Tax Policy and the 2004 Elections

What do Tuesday’s election results mean for tax 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 tax rates, the child credit and marriage penalty 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 tax, or another type of consumption tax.

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 base 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.