Commentary

Will Democrats Raise Taxes?

This article appeared in Tax Notes, January 8, 2007.

Like most people, I thought the Republicans deserved the thumping they received in November. And as a fiscal conservative, I thought we would be safe from tax increases for the next two years because the Democrats already have their eyes on 2008. In their hearts, most Democrats prefer higher taxes because they want to fund larger government. But as the Republicans have demonstrated in recent years, the lust for retaining power is far more important to the parties than ideology.

So I thought taxpayers were safe. Then I realized that the real taxpayer threat lies at the other end of Pennsylvania Avenue. The Democrats won’t push for tax hikes unless the White House gives them cover, and I’m afraid that is exactly what it might do. After all, President Bush just switched positions and agreed to a minimum wage increase. The reason, he said, was to show that he can work in a bipartisan manner with the new majority in Congress. Ugh!

Bush’s quest for bipartisanship, and his proclivity to sign any and all bills that come to his desk, could lead to big tax increases. One scenario would be the parties getting together and conspiring against taxpayers in a bipartisan entitlement “summit.” President Bush says that he wants to work with Democrats on a Social Security deal with all “ideas on the table.” Treasury Secretary Henry Paulson is eager to sit down with the Democrats to cut talk entitlements with “no preconditions.”

However, the only entitlement deal that could be made with Democrats is one that includes a big tax increase, and it would be the worst type of tax increase. Such a deal would not raise the payroll tax rate by a small amount, it would raise the payroll tax’s wage cap. That would create a huge marginal rate increase on millions of the nation’s most productive workers and the self-employed.

Some conservatives are hinting that it is worth taking a deal that combined a small payroll tax increase with big cuts to Social Security benefits and the creation of personal accounts. But the administration’s track record shows that it is not capable of negotiating such a deal.

When it came into office, the Bush administration made some pro-reform noises on farm policy, then it agreed to the massive 2002 farm subsidy bill. Leading up to the education law of 2002 and the Medicare drug law of 2003, we were told that the bills would include major pro-market reforms in exchange for modest compromises. But in all cases, Bush caved in and agreed to a series of big government monstrosities.

More importantly, the government does not need tax increases of any size in order to solve its budget problems. In fiscal 2006—with the Bush tax cuts and alternative minimum tax relief in place—federal revenues were 18.4 percent of gross domestic product, which is about the average over recent decades. Long-term budget projections show that the problem is exploding costs in entitlement programs, not falling revenues.

Another threat is White House approval of tax increases in exchange for repeal or reform of the alternative minimum tax. Administration officials have said that the AMT should be fixed on a “revenue-neutral” basis. But I don’t think many of the public appreciate the meaning of that policy position.

In 2006, the AMT raised about $24 billion—a decent chunk of change, but nothing compared to the more than a $1 trillion it will raise over the next decade unless repealed. In Washington, “revenue neutral” means raising that projected AMT revenue some other way, such as ending income tax deductions or raising rates. But to average families, that would not be neutral at all, it would be a huge tax hike compared to what they pay right now.

The Democrats say that they favor AMT relief, but they also favor “pay-go” budget rules. Those rules require that proposed increases in spending or reductions in taxes be offset by other tax and spending changes. How will the Democrats offset the roughly $50 billion needed for AMT relief this year?

Democrats are talking about reducing the “tax gap” of untaxed income, which the Government Accountability Office puts at $345 billion. But the vast majority of that gap is individual, not corporate, with the largest share stemming from small businesses. It makes no sense—politically or economically—to crush the nation’s entrepreneurial sector with more intrusive tax reporting and enforcement.

And while the GAO says that “billions of dollars” could be raised by taking steps to close the tax gap, it also notes that the gap has remained relatively stable over the decades “in spite of many efforts to reduce it.” The bottom line is that tax gap talk makes good press, but there is little real money there for the Democrats.

In sum, the Democrats will play a temptress to the administration, trying to seduce it into a tax increase with the warm embrace of bipartisanship. The administration should keep its distance—no joining hands in budget summits or commissions—while asserting its fidelity to the Republican tax-cutting record and pro-growth agenda.

Chris Edwards is director of tax policy.