8. THE ILLUSION OF TAX CUTS
Politicians and editors, even those opposed to the tax changes of the 1980s, routinely and unthinkingly refer to the “Reagan tax cuts.” This is a huge misconception because, except for the upper brackets and corporations, there were no overall tax cuts. While the percentage of the national economy (GDP) taken by federal taxes dropped slightly (19.2% in 1980 to 18.7% in 1990), that is only part of the tax burden. The federal government continued to mandate state and local programs, while cutting down its revenue sharing. This shifted the burden to more regressive taxes: state sales taxes, local property taxes, and miscellaneous charges and user fees.
PER CAPITA TAXES
Total tax--Fed. Fed.
Fiscal state & local Federal taxes % of
Year Nominal Real Nominal Real Total
1980 $2,535 $3,076 $1,548 $1,879 61%
1990 4,558 3,487 2,542 1,945 56%
1994 5,401 3,644 2,998 2,023 56%
1995 5,728 3,759 3,214 2,109 56%
Source: 1998 Statistical Abstract of the United States, Table 499. Real (constant) dollars are stated in terms of 1982-84 purchasing power.
In 1982-84 constant dollars, as shown above, per capita total federal, state and local taxes rose 13% from $3,076 in 1980 to $3,487 in 1990. Of these totals, the federal share dropped from 61% to 56%. There were really no Reagan tax cuts, only a shift in the burden from federal to state and local governments and from
upper-income to middle-income taxpayers. Parenthetically, figures for 1995 (the most recent available) show a further 8% total tax increase in only five years and no change in the federal share.
Kevin Phillips, who had been the chief political analyst of Nixon’s 1968 campaign, declared President Reagan emulated the Harding-Coolidge era when he “cut top individual rates from 70% in 1981 to just 28% as of 1988-1988—effectively matching the 1921-25 reduction from 73% to 25%.”57 Although Democrats and Republicans in Congress voted for the tax revisions, they are usually credited to the President because the bills were enacted on his watch, with his approval, and signed by him.
The infamous “Laffer Curve”
These changes were supposed to help everybody. The argument is that reducing upper-bracket taxes gives those whose taxes are lowered more incentive to work and to save, which will increase national production, and “a rising tide lifts all boats.” There is not supposed to be any loss of tax revenues because previous high rates were assumed to have reduced incentive, so cutting the rates would cause people to make more money and pay more taxes even at lower rates. The key to this argument is the so-called “Laffer Curve.”
Prof. Laffer used to doodle on napkins in restaurants, drawing a curve shaped like a mountain that was supposed to represent the amount of revenue from income tax. At the left where the tax rate was zero the revenue would, of course, be zero, and at the right where the tax rate was 100% (so that nobody could earn any income without the government seizing it all) the revenue would be zero also. The peak of the mountain represented the point where increasing the rate would so discourage effort that revenue would decrease as rates went up.
Laffer persuaded Reagan that rates were already beyond the high point of the curve so reducing rates would bring in more revenue by climbing backwards up the mountain. Unfortunately, a four-trillion-dollar national debt had been amassed at the end of the trial. This seemed to have convinced most experts that Laffer was wrong, but some apologists for the deficit years of the 1980s keep claiming it works. In the 1996 vice-presidential TV debate
Jack Kemp repeated the claim that tax cuts boosted tax revenue to the government. Tax receipts did rise during the 1980s, but the claim ignores inflation and fails to compare with a base period.
To measure changes over the years we need dollars of constant purchasing power—inflation-adjusted dollars economists call “real.” Raw amounts not so adjusted are called “nominal” and politicians use nominal figures when it serves their purposes. “Figures don’t lie, but liars figure.” Total receipts, used by some debaters, are irrelevant because they include Social Security contributions (FICA) and various receipts other than income taxes.
