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Can Taxes On The Middle Class Ever Be Raised? Can Entitlements Ever Be Reformed?

Ross Douthat wrote [1] a smart blog post basically asking those questions, and, apropos of the deal that prevented us going over the fiscal cliff, concluded, basically, “no.” Democrats may believe that they are the responsible party, who would be willing to do both if push came to shove, but, in Douthat’s view, this is as much fantasy as the Republican view that all would be well if we simply cut unspecified unnecessary spending.

But here’s the thing. The Obama Administration both raised taxes on the middle class and instituted serious entitlement reforms in its first term. As Chief Justice Roberts made clear to the electorate, the mandate in Obamacare is a tax (that’s why it’s constitutional), and it’s a tax that overwhelmingly hits the non-wealthy. Plus there are a variety of other taxes embedded in Obamacare that skew more toward higher-income individuals, but still hit much lower than the $400,000 threshold. And, as the Romney/Ryan campaign made clear to the electorate, Obamacare also mandated reduced payments to Medicare providers, using the savings to pay for expanded coverage for the uninsured. You may not like those taxes or those cuts – and you may not believe they will be maintained. But they were passed. And President Obama won reelection handily nonetheless.

The fiscal cliff was not a test of Democratic ability to raise tax rates on the middle class, because the Democrats went into the negotiation saying they didn’t want to raise tax rates on the middle class. If we had gone over the fiscal cliff, taxes would have spiked across the board and spending would have been slashed. The Democrats would then have proposed a bill restoring spending and cutting taxes on earners below $250,000. And the Republicans would have countered with a bill restoring only defense spending and cutting taxes for everybody. And we’d then have had a negotiation about whether restoring all that domestic spending was worth compromising on taxes, with the clock ticking as the market demanded some solution to the sudden austerity. Is it so obvious that we would have wound up in a different place than we are now?

There is clearly substantial opposition within both the Democratic and Republican parties to raising income tax rates on anyone but the wealthy. Within the Democratic coalition there’s debate about who constitutes the wealthy; within the Republican coalition, a majority opposes raises tax rates on anybody. But we’re still talking about income tax rates. If we now move to tax reform, that leaves open the possibility of loophole-closing tax reform that raises revenue without raising rates. And it leaves open the possibility of new consumption taxes (a VAT, or a carbon tax, or a series of smaller Pigovian taxes [2]). For that matter, the expiration of the payroll tax holiday was a tax hike on the middle class that just passed with bipartisan support. These kinds of taxes aren’t going to be popular. But they are not the same as raising income tax rates. The real question remains whether Republicans would be willing to consider additional revenue as part of a tax reform package.

As for entitlement spending, my view for a long time has been that a prerequisite for tackling it is putting Medicare on a budget, the way it is in Canada. Congressman Paul Ryan has advocated doing precisely this [3] for Medicare as part of his privatization scheme; indeed, the only way in which his privatization scheme can be demonstrated to save money is that it imposes such savings by fiat. And Ryan just voted for the fiscal cliff deal. The most persuasive reason, from my perspective, why he might have done so, rather than side with Cantor and Rubio and other Republican legislators who preferred to keep their hands clean of tax increases, is that he wants to be part of the negotiation over entitlements, on the inside and not the outside. He’s not likely to get privatization (President Obama ran on opposition to voucherizing Medicare), but if he actually wants to focus on controlling costs, it seems to me he’s bought himself a seat at the table. Now we’ll see whether the Obama Administration wants to take another bite of that particular apple, in the context of the “grand bargain” that President Obama seems eager to get.

I’m not saying I’m an optimist about the prospects for either tax or entitlement reform. But I don’t think the negotiations over the fiscal cliff specifically offer grounds for outright pessimism either. The situation is pretty much the same as it’s been for some time: our system as currently constituted can’t pass anything without wasting a huge amount of time, driving up to the brink of crisis, and generating massive uncertainty about policy outcomes, all of which can’t be good for the economy. But the endgame of the fiscal cliff negotiations looks pretty good to me. President Obama got his rate hike, and now we know what tax rates are going to be going forward. Additional revenues are going to have to come from tax reform. Good. And on we lurch to the next inevitable crisis.

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10 Comments To "Can Taxes On The Middle Class Ever Be Raised? Can Entitlements Ever Be Reformed?"

#1 Comment By Chris 1 On January 3, 2013 @ 6:01 pm

The time will come when both middle class taxes and entitlement reform (which mostly benefits the middle class) can be profitably discussed.

Before that happens, however, the issue of overwhelming government largess at the very top must be dealt with. No middle-class voter is going to agree to higher taxes and the possibility of going bankrupt due to mom or dad’s illness while protecting Mitt Romney’s right to pay between 9.5% and 13% of his income in taxes, much less giving in to his preference to pass his estate to his heirs tax-free.

Once the issue of tax fairness is addressed, then it will be possible to start to address entitlements and middle-class taxation. Until then, it’s a political non-starter.

#2 Comment By argh On January 3, 2013 @ 9:12 pm

The average middle-class voter pays negative to 5% of their income in taxes, even including the payroll taxes (due to the generous nature of tax credits for those making the median income or less).

Yes, ‘rich’ people have lowish effective tax rates. So does the majority of the country. It’s the upper-middle class (75k-250k) who have the highest effective rates. They can’t take advantage of tax sheltering and they aren’t low-income enough to rake in EITC and child tax credits.

#3 Comment By M_Young On January 4, 2013 @ 11:12 am

“As Chief Justice Roberts made clear to the electorate”

LOL. I’m pretty sure that a majority of the electorate, particularly Obama’s core constituents, couldn’t tell you who John Roberts is, let alone expound on his decisions on anything.

