rates) on his most loyal supporters--the middle class. This will be an exceedingly difficult task and it will only be accomplished if the President presses for it as eagerly as he did for the 1981 tax cut. Tax reform will be bitterly and strenuously opposed by numerous groups: by the news media, which increasingly resemble a lobbying group for domestic socialism; by the Democrats, who undoubtedly recognize that real assistance for the middle class will ensure a generation of Republican rule; by (I fear) some of Reagan's top aides, who seem unalterably persuaded that what is good for America, and for Reagan and his "place in history," is whatever the Washington Post counsels on the subject; and finally by the dreaded special interests, who recognize that the current loopholes channeling economic activity in their direction will by ineffective if marginal tax rates are lowered sufficiently.

The real-estate lobby, of course, is the best-known example of this, but here's another one showing how some people love a complex tax code. At Senate Finance Committee tax hearings recently, the American Institute of Certified Public Accountants argued against any change in the tax structure, claiming that tax changes aimed at simplifying the system are themselves complex and not yet fully understood. "Let the rules take hold" before any change is made, the CPAs said. Who will need a CPA to help prepare tax returns, after all, if we have a simple flat tax?