The Mother of Middle-Class Tax Cuts

Do the presidential candidates want a bold economic idea? Try slashing payroll taxes.

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For a growing number of taxpayers, income taxes really don't matter. Roughly 60 million tax filers, representing 120 million Americans, pay no income taxes, thanks in large part to an increase in various tax credits, deductions, and exemptions. (As a result, the top 1 percent in income now pay around 40 percent of all income taxes.) But it's pretty tough to escape payroll taxes for Social Security and Medicare. Indeed, two thirds of Americans pay more in payroll taxes than in income taxes. So how to give America a payroll tax cut? Here are a couple of options:

1) Extend the retirement age and start indexing benefits to inflation rather than wages. That would leave Social Security overfunded by trillions of dollars, and thus payroll taxes could be slashed.

2) In 2002, economist Kurt Hauser at the Hoover Institution suggested creating a 22 percent flat tax with no taxes on interest, dividends, capital gains, and inheritance. (There would be a $30,000 standard deduction.) It would also broaden the tax base by eliminating all deductions, credits, and exemptions. With that $400 billion in revenue, payroll taxes could be eliminated. As Hauser concluded (bold is mine):

The reduction in the tax base resulting from deductions and other tax expenditures results in higher tax rates to raise the same amount of total tax revenue. However, higher tax rates encourage the shifting, hiding, sheltering, and underreporting of income. High marginal tax rates also reduce the incentives to work, produce, save, and invest, thereby dampening overall economic activity and job creation. ... [My] model is static in that it assumes no behavioral change resulting from the incentives unleashed by a lowering of tax rates and the redirection of labor and capital to productive investment. Under a dynamic analysis it is likely that a flat tax would increase government tax receipts, as the behavioral response to the increased incentives to work, produce, save, and invest would enhance overall economic activity. The tax rate could then be lowered to a point of equilibrium.

income tax
federal taxes
2008 presidential election

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