November 5, 2010

Not a taxing solution

Reforming tax policy can facilitate bipartisanship

As Republicans celebrate their new majority in the House, many observers from across the political spectrum have begun to fear that nothing will be accomplished in Washington at all until at least 2012. The ideological chasm that seems to divide the parties (especially now that many candidates backed by the Tea Party have won seats) and the Republicans’ persistent obstructionism over the past two years provide ample grounds for such concerns. However, there is a major policy area where both parties could work together without significantly compromising their principles: tax policy. The controversy over the Bush tax cuts will have been decided one way or another by the time the new majority gets to Washington, so there will be room for tax changes that could address important national problems while helping both Democrats and Republicans politically.

There are two different tax policy changes especially well suited to addressing one of the biggest economic challenges we face. The largest short-term economic problem facing the United States is mass unemployment—the unemployment rate is hovering just under 10 percent and the painfully slow economic growth we’ve experienced recently has done virtually nothing to reduce it. In the medium to long-term, we face massive projected federal deficits fueled by the increased spending on entitlement programs that will be required as the population ages.

In the short-term, both parties should consider a large cut in the payroll tax as a way of alleviating our unemployment problem. The payroll tax is one of the most economically harmful taxes the federal government collects. Because the amount that employers must pay increases with the size of their workforces, the tax directly increases the cost of hiring additional workers and thereby makes it less likely that employers will do so. Collecting such a tax is problematic even under normal conditions, but it seems especially unwise to continue doing so in our current circumstances, faced with slow growth and high unemployment. A cut in the payroll tax would reduce unemployment by lowering the cost of hiring, and would therefore make firms more likely to hire new workers.

Furthermore, reducing the payroll tax to stimulate the economy should be appealing to both Democrats and Republicans. Republicans’ reasons for favoring the policy should be obvious: They have a long record of using tax cuts to stimulate the economy. Also, because the employee contribution to the payroll tax takes up a larger share of the typical American household’s tax bill than does the federal income tax, getting behind a big payroll tax cut could pave the way for a new conservative approach to taxes that would likely have broader appeal than the right’s current obsession with cuts in marginal income tax rates. Democrats should favor reducing the payroll tax because it is one of the most regressive federal taxes. Because there is a cap on the amount of income subject to the tax, wealthier households pay a much smaller share of their incomes in payroll taxes than poorer ones do.

To address the long-term deficit problem, however, both parties should consider making a major permanent change to the federal tax code: They should work to substantially reduce the amount of revenue lost in tax expenditures. Tax expenditures are provisions of the tax code that reduce or eliminate taxes on income that is earned or spent in certain ways–for example, income received as employer-provided health insurance or donated to charity. While some of these tax breaks may be worthwhile, many have been inserted into the tax code by special interests who want subsidies for activities they would engage in anyway. They can also provide incentives to over-consume certain products (like housing) in a way that hurts the broader economy. They are, in short, incredibly costly: A recent study by the Office of Management and Budget estimates that they cost the federal government approximately $1.1 trillion in lost revenue. This loss is inexcusable, since cutting back on tax expenditures is consistent with both parties’ governing philosophies. Democrats should oppose tax expenditures because they often subsidize industries that the left dislikes, such as oil companies, and because they crowd out direct government spending that can address social problems in a more direct manner. Republicans dislike them because it involves the government interfering with the workings of the market by favoring some industries over others.

Of course, neither of these changes will be simple or easy to enact. The bitterness of the current political climate and opposition from industries that receive tax breaks present difficult obstacles. But voters are judging both parties on their ability to reduce unemployment and close the deficit. This should give them a reason to look for areas where they can work together to pass legislation without compromising their principles substantially, and tax policy would be an ideal candidate.

Ajay Ravichandran is a third-year in the College majoring in Political Science.