The record is as follows:
FEDERAL INCOME TAX RECEIPTS
Fiscal year 1990 1980 1970 1960
Individual income tax
nominal $466.9 $244.1 $ 90.4 $40.7
real 357.2 296.2 233.0 137.5
Corporate income tax
nominal 93.5 64.6 32.8 21.5
real 71.5 78.4 84.5 72.6
Total income tax
nominal 560.4 308.7 123.2 62.2
real 428.8 374.6 317.5 210.1
Note: Real amounts in constant 1982-84 dollars adjusted for inflation by the Consumer Price Index (CPI). All amounts except CPI in billions of dollars.58
Individual income tax receipts rose 91% in nominal terms during the 1980s, but only 21% in real dollars. Corporate income tax receipts rose nominally 45% but actually declined 9% in real terms.
Even in nominal terms, receipts from income taxes of individuals and corporations rose only 82% during the 1980s, compared to 151% in the 1970s and 98% in the 1960s. After correcting for inflation, they grew only 14% during the 1980s, compared to 18% growth in the previous ten years and 51% in the
1960s. Thus Kemp’s claim was wrong regardless of whether nominal or real dollars are compared.
Proponents of the “Laffer Curve” approach, were fond of citing the successful JFK tax cut to prove their point. In January 1963, President John F. Kennedy proposed to Congress a reduction in individual income tax rates from 20% to 14% at the bottom and 91% to 65% at the top, while the corporate rate would drop from 52% to 47%, with special reductions for small business. Ironically, the Republicans on the Ways and Means Committee opposed the Kennedy tax reduction as fiscally irresponsible.
Eventually, after Kennedy was assassinated and Lyndon Johnson became president, a bill along these lines was passed. Virtually all the econometric studies agree that it was highly stimulative to the economy. Because of that, and earlier Kennedy policies, unemployment dropped sharply between 1961 and 1969, especially for adult black males whose unemployment went from 11.7% to 3.7%.
In 1977 Walter Heller testified...“the tax cut...was the major factor that led to our running a $3 billion surplus by the middle of 1965 before escalation in Vietnam struck us....” Bruce Bartlett of the Congressional staff in his 1981 book commented: “It is ironic that the most important reduction in tax rates since the 1920s was accomplished by a liberal Democrat for decidedly liberal reasons—to pump up demand....The economic record is clear: the period following the enactment of the Kennedy program is the best this country has had in the last quarter century.”59
9. BEWARE OF TAX REFORM AND SIMPLIFICATION
President Carter recalled in his memoirs the difficulty of achieving real tax reform: “We had proposed to Congress substantial improvements in the income-tax laws that would have reduced taxes further and eliminated some of the gross inequities, but throughout my term it was all we could do to hold our own and prevent the tax relief avalanche that was always ready to descend and wipe out, with even more loopholes, any chance for responsible budgeting.
“In the end we considered ourselves fortunate that a massive tax giveaway program was not passed over my veto. As soon as I left office, the special interests were successful in implementing proposals far worse than those which had been considered by Congress while I was President.”60
The first major tax revision of Carter’s successor, President Ronald Reagan, was the 1981 “Economic Recovery Tax Act,” falsely described as “reductions across the board.” Although rates were cut 5% in 1981, then 10% in 1982, and another 10% in 1983, upper bracket taxpayers got special benefits immediately.
The maximum rate for unearned income (such as rents and interest) was reduced from 70% to the same 50% maximum that had applied to earned income since 1972, the top rate on capital gains was effectively cut to 20%, estate tax was greatly eased, and corporations got benefits that cut in half their share of federal tax revenues.61 Meanwhile, the reduction of income tax rates for individuals was wiped out for most workers by FICA tax increases, and they were further burdened by state and local tax increases to make up for cuts in federal grants and services. A January 1985 poll showed 75% agreeing that the “present tax system benefits the rich and is unfair to the ordinary working man or woman.”62
The changes in corporate income tax rules were known to few beyond those directly affected. Alan Blinder commented: “Because of the complexities of depreciation allowances,
investment tax credits, and a zillion other features of the tax code,...investment decisions are tilted toward lightly taxed activities and away from heavily taxed ones. But when tax preferences get so extreme that beating the tax collector becomes more important than beating your competitors, economic efficiency is in deep water. The business tax cuts of 1981 did not create this problem, they just made it worse [and] drastically increased the degree to which investments in equipment were favored over investment in structures....
