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Tax Policy and the 2004 Elections

3 min readBy: Scott Hodge

What do Tuesday’s election results mean for taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. policy over the next four years? It can be summarized in two words: permanence and reform.

Expect George W. Bush and the 109th Congress to move quickly next year to make the President’s tax cuts permanent. At varying times over the next six years, all of the major components of the President’s tax cuts will either sunset or diminish in value. For example, the 15 percent tax rates on capital gains and dividends are scheduled to sunset on December 31, 2008. Two years later, at midnight on December 31, 2010, the remaining components of the Bush tax cuts—the lower individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. rates, the child credit and marriage penaltyA marriage penalty is when a household’s overall tax bill increases due to a couple marrying and filing taxes jointly. A marriage penalty typically occurs when two individuals with similar incomes marry; this is true for both high- and low-income couples. relief—will expire and revert to the tax law that was in effect in 2000. Making these tax cuts permanent will not only avoid a massive tax hike for Americans, but will bring badly needed stability to the tax code and allow taxpayers to plan for the long term.

While Bush was quite forceful throughout the campaign in his desire to reform the tax code, he was coy about indicating which of the various reform plans he favors – a flat income tax, a national retail sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. , or another type of consumption taxA consumption tax is typically levied on the purchase of goods or services and is paid directly or indirectly by the consumer in the form of retail sales taxes, excise taxes, tariffs, value-added taxes (VAT), or an income tax where all savings is tax-deductible. .

The problem with Bush’s desire to overhaul the income tax is that the last four years of tax cuts have made the task of reform more difficult. Despite the charges of critics, Bush’s tax cuts were very successful in eliminating the tax burden for low and middle-income taxpayers while shifting the tax burden to the so-called rich.

Indeed, this year a record 44 million Americans will file tax returns but pay no income taxes after they have taken advantage of credits and deductions while millions more will owe next to nothing. As a result, the wealthiest 20 percent of taxpayers (those earning more than roughly $68,000 per year) will pay a record 82 percent of all income taxes.

Here’s the dilemma for Bush’s tax team: If the goal of fundamental tax reform is to expand the tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. while lowering tax rates, how do you craft a tax reform plan that (1) doesn’t raise taxes on the 44 million low-income Americans who now pay nothing and (2) doesn’t “cut taxes for the rich” who now pay everything? There is no easy answer, especially if the administration is committed to enacting tax reform in a revenue neutral manner.

One thing the administration can do to counter the “tax cuts for the rich” charges that dominated this year’s election is better educate the public on who the so-called rich are today. The wealthiest 20 percent of taxpayers are overwhelmingly comprised of dual-income working couples and business owners. These taxpayers are now the new “middle-class.” The statistical middle 20 percent of taxpayers, the group that politicians claim to want to help, is now overwhelmingly comprised of single individuals, not traditional married couples.

While the changing demographics of the American taxpayer will make the task of crafting and selling fundamental tax reform much more challenging, the long-term benefits that reform will bring to the American economy are worth the effort.

Scott A. Hodge is president of the Tax Foundation.