FICA Follies

Election season is upon us, and it's once more time for our quadrennial ritual of political leaders announcing tax-cut proposals. George W. Bush has been first off the mark, offering a $483 billion reduction in federal income taxes, two-thirds of which (according to Citizens for Tax Justice) would go to the top 10 percent of earners and just one-tenth to the lower 60 percent.

The Bush plan concentrates on cutting marginal rates from the present five graduated levels (15-28-31-36-39.6 percent) to a flatter four (10-15-25-33 percent). It sounds great until you analyze it. The wealthiest among us, for instance, those making over $250,000 a year, would get a tidy 7 percent rate reduction. On the other hand, those earning between $32,000 and $78,000 (the middle and upper-middle classes) would get just a 3 percent reduction, while those earning between $12,000 and $32,000 (the lower-middle class and the working poor) would get no rate reduction at all, staying at the current 15 percent level.

The Bush plan does throw a few goodies at middle-income Americans -- increased child tax credits, a reduced marriage penalty, expanded tax-deferrable educational savings accounts, and so on -- but these hardly offset the rate bias in favor of the top income groups. The wealthy few, who inherit virtually all taxable estates in the country, would also benefit from a total elimination of inheritance taxes under the Bush scenario. Put it all together and George W's tax "reform" gives an average annual tax cut of $50,000 to the richest 1 percent of the population, compared to $200 or less to the poorest 40 percent, and it threatens government solvency besides.

Vice President Al Gore does a little better. Although late to the tax-cut sweepstakes, he also commits to reducing the federal income levy. Gore sticks to the established graduated-rate schedule, maintaining its modest progressivity, and aims instead at nibbling around the edges with selective reductions targeted mostly at the middle and upper-middle classes. These include expanded tax-free educational savings accounts, higher standard deductions for married couples, an increase in the Earned-Income Tax Credit, tax-deferred retirement savings accounts for those without IRAs or 401(k)s, and permanent research-and-development tax credits for business. None of this is especially bad, but little of it affects to a meaningful degree taxpayers who are truly in need of relief.

Strangely enough -- maybe not so strange when you consider that business interests and the wealthy finance our political campaigns -- neither of the major party presidential candidates wants to discuss the tax that really needs to be reformed: the Social Security (or FICA) payroll tax. Their failure to do so perpetuates a fundamental unfairness in revenue raising that has persisted for at least a generation.

The trouble started in the election year of 1972, when Congress and the Nixon White House decided to increase Social Security benefits by 20 percent and index them against inflation (a good thing) without providing for proper financing (a bad thing). This led to an eventual doubling in benefit outlays and a halving of poverty among the elderly, but also to a funding crisis of significant proportions in the late 1970s and early 1980s. To solve the growing funding problem, the Carter Administration (in 1977) and the Reagan Administration (in 1983) both pursued the expedient of simply raising the flat payroll-tax rate in stages, ignoring concerns about progressivity in the process.

As a result, the Federal Insurance Contribution Act (or FICA) tax shared by workers and employers gradually rose from 11.7 percent in 1977 to 15.3 percent in 1990, where it remains today, with the employee half (5.85 percent in 1977) now amounting to 7.65 percent, 6.20 percent for Social Security and 1.45 percent for Medicare. That's a hike of one-third in little over a decade, most of it at the behest of the Reagan-appointed Greenspan Commission (yes, that Greenspan). Meanwhile, the top federal income-tax rate applied to the richest Americans was cut in half under Reagan, dropping from 70 to 36 percent between 1981 and 1986, before inching back up to 39.6 percent during the first year of the Clinton presidency.

This combination of developments -- a lowering of graduated incomes taxes, primarily at the upper end, and a raising of the FICA flat tax, capped to apply only to average workers -- had the effect, according to economists Robert Heilbroner and Lester Thurow, of increasing the total tax burden on nine out of ten American families between 1977 and 1990. Simultaneously, those at the very top, the richest 1 percent, experienced a one-third decrease in their overall obligations. Largely because of these tax changes, Heilbroner and Thurow report, all income gains arising from the expanding GNP during that period went to the upper 40 percent in income, while the bottom 60 percent endured economic stagnation.

Underlying conditions have changed little in the past decade; the tax imbalance has remained roughly constant, exacerbating a national income gap that persists in the face of a booming economy. One unforeseen outgrowth of our continuing lopsided tax structure is that nearly three-quarters of all working Americans now pay more in payroll taxes than they do in income taxes. Another is that the highly regressive payroll tax has established itself as the leading growth tax of the post-World War II era, having surpassed the corporate income tax as far back as 1971 and come close to challenging the income levy as the prime source of federal dollars.

As a proportion of total government revenues, the Social Security tax has gone from 4 percent in 1949 (when the individual payroll assessment was 3 percent), to 12 percent in 1960, then to 23 percent in 1971, and now to 33 percent in 2000. In the process, it has evolved from a minor and necessary fiscal annoyance accepted by most working Americans to a genuine economic burden that should and must be lightened in some fashion -- or at least made more equitable. Therein lies the road to real tax reform in this election year.

[To be continued ...}

O'Leary is a writer in Orono, Maine.

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