Monday, December 05, 2005

Fair Tax Reform

Economist Dean Baker pushes for tax reform that treats income equitably a la Ronald Reagan '86.

The key idea behind the ‘86 reform was not to lower tax rates, but to eliminate loopholes. It also took a key step that stands in opposition to the current flavor of Republican tax breaks. The ’86 tax reform treated all types of income—wage income, capital gains, dividends and rents—the same way. This meant that a person who earned $70,000 from working would pay the exact same tax as someone who got $70,000 in dividend checks or who made $70,000 in profit on stocks.

Taxing all income the same way meant that there was no money to be made by gaming the system—for example, by disguising wage income as capital gains income. Reagan proudly boasted when he signed the bill that people would now make money by working and investing, not gaming the tax code.


Compare this to the type of reform being pushed by the Bush administration.
This spirit behind this approach to taxes runs counter to the current tax cuts being pushed by President Bush and the Republicans in Congress. Sen. Frist, in particular, has pledged that he won’t bring back a conference committee on the tax cuts to the Senate floor without the capital gains and dividends provision. Frist and his colleagues think it’s unfair that people who get money from dividends or profits on stock pay the same tax rate as people who earn their living working as truck drivers or schoolteachers. The Republicans want to extend their tax breaks from 2003, under which the maximum tax rate on dividends and capital gains would be just 15 percent. This compares to the 25 percent rate paid by many middle-income workers.


Republicans claim that most Americans would benefit from tax breaks on dividends and capital gains because so many people are now stockholders. However, this claim is misleading. The vast majority of shareholders own very little stock that would benefit from a tax break.
Most people hold their stock in 401(k) type retirement accounts. The money earned in these accounts is taxed as normal income after retirement, regardless of how it was earned. This means that when a schoolteacher or firefighter pays taxes on the dividends earned by the stock held in their 401(k)s, they will pay the standard tax rate—quite possibly 25 percent. The special 15 percent tax rate is reserved for that relatively small group of wealthy people who have substantial stock holdings outside of retirement accounts.

Our tax code should treat workers and investors the same; to treat them differently smacks of class discrimination. However, that's precisely the message the GOP seems to be sending: Americans fortunate enough to sit around all day and live off of their trusts funds deserve more tax relief than hard-working Americans who bust their tails to go to work everyday.

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