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Taxes, Social Security & the Politics of Reform

From the November 29, 2004 issue: A Reaganite plan for Reagan's heirs.

Nov 29, 2004, Vol. 10, No. 11 • By JOHN D. MUELLER
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BY PUTTING INCOME-TAX and Social Security reform atop his second-term domestic agenda, President George W. Bush courageously zeroed in on the two most important fiscal issues facing American families for at least a generation. The basic choice is whether to retain the formula Ronald Reagan advocated and pursued in office--combining a broad-based, low-rate income tax with a pay-as-you-go Social Security system--or shift to taxing the narrower base of "consumption" at higher rates while replacing Social Security pensions with individual retirement accounts.

In a seminal February 1977 speech, Reagan cautioned against those "on the left or right . . . who worship the god of political, social, and economic abstractions, ignoring the realities of everyday life." He called for a "new Republican party," which, by applying traditional conservative principles to economic, social, and national security policy, would serve as the "political mechanism through which the goals of the majority of Americans can be achieved." The most striking political fact about Republican presidents and presidential candidates since Reagan's departure is that, while faring steadily better on social and national security issues by following the Reagan approach, they have fared steadily worse on economic policy by moving away from it. For example, President Bush's 2004 reelection resulted from a whopping 19-point advantage in social and national security issues, which outweighed an 18-point deficit on economic policy issues. Had Bush merely broken even on economic policy, he would have enjoyed a historic landslide. This gives a sense of the magnitude of the political upside if Republicans can recapture the success of the Reagan fiscal program.

Beneath the legal barnacles left by decades of hand-in-pocket relations between lawmakers and lobbyists, U.S. fiscal policy retains a discernible economic, moral, and political logic, which owes much to Abraham Lincoln (who introduced the first income tax in 1862), to the "maternalist" (Allan Carlson's apt term) group of women who designed the pay-as-you-go Social Security retirement system in the 1930s, and to Ronald Reagan, who led bipartisan efforts to balance Social Security taxes and benefits (in 1983) and to reform the income tax (in 1986). This logic can be stated simply: The most just, efficient, and popular way to pay for common goods like national defense and general government is an income tax with the broadest possible base, lowest possible tax rates, and most equal treatment of labor income (salaries, wages, fringe benefits) and property income (interest, capital gains, dividends, rent, royalties, etc.). This last point is the one that has bedeviled the post-Reagan Republican party, as it has repeatedly been tempted in the name of capital formation, investment, and growth (all good things!) to tax property income less heavily than labor income, rather than treating the two equally. This is why Republicans, for all their reputation as tax-cutters, have had almost nothing to say about the larger bite of payroll taxes over the last two decades.

The same logic dictates that narrower benefits require narrower funding. For example, transfer payments to persons or families (including Social Security and unemployment benefits) should be paid by taxes on labor income, and subsidies for property-owners by taxes on property (like gasoline taxes and vehicle tolls to fund roads and bridges). In my experience, these principles are the key to an economic policy that is legislatively successful and politically popular. Ignore them and plausible schemes startle their proponents by erupting in political flames--as has happened with all proposals so far for a flat tax or Social Security privatization (most recently in 1996 and 1999, respectively).