[Ramesh Ponnuru] Free Republicans from middle-class tax trap

For more than 30 years Republicans have won elections by promising to cut middle-class taxes, or at least to stop middle-class tax increases. No domestic issue has been as reliable a vote-winner. But now Republicans are in a bind. The huge deficit makes tax-cut promises seem impractical.

They also worry that cutting middle-class taxes will leave high earners paying an even larger share of income taxes than they already do, and that increasing their burden will harm both economic growth and the cause of limited government.

That seems to leave two options for Republicans. There’s the approach favored by presidential candidate Tim Pawlenty, which is to pretend that economic growth and unspecified spending cuts will let us reduce taxes without making the deficit worse. Then there’s the flat tax and the so-called fair tax favored by other Republicans, which go the other route: Some versions would actually increase middle-class taxes. Neither type of proposal is at all likely to be enacted.

There’s a better alternative, one that might serve the public interest in having a simpler, more efficient tax code. When Republicans began their tax-cutting streak in the 1980s, middle-class voters were upset about high and rising income-tax rates. Now, millions of them pay more in payroll taxes than in income taxes. But Republicans have had little to say about those taxes.

The payroll tax, now set at 15.3 percent of wages for most people, finances Social Security and Medicare. Although those programs’ troubles have been in the news a lot, one problem with them has received little attention: They’re unfair to families. As Robert Stein explained in a recent essay for National Affairs, parents contribute to the programs both by paying payroll taxes and by making financial sacrifices to raise the children who will pay tomorrow’s payroll taxes. But they only get credit for the first set of contributions.

Stein’s solution is to offer parents tax relief, by expanding the tax credit from $1,500 per child to something closer to $5,000. A family with two kids would use the credit to wipe out $10,000 of tax liability (assuming they owed more than that in payroll and income taxes). It would be a huge tax cut for millions of middle-class families.

Of course, cutting taxes in this way would mean a big revenue hit for the federal government, especially if combined with such pro-growth measures as cutting the corporate tax rate. There are two ways to make up the revenue. The first is to scale back tax breaks. The deduction for state and local tax payments, which is a subsidy from people in low-tax states to people in high-tax states, should go. Ideally, they would all go, except for the ones for charitable donations and savings. (In practice, the mortgage-interest deduction is probably unkillable. But its value should be reduced.)

The second way to make up revenue is by lowering the floor on the top tax bracket. The point of this wouldn’t be just to get more people paying the top rate. It would also mean that people who are already paying the top rate would pay it on more of their income. Widen the bracket sufficiently, and eliminate enough tax breaks, and there might even be enough money to bring that top rate down a bit.

A tax reform that tries to raise as much revenue as the current system, and without relying on assumptions that the economy will take off, is by definition going to inflict some pain. Stein’s plan would mean a larger tax bill for people who are childless, affluent or live in high-tax states. In many cases, though, it would be a temporary hit, because people often move or become first-time parents.

The average tax rate would not have to rise. The top marginal rate, which supply-siders regard as the most important tax rate, wouldn’t rise either. The rich would pay more, in other words, but their incentive to work, save and invest would be as strong as ever.

Expanding the child tax credit would take a lot of people off the tax rolls, and many Republicans have convinced themselves that people who stop paying taxes start voting for big government. But the child credit wouldn’t take people off the tax rolls forever, just while they have minors in their households. And if any group of voters is going to be mindful of the future, it’s parents. So conservatives shouldn’t worry.

Democrats, too, should find something to like. They have made two central objections to tax cuts over the last generation: that they recklessly increase the deficit and that they unfairly shower rewards on the rich. Neither objection applies to this tax reform.

It could be implemented in a way that left revenue unchanged. And it would have three progressive elements: scaling back tax breaks that tend to get used more by the affluent, expanding a credit that is more important to middle-income than upper-income taxpayers, and increasing the amount of high earners’ pay that is subject to the top tax rate. The effect would be to redistribute the tax burden upward.

There would still be plenty to argue about. Liberals would want to increase the tax rates to raise more money than the current code, and conservatives would want to cut spending and tax rates. Still, we would have a tax code that does more to satisfy both liberals and conservatives than the one we have now. And middle-class families would come out way ahead. Some young people who have been waiting for the financial stability to start a family, or expand one, might have the confidence to go ahead.

So what’s not to like? If Republicans have tired of cutting taxes for middle-class families, maybe Democrats should adopt the idea. 

By Ramesh Ponnuru

Ramesh Ponnuru is a Bloomberg View columnist. The opinions expressed are his own. ― Ed.