Capital Scene January 28, 1998

R A I S ET H ER O O F

LAWRENCE KUDLOW & STEPHEN MOORE

Mr. Kudlow, chief economist at American Skandia Marketing,
and Mr. Moore, director of fiscal-policy studies at the Cato Institute,
are both NR contributing editors.

WASHINGTON, D.C.

WHAT ever happened to the Reagan Democrats? These socially conservative working families, with incomes ranging from $30,000 to $50,000 per year, who make up 27 per cent of the electorate, powered the Gipper to landslides in 1980 and 1984, giving him 59 per cent of their vote. In 1988 they stayed with George Bush, giving him 56 per cent of their vote. In the Nineties, however, Republican presidential tickets appealed to an average of only 36 per cent of Middle America. These folks walked away from Bush and Dole, as the GOP was trounced by Bill Clinton.
Pollster John Zogby, the most accurate presidential predictor in recent years, puts it bluntly: ``Middle America is the critical heartland. You can't win a national election without this voting bloc.'' When it comes to tax policy, recent Republican presidential candidates have ignored the heartland. Since the sweeping Reagan tax-rate cuts of 1981 and 1986, the GOP has done little to the direct benefit of middle-class pocketbooks. As a result, whereas Republicans used to get high marks on the tax issue, now Democrats are seen by middle-income voters as just as good or even better.
In tax politics, push comes to shove in the 15 and 28 per cent brackets. Here's the problem. Consider someone who was earning $25,000 a year in 1986 and was in the 15 per cent bracket. Say that person is still employed and has received an average annual raise of 3 per cent (above inflation). He or she would now be earning $48,108. However, this prospering job-holder has been bumped up from the 15 to the 28 per cent bracket. So instead of keeping 85 cents for every additional dollar earned, the taxpayer receives only 72 cents. This amounts to a 15 per cent tax penalty on success. Call it real-income bracket creep. It's enough to make a middle-class wage-earner switch political parties.
What's more, our hard-working member of the silent majority has also faced steady increases in Social Security and Medicare payroll taxes over the past decade. Together, the payroll taxes alone now impose a 15.3 per cent burden. Thus, the benefits of the Reagan income-tax cuts have been canceled out, nearly dollar for dollar, by hikes in the regressive payroll tax. For the owner-operators of small businesses -- really the working backbone of the nation -- their 43.3 per cent combined marginal tax rate (28 per cent on income and 15.3 per cent payroll) exceeds the 42.5 per cent rate paid by those in the top bracket (i.e., those who make over $250,000). That should be no one's definition of fairness.
Rep. Dick Armey (R., Tex.) has called this plight of American workers ``the middle-class squeeze.'' That is exactly the right diagnosis. But what is the Republican Congress doing about it? Last year it passed a tax cut only about one-third as large as Republicans had promised in the 1994 Contract with America. Families with young children and investors with market profits got some relief. But there are millions of middle-class taxpayers without kids at home and without capital gains; they will angrily learn, come April 15, that they got essentially nothing out of the 1997 tax bill.
This year Reps. David McIntosh (R., Ind.) and John Kasich (R., Ohio) propose to end the marriage tax penalty by allowing married couples to file their taxes separately. This would provide tax relief to 15 million households, at a cost of nearly $20 billion a year. But what about unmarried taxpayers? Where is their relief? Instead of targeted tax credits for some, why not borrow a page from President Reagan's script and propose an across-the-board rate reduction for all?
Until the GOP makes a decision on big-bang tax simplification, it could bolster its credibility and reconnect with all middle-class taxpayers by raising the income ceiling on the 15 per cent tax bracket. Under current law the 28 per cent bracket creeps up on single workers at $25,350 and on married couples at $42,350. The 15 per cent bracket should be stretched to $35,000 for singles and $50,000 for couples. Eventually the ceiling for couples should be raised all the way to $65,000 -- the income level where people stop paying payroll taxes. Of course, this also implies a future increase in the income ceiling for the 28 per cent bracket.
Internal Revenue statistics indicate that there are 21 million households with incomes between $30,000 and $50,000 a year. This plan would provide tax relief of roughly $800 in the first year for single and married filers, with more relief coming later as the plan is expanded. Effectively, this approach provides simple marginal-tax-rate relief. Those earning lower middle incomes would remain in the 15 per cent bracket. Those earning average middle incomes would remain in the 28 per cent bracket (some might even drop back to 15 per cent). Tax-bracket creep would be eliminated -- without any gimmicks, targets, loopholes, or complexities.
The latest Treasury Department numbers on federal spending and revenues show a budget surplus over the past 12 calendar months. Based on the first two months of fiscal year 1998 (October and November), this year could produce a $75-billion surplus, which would be enough to pay for the proposed tax plan. Unbelievable as it may sound, our zero-inflation, high-tech information economy is powering the nation into an era of surplus politics. Now it is up to the Republican Congress to invest every nickel and dime of these surpluses in broad-based tax relief -- especially for the middle class. These are the people who gave the Republicans their majority in Congress. And as the last two presidential elections demonstrated, they are the ones who could take it away.