#4 Comment By cw On January 4, 2013 @ 12:13 pm

The republicans are the ones in the worst position. In order to con votes they have somehow been forced to take the anti-deficit position when their base are the most pro-deficit people imaginable: the wealthy, old white people, white working class males. What do these people most want? The very things that cause high deficits: low taxes (especially on investments) and medicare and social security.

This means that the republicans have to pretend to scream and wail about reducing the deficit but can’t ever do anything about it. They can’t raise taxes, which we already know. But they also can’t really cut social security or medicaid in any meaningful way, at least not for anyone in their base.

What they try to do in their proposals such as Ryan’s is cut benefits for younger generations, but if this idea ever makes it to the legislative stage and the general public actually becomes aware of the details, the younger generations are going balk like crazy, and with good reason. Why would they pay for the older republican generations cadillac health plans on the promise of a pinto? Once the basic unfairness of any republican friendly benefit reduction plan becomes public, its dead in the water.

The republicans also can’t put forth and detailed tax restructuring becasue any plan that actually reduces the deficit means reducing big deductions and loopholes that are dear to their base. Home mortgage for instance. You eliminate that and taxes go up for a huge chunk of the republican base (and their kids). Or a VAT? Who pays that. Rich people.

Obama should just call their bluff. Tell them if they want to reduce the deficit so bad to propose a plan. They won’t be able to do it. I don’t know for sure where that would leave us, except that maybe exposing the basic hypocrisy of republican position will delegitimize and weaken them. It might also clarify our budgetary dilemma for the public, who whose blindness about needing to pay for services received is the dilemma’s root cause.

#5 Comment By loudonisafool On January 4, 2013 @ 1:17 pm

It’s the upper-middle class (75k-250k) who have the highest effective rates.

This really isn’t consistent with CBO data, although I suppose it depends on how you incorporate corporate level taxation into the calculation of effective rates. All in effective rates are continually progressive up to the top 0.01% (households making tens of millions of dollars). And even for the mega-rich they’re still progressive with respect to the middle class, the top 0.01% just pay a slightly lower rate than the top 0.1% (guys making millions, but not tens of millions per year). If you’re only looking at effective rates of federal individual income taxes it’s still progressive well up into the top 1%. While I agree that taxpayers in the low six figures get squeezed (and rightly feel like they’re being squeezed) because their effective rate as a proportion of disposable income is high (especially compared to middle class taxpayers), their effective rate is still lower than the effective rate of the rich and super-rich taken as a group.

More applicable to the post, the lesson of Obamacare may be that the only way to raise taxes on the middle class is to hide them and, probably more importantly, defer the effective date of the hikes to the next election cycle.

#6 Comment By tomtom50 On January 4, 2013 @ 11:06 pm

Obama did not raise taxes on the middle because the economy is still delicate and increasing inequality has sparked an appetite for progressive taxation.

#7 Comment By SDS On January 5, 2013 @ 3:45 pm

And still nobody sees that the ” deal ” did nothing AT ALL to address the deficit… Which was the whole reason for the sequester deal in the first place…..
Kick the can one more time…..

#8 Comment By Sam On January 6, 2013 @ 11:52 am

Until the biggest problem of income inequality is figured out you won’t be able to address the problem of tax inequality. The “rich” should be paying more because they control so much of the wealth. So much so that I don’t think many of us even realize how unequal it has gotten.

If more people are able to generate higher incomes instead of concentrating that financial reality on the few people it does now then I think you can effectively raise rates via a rate increase or as Millman says through deduction elimination.

This isn’t a “spread-the-wealth” type of argument. I’m not advocation for raising the minimum wage by 300%. I’m just noting that the system as it’s set up now encourages the super wealthy to hoard. If we could find the average american income somewhere closer to $100K instead of $55K then I think you can easily start to talk about reforming the tax code and raising rates. Then I think that burden falls on the private sector to encourage more of the profits to be driven to the employees. The more people get paid the bigger the boost to the economy as well. It’s the middle class that drives spending and investment.

#9 Comment By tomtom50 On January 6, 2013 @ 1:43 pm

Excellent post. Chris 1’s comment well taken.

“The fiscal cliff was not a test of Democratic ability to raise tax rates on the middle class, because the Democrats went into the negotiation saying they didn’t want to raise tax rates on the middle class.”

That undercuts Douthat’s claim so simply.
When the time comes to raise taxes on the middle the wealthy will see yet another increase, increasing progressivity yet again. This tax rise will not satisfy the public at large. The reality of widening inequality is sinking in. The tax code is an obvious way to level things out a bit.

The rich have over-played their hand. Arguing for tax cuts at the top, running a candidate who pays less tax than an engineer? Even as the piece of the pie going to the wealthy gets larger and larger? Not smart.

#10 Comment By Franklin Evans On January 7, 2013 @ 10:49 am

Loudon’s point cannot be over-emphasized (with my personal addendum here): effective tax rates on employment compensation are as progressively equitable as in past decades.

The problem remains taxes collected on non-employment compensation. The Buffett claim is valid only for total earnings, not when one counts other sources — mostly, of course, investment earnings.

The cognitive disconnect that always gets me is the notion that people with money to invest do so in “job creating” companies, when their first and mostly only priority has been investment return… which, if you look at the simple arithmetic of corporate balance sheets, comes from the minimization or reduction in costs of doing business, with worker compensation at the top of that list. The essentially flat compensation of the vast “middle” of the curve for many years is where the concern should be, not the mythic reduction in investments from increasing taxes on their returns. With that, one can also do the arithmetic and see lost tax revenues on workers’ compensation that isn’t going up.