For years the Institute for Policy Innovation has supported fundamental tax reform, such as the suggested “flat” income tax. There are, of course, other tax reform plans as well that accomplish the goals of a tax code that is low, flat, broad-based, simple, neutral, and rewards investment without trying to manipulate taxpayer behavior.
But we increasingly wonder whether it remains possible for the country to move to such a system, even with favorable political winds. The issue is the growing progressivity of our current income tax system, and the trend toward using the tax code for redistribution.
Notwithstanding all the liberals’ and Barack Obama’s claims to the contrary—that only the rich get the tax breaks—the bottom 40 percent of workers pay no—zero, nada, zilch—income tax. And that 40 percent is trending higher.
Oh, they do pay payroll taxes, but they don’t pay income taxes. And the distinction between payroll and income taxes is legally significant, so tax reformers have traditionally walled off payroll taxes from tax reform discussions.
The problem is that we are approaching a point, if we haven’t reached it already, where implementing any kind of tax reform would necessitate an increase in what the lower and lower-middle income tax brackets—the two bottom quintiles—pay in income taxes.
Of course, it would depend to some extent on exemption levels. When then-House Majority Leader Dick Armey was aggressively promoting a flat tax, he had a very high standard deduction, which meant that a family making $26,200 would pay no income tax (and that’s 10 years ago). Under the Forbes flat tax, a family of four making $42,000 would pay no income tax.
Now, however, Barack Obama wants to give 95 percent of Americans a “tax cut,” which for most will simply be welfare through the tax code. And that means that the total “tax” burden for millions of Americans will fall into negative numbers.
But that also means that any new effort to push tax reform with low rates and a broad base, which eliminates all the “tax cuts” and handouts Obama would give, would effectively raise the tax burden on millions of families. In other words, such tax reform could mean a net loss for working families with their transfers taken away.
Going forward, we tax reformers will have to rethink what is politically possible in a country where the effective tax base is becoming limited to business and upper-income earners only.