In 1986 Congress passed and President Reagan signed a landmark and heroic piece of legislation: the 1986 Tax Reform Act. The 1986 TRA closed economically inefficient tax loopholes and dramatically reduced income tax rates for all Americans.
The result of the 1986 Tax Reform Act was to create a simple two-rate income tax system: 15 percent and 28 percent. It should be emphasized that the 1986 TRA was a bipartisan measure and was sponsored by Democrats Rep. Richard Gephardt and Senator Bill Bradley and Republicans Rep. Jack Kemp, and Senator Bob Packwood, with important contributions from the now Chairman of this Committee, Bill Archer.
A major objective of the 1986 Act was for the 15 percent income tax bracket to apply to all low income and the vast majority of middle income workers. The 28 percent bracket was primarily to apply to wealthier workers.
In the post-1986 TRA era, we have passed several bad tax bills, most notably the 1990 budget deal and the 1993 budget deal, both of which unraveled tax simplification and created a new multitude of tax rates climbing to a high of 39.6 percent. I agree wholeheartedly with Jack Kemp and others that a very good start to tax reform would be to get us back to the two bracket system of 15 and 28. We have a plan that we are promoting at the Cato Institute called the MAXTAX that would be even more pro-growth. It would create two income tax rates at 10 and 25 percent wrapped around the payroll tax. I have attached to my testimony an explanation of that plan, which involves giving taxpayers the freedom to choose between this low rate gross income tax or the complex current system.
Another pernicious trend since 1986 should be rectified by this Committee to restore tax fairness for the middle class. More and more middle income workers have now been pushed into the 28 percent tax bracket — and some are now paying the 31 percent bracket. This phenomenon is occurring because the tax brackets are not indexed for real income growth, just nominal income growth.
Today, there are roughly 21 million workers with earnings between $30,000 and $50,000 a year most of whom pay marginal income tax rates of 28 percent.
Believe it or not, these workers pay the highest marginal tax rates under our federal tax system. Why? Because they pay a 28 percent federal income tax rate on top of a 15 percent payroll tax. The combined rate of 43 percent is higher than the top income tax bracket for even the wealthiest Americans at 39.6 percent. The two charts that I have attached to my testimony show the problem graphically. The middle class workers — particularly single workers — face punitive tax rate burdens. And as Reagan taught us: taxes matter most at the margin.
Nixon once called these neglected citizens the “silent majority.” Both parties lay claim to speaking for these working class Americans, but neither party seems to be listening to them. Ever since the sweeping Reagan tax cuts of 1981, neither political party has done much to directly benefit the middle class in the pocketbook. The latest figures from the nonpartisan Tax Foundation highlight that since 1980, despite a Republican in the White House for 12 of those 17 years and a Republican-controlled Congress for 3 of the 5 others—the tax bite on median-income families has continued to ratchet upward to 38.5 percent. Federal taxation is now at its highest peacetime level, as a share of Americans’ incomes, since the height of World War II.
Much of the escalating tax burden has, of course, been attributable to hikes in the regressive payroll tax. For most Americans, payroll tax increases have canceled out, nearly dollar for dollar, the benefits of the Reagan income tax cuts. Meanwhile, the federal gas tax has been tripled since 1980, state and local property taxes continue to climb and so does a multitude of obnoxious fees and assessments.
Last year Rep. Dick Armey (R-Tex.) called this plight of American workers, “the middle class squeeze.” Exactly the right diagnosis. But what is either party doing about it? Last year Republicans passed a niggling tax cut about one-third as large as what they had promised in 1994.
Yes, for families with young kids this is blessed relief—a $1,000 tax cut for a family of four. There are still millions of middle-class households without kids at home and without capital gains income that will angrily learn come April 15th that they get essentially nothing out of this tax bill.
Jack Kemp and Ronald Reagan taught us that tax rates matter, too. Combining payroll tax, federal income tax, and state income taxes, many middle income families are approaching a 50 percent marginal tax burden. If a stay-at-home mother wants to get back in the workforce, full- or part-time, she’s paying nearly 50 percent tax on her first dollar of income earned. Counting the costs of child care, she may only bring home 20 cents on the dollar. Often she can’t afford to work.
Republican Senator Paul Coverdell of Georgia has proposed relieving the middle-class squeeze. He would raise the income threshold on the 15 percent income tax bracket. I understand that Mr. Archer will propose to do so as well.
Under current law the 28 percent tax bracket creeps up on single workers at an income level of $25,350 and on married couples at $42,350. The 15 percent bracket should be stretched to $35,000 income for singles and $50,000 for married couples. This would reduce federal revenues on a static basis by $25 billion a year — or roughly the amount of the budget surplus now being projected. The principle here is simple: all middle-class families in America should be in the 15 percent tax bracket—not the 28 percent bracket.
In fact, eventually, Congress should expand the 15 percent tax bracket to apply to all Americans with earnings below $65,000 a year —the income level where people stop paying payroll taxes.
This is not a plan that is vulnerable to attacks as a “tax cut for the rich.” It is designed to benefit the workers who earn between $30,000 to $50,000 a year.
This plan would provide middle-class workers, not symbolic, but meaningful tax relief. A single filer with an income of $32,000 a year would receive an $864 tax cut. A married couple with taxable income of $48,000 a year would receive a tax cut of $734. Preliminary estimates indicate that the plan would result in a static revenue loss of $20 to $25 billion annually. This is less than the projected budget surplus. Dynamic analysis would suggest that as much as one-third of the static revenue loss would be recouped through more work and savings.
Newt Gingrich and Trent Lott have announced that Republicans will cut taxes again in 1998. The bigger the tax cut, the better. But I urge this committee that whatever is done: cut taxes and aim to simplify. No more “targeted” education tax credits, no more loopholes and complexities. The President’s tax plans are deeply flawed in this area. H&R Block is the primary beneficiary of the White House proposal. Tax cuts in 1998 should make the tax code simpler and the tax burden lighter.
Consistent with these principles, I am very much in favor of two other ideas that have been presented before this Committee: indexing capital gains for inflation and relieving Americans from the burden of the Alternative Minimum Tax. Inflation is a thief. It is not fair to tax Americans purely on phantom gains. In this low inflation environment, indexing capital gains would not impose much of a cost on the Treasury, but would provide investors an insurance policy against a return to a high inflation regime.
Bill Archer and Paul Coverdell’s ideas are sound. Marginal rate cuts are necessary to improve American competitiveness in the global economy. It is noteworthy that almost all nations in the world have been cutting tax rates since 1981 — see tables. We should broaden the 15 percent tax bracket this year. In 1999 or 2000 we should vastly simplify the tax system by flattening the income tax, or better yet, by adopting a national consumption tax.