Actually, conservatives should favor even fewer people paying income tax
The outrage over Mitt Romneyâs extended off-the-record riff to wealthy donors about the fact that â47 percent of Americans pay no income taxâ has shown no sign of dying down. As of now, this looks like the defining moment of his presidential campaign. In lumping together those who have no federal income tax liability with those âwho believe the government has a responsibility to care for them,â the former Massachusetts governor gave new life to every crude caricature of conservatives as class warriors for the ultrarich.
But did off-the-record Romney have a point? Is it a problem that we have narrowed the federal income tax base, or is there a case that conservatives seeking to contain the growth of government should strive to make the income tax base even narrower?
In a 2001 interview with Nicholas Lemann of the New Yorker, RepublicanÂ Senator Jim DeMint of South Carolina called the narrowing of the tax base âa major crisis in democracy.â Just months before the first Bush tax cut removed millions of households from the federal income tax rolls, DeMint warned that âthe tax code will destroy democracy, by putting us in a position where most voters donât pay for government.â DeMintâs dark premonition wasnât enough to get President Bush to revamp his tax cut, but the idea has grown more popular among conservatives in the intervening years, hence Romneyâs riff.
Critics of DeMintism point out that virtually all of the households that donât pay federal income taxes pay other taxes, including payroll taxes and state and local taxes. Indeed, some pundits have declared that this is Romneyâs saving grace: Hardly anyone in the GOP nomineeâs 47 percent actually believes that he or she is part of the 47 percent.
The deeper problem isnât that too few people are paying federal income taxes, as DeMint and Representative Michelle Bachmann and now Mitt Romney maintain. Rather, it is that most of the taxes we do pay, with the big exception of retail sales taxes, are quite stealthy. In the days before income tax withholding, taxpayers had to write checks to the federal government. Now, many taxpayers have a better sense of the size of their income tax refund than of what theyâve actually forked over to the federal government.
It turns out that the best way to address Romneyâs underlying concern âÂ that a large and growing number of Americans have lost sight of the real cost of government âÂ might be to remove even more households from the income tax rolls and create a very visible new tax to make up the difference. That is why Republicans, Mitt Romney included, should give serious consideration to Michael Graetzâs Competitive Tax Plan (CTP).
Conservatives hate the idea of new taxes. But imagine if every time you bought a cup of coffee, it said on the receipt that you had also just paid a 12.3 percent consumption tax to the federal government. Instead of paying your taxes once a year, you would pay taxes every time you made a purchase. What better way to remind people of all of the money government spends, and all of the money government spends foolishly, than to make them pay for government several times a day?
Thatâs not all. Imagine also that the federal income tax only applied to income over $100,000 for married couples, $50,000 for single filers, and $75,000 for head of household filers. Households that earn less than this âfamily allowanceâ would be under no obligation to file a federal income tax return. In that case, the 12.3 percent consumption tax would pay for liberating millions of Americans from the IRS. According to a recent analysis from the Tax Policy Center, the tax policy rules in effect today will require 147,540,000 tax units to file taxes in 2015. Under Graetzâs CTP, that number would fall to 36,625,000.
Even those poor souls who still have to file under the CTP will benefit, paying a much-reduced federal income tax at a basic rate of 16 percent and a surtax rate of 25.5 percent on income above $200,000. These low marginal tax rates would improve work incentives for high earners far more than Mitt Romneyâs proposed tax cut and would be an even bigger improvement relative to President Obamaâs proposed tax increase for the top 2 percent of households. And though the CTP wouldnât completely eliminate taxes on savings and investment, it dramatically lowers them, particularly for families of modest means.
One concern is that even with this radical shrinking of the income tax, poor families that spend the bulk of their income would pay more under a consumption tax. That is why the CTP includes a generous per-worker and per-child rebate that would be used to offset payroll taxes. These rebates would also serve as a replacement for the earned-income tax credit, which is the chief reason tens of millions of low-income households have to go through the hassle of filing income tax returns. The end result is that the tax burden under the CTP would be exactly as progressive as it is under todayâs tax rules.
The CTP would strike a blow against the IRSâs intrusiveness, a cause all conservatives should cheer. And as Graetz explained to me, âby eliminating millions of people from the income tax, youâll never get them back.â Once the inflation-indexed exemption is raised, âyouâll never get a politician to agree to lower the exemption from $100,000.â It has many other benefits as well. For example, while Mitt Romney has called for a 25 percent corporate tax rate and President Obama has called for a 28 percent rate, the CTP cuts the corporate rate to 15 percent. In one fell swoop, this would make the U.S. a far more attractive destination for foreign investment, reduce tax avoidance and be conducive to economic growth.
So why havenât conservatives signed up for Graetzâs ingenious proposal? The big barrier on the right is the view that a consumption tax is a one-way ticket to socialism. While most states have retail sales taxes, the United States is one of a small handful of countries that does not use a value-added tax, or VAT. In Europe, VATs raise a huge share of government revenue, and the statutory rates tend to be very high. The worst thing about the European approach to the VAT, from a conservative perspective, is that itâs invisible. That is, consumers often have no clear indication of how much of what theyâre paying is accounted for by the VAT. This is one reason why many European governments have hiked their VAT rates over the years âÂ because taxpayers wonât know the difference. Anti-VAT conservatives fear that an American VAT would be susceptible to the same tendency to creep higher, indiscernibly.
But outside of Europe, the picture looks very different. Canadaâs VAT, known as the GST, for goods and services tax, was 7 percent when it was first introduced in 1991. Since then, it has fallen to 5 percent. Although the GST remains extremely unpopular, it has played a crucial role in helping Canada shrink its yawning federal budget deficits. Moreover, the two decades since the introduction of the GST have seen Canadian federal spending and federal debt plummet as a share of GDP while the United States has gone in the opposite direction. That is an outcome all small-government conservatives should respect
There are, to be sure, huge obstacles in the way of Graetzâs Competitive Tax Plan, as he freely acknowledges. If a Republican gets behind it, we can expect Democrats to demonize it as a tax hike on the poor to fund income tax cuts for the rich, leaving aside the generous rebates and the family allowance. If a Democrat gets behind it, Republicans might wage war against the VAT as a diabolical foreign plot.
All the same, the CTP is the only realistic plan that will preserve progressivity while giving 100 percent of Americans the sense that they are bearing the cost of our federal Leviathan.
PHOTO: U.S. Republican presidential nominee and former Massachusetts Governor Mitt Romney pauses as speaks to reporters in Los Angeles, September 17, 2012. REUTERS/Jim Young