“Had the 1981 law remained in effect, the efficiency losses from tax distortions would have become monumental—and all in the name of unleashing private enterprise! Fortunately...the most grotesque provisions of the 1981 law were repealed in 1982....”63 However, the tax “reformers” were at it again in 1986.
If you experienced the avalanche of praise from the media and politicians of both parties that accompanied the enactment the “U.S. Tax Reform Act of 1986,” you may find it hard to believe that this law, enacted by a bipartisan coalition in Congress and applauded by corporate lobbyists, was hideously flawed. If you recognize its deceptive nature, you may wonder how a bill that promised reform and simplification came to be such a monstrosity.
It started in November 1984 with a Treasury Department proposal entitled Tax Reform for Fairness, Simplicity, and Economic Growth, described by Blinder as logically coherent, bold, equitable, efficient, and simpler. He said that, with few exceptions, it “championed the national interest by stepping hard on the privileged toes of the vested interests.” The revised version, Treasury II, issued six months later with presidential approval, had most of its best features deleted, and then Congress added its typical touches. After another six months a 1,400-page bill emerged from the House Ways and Means Committee. In its turn, the Senate Finance Committee took care of its favorite interests.64
Falsely depicted as tax simplification, the law cut the top rate of individual income tax to 28%, applying it to single taxpayers earning over $17,850 the same as billionaires, and raised the tax rate from 11% to 15% for nearly two million
taxpayers earning less than $10,000 a year. Quoting government handouts, the media mentioned only two brackets, 15% and 28%, although the highest marginal rate was actually 33%. Rather than create an explicit 33% bracket for all to see, Congress inserted complex provisions only experts could follow, including a 5% surcharge that applied, in the case of to a family of four, for example, until taxable income reached $194,050. Above that level the marginal tax rate reverted to 28%. Blinder commented in his 1987 book: “In a departure from a tradition as old as the income tax itself, the highest marginal rate no longer applies to the highest incomes.”65
Reporter Henning Gutmann in The New York Review of Books (Feb. 12, 1987) declared the 1986 law “a gift to the rich unmatched since Calvin Coolidge,” pointing out that “a science researcher making $22,000 a year pays the same 28% marginal tax rate as Lee Iacocca, who makes over $1,000,000 a year.” Tax lawyers, according to Gutmann, agreed that the new bill was anything but a simplification.66
Apart from bracket changes, middle class and poorer working taxpayers lost many other benefits. Various forms of “employee business expense” were curtailed or disallowed. Deductions were abolished for state and local sales taxes and for interest, except on mortgages, where a taxpayer could deduct all the interest on as much as two $500,000 homes (opening a market for tax-deductible “home equity” loans). The two-earner marital deduction was abolished, resulting in what was denounced a decade later as the “marriage penalty,” and the popular Individual Retirement Account (IRA) was all but eliminated.
The bill also repealed deductions or favorable treatment for unemployment compensation, child adoption expenses, most prizes and awards, scholarships, fellowships, educational travel, and farmers’ land clearing expenses. Income averaging, which had helped people like athletes, entertainers, and others whose period of stardom can be brief and whose incomes can fluctuate wildly from year to year, was repealed. Senator Levin (D.-Mich.) pried the information from the Treasury that 359,000 taxpayers earning over $200,000 were going to get an average tax cut of
$52,535, while the bill would raise taxes for 25 million taxpayers and leave the taxes of 33 million unchanged.
A bonanza for business
Meanwhile, corporations “made out like bandits.” Some business excesses were trimmed, such as business meals and entertainment deductions, although plenty of other corporate executive perks remained tax free, and the maximum corporate income tax rate was reduced from 46% to 34%, while oil and gas tax shelters were not touched. “Transitional” rules created 174 special exceptions for corporations including Unocal, Phillips Petroleum, Texaco, Pennzoil, General Motors, Chrysler, Goldman Sachs, Manville, General Mills, Walt Disney, Pan Am, Northwest Airlines, Delta, Control Data, Multimedia, Metromedia, Mitsubishi and Toyota.67
The benefits to business were bipartisan. The Republican Senate Finance Committee Chairman Packwood and Democratic House Ways and Means Committee Chairman Rostenkowski worked smoothly together for the business interests who contributed heavily to both parties. Chairman Packwood formed a coalition of 31 senators who agreed before the bill was introduced to oppose any amendment of it. The “transitional rules” were the way he paid for support. Chairman Rostenkowski received requests on 3”x5” cards from the 36 heavily lobbied members of his committee. After a private meeting of the two chairmen, Rostenkowski came out with a stack of the cards and passed them out to the winners.68
Cathie Martin’s 1991 book describes how Packwood engaged in “a final orgy of vote buying” for up to $100 million each in tax expenditures. “Symms (R.-ID) was given an amendment to exclude mining exploration and development costs from minimum tax base. Heinz (R.-PA) and Durenberger (R.MN) won a shorter depreciation period for residential rental real estate....Six major steel companies got a transition rule worth about $500 million....Cabbage Patch magnate, Xavier Roberts, received a tax break designed exclusively for a “taxpayer who incorporated on Sept. 7, 1978, which is engaged in the business of manufacturing dolls and accessories.”69
Despite all this log-rolling, most of the information media, amazingly, praised the law for fairness and simplification, but 1987-89 public opinion polls declared it less fair and more complicated than the previous law (which had already been judged unfair by 75% of respondents in 1985).70
Simplification that complicates
Politicians use the word “simplification” as casually as they do “reform” and journalists often fail to do a reality check, although taxpayers find they have been bamboozled when they get their bills from H. & R. Block. There was a time when laws were titled “The Revenue Act of 19xx,” but, as Orwellian spin grew to become the political norm, titles began to incorporate an advertising message: “The Economic Recovery Tax Act of 1981,” “The Tax Equity and Fiscal Responsibility Act of 1982,” and “The Tax Reform Act of 1986,” for example. The chief claim made for the 1986 law was simplification.
By 1992, Quirk and Bridwell, in Abandoned: The Betrayal of the American Middle Class Since World War II, noted: “The Reagan administration tripled...the number of pages in the Internal Revenue Code....Revenue raising still takes about 15 pages of the code; the remaining 4,000 pages are devoted to influencing personal and economic behavior, and to special-interest handouts.”71 In June 1991 the IRS reported that tax compliance by small business dropped sharply in the 1980s, and IRS Commissioner Fred Goldberg told Congress most of the noncompliance was unintentional due to the complexity of the tax laws.
Further confusion was introduced in the 1997 tax law, praised by President Clinton and Congressional leaders as part of their compromise “balanced budget” agreement, and also heralded by most of the communications media. Continuing the practice of sloganizing titles, it was labelled “The Taxpayer Relief Act of 1997.” Tax simplification got another setback as some tax changes had different effective dates and varied from year to year for ten years.
“If anything, the language in this is more arcane than anything I have ever seen,” declared Doug Walters, H&R Block’s
head of education. The 100 largest firms in tax preparation were estimated to have received $5.2 billion in revenues in 1995. The worksheet for capital gains taxes was nearly doubled in size with about three dozen new lines, according to Sheldon Schwartz, who oversees IRS tax forms and publications. The 1997 law is the 54th major public law change to the tax code since 1986, according to another IRS official, Stuart DeWitt.72 The following year a further change was made affecting capital gains on assets sold after January 1, 1998.
Claims of simplification often hide efforts to insert special favors in the tax law, as was true in the case of the 1986 law and also the “flat tax” proposals that keep cropping up. Since wealthy individuals and corporations are the major contributors to political campaigns, they have reaped the benefits of most changes in the tax law since World War II. The top income tax rate on incomes over $200,000 remained 91% from 1941 to 1964, but was reduced to 70% in 1964, 50% in 1981, 28% in 1986, and only slightly increased to 31─35% in 1991.73
The special favors to business in the 1986 tax law had a counterpart in 1990 after George Bush became president. Special interests put together a new set of transitional rules and specific giveaways including (1) developers of low income housing; (2) oil and gas producers (Senators Dole and Bentsen); (3) all property and casualty insurance companies; (4) selected wineries (Senator Packwood); and (5) charitable deduction for full market value of painting given to museum (Senator Moynihan). The Joint Committee on Taxation reported, on Oct. 26, that the 1990 Budget Deal revenue-losing provisions would cost taxpayers $27.4 billion over the next 5 years.74
