LAST SPRING, Sen. Pat Moynihan lobbed a fine grenade into the tax and budget debate when he proposed a cut in the payroll tax on wage-earners. The Moynihan bill went nowhere as legislation, for it would have diverted too much money from the Social Security system. But its subtext -- how about a tax break for working stiffs? -- bore fruit in the eventual budget deal of last November.
Moynihan's real political contribution was to remind Congress why it makes sense to have progressive taxes. Namely, rich people are where the money is, while the middle class is already overstressed.
Having slowly reawakened to this political and economic truth, Congress ultimately insisted on a genuinely progressive tax formula -- taxing richer people at higher rates, reversing a decade-long trend -- as the price of a deficit-reduction deal. In the end, President Bush signed a bill which had seemed inconceivable only a few months earlier, disproportionately hiking taxes on the well-off.
Having proved the political worth of this approach, the time is now ripe for a "Moynihan II." Wage-earners really are