10. IS THE TAX BURDEN SHARED FAIRLY?
Besides the fallacious claims already discussed (that the upper-bracket tax reductions stimulated economic growth and that they increased government revenue by the “Laffer effect”), another claim was that the well-to-do were taking on more of the tax burden. This amazing conclusion was propounded with statistics that don’t bear close examination. Some proponents of this idea traced changes in the share of income taxes paid by those in tax brackets above a specified dollar amount, while ignoring the variation in purchasing power of those dollars (nominal vs. real dollars). For example, $200,000 would buy $200,000 worth in 1980, but only about $169,000 worth in 1988 and $153,000 worth in 1990 (as measured in the purchasing power of 1980 dollars), thus expanding the bracket downward to include incomes of less purchasing power (a phenomenon known as “bracket creep“).
This shows how misleading statistics can be when statements that appear to be literally true fail to reflect reality. Of course, more of the federal income tax revenues come from the rich and near-rich than from other taxpayers (ignoring all other taxes at federal, state, and local levels), but the share paid by them did not grow during the 1980s, as is clear from the previous discussion of tax law changes. Even if their share had grown, that could simply be due to the larger share of national income concentrated in their hands, and a small price to pay for their improved after-tax income.
What is a fair share?
Over time the federal income tax has reached lower and lower income brackets. From its inception in 1916, when relatively few were liable for tax, it was extended to almost everyone at the time of World War II. This was made practical by introducing the practice of withholding taxes from wages.
The idea behind the personal exemption, according to Quirk and Bridwell, was that a “family of four making the median income is not able to, and should not pay, any income tax.” As
Steve Schlosstein in End of the American Century (1989), pointed out, in 1948 the median income for a family of four was $3,468. Because of the personal exemption and standard deduction, only $801—or 23% of income—was subject to any tax. In 1990 such a family had an income of $29,184 of which $20,421—or 70%—was subject to tax. Federal income tax and FICA amounted to 6% of the income of that typical family in 1948, but 19% for its counterpart in 1990.75
For 1990, as computed by the Tax Foundation from IRS data, of the adjusted gross income reported by all taxpayers, the top 5% of taxpayers paid 43% of the taxes; the top 10% paid 54%; the top 50% paid 94%. The bottom 50%, on the other hand, paid only 6% of the taxes, as shown below (note that the “share of income tax“ refers not to their tax rates but to their percentage of the total federal individual income tax paid by all brackets).
DISTRIBUTION OF INCOME
AND OF FEDERAL INCOME TAX
Brackets Share of income Share of income tax
Top 5% 28% 43%
Top 10% 39% 54%
Top 50% 86% 94%
Bottom 50% 14% 6%
It could be argued that when 5% of the people pay 43% of the taxes they have paid at least their fair share. On the other hand, the bottom half of taxpayers each earned less than $19,616 and were lucky to cover necessities after the tax bite. For upper-bracket taxpayers the tax merely put a dent in their luxuries and, because of loopholes, they typically received money and valuable perks that are not counted in adjusted gross income.
Those who consider the wealthy overtaxed cite the rates of federal individual income tax as if it were the only tax Americans pay. In 1995 that tax produced $476 billion or only 21% of the $2,262 billion combined federal, state, and local revenues (it had been 26% in 1980 and 23% in 1990). The other
79% was collected by taxes (and revenue sources not labeled as taxes) that are mostly regressive (that is, they impose the greatest burden on the poor).76
Compilations for 1990 showed that combined state and local taxes took 14.8% of the annual income of the poor, about 10% of that of the middle classes and a much lower 7.6% from the top 1%, according to Kevin Phillips (1993).77 The financial transactions of high-income individuals and businesses are much harder to trace than those of lower-income and middle-income taxpayers, whose wages, receipts and transactions can be easily monitored. Small fry are not likely to put much over on the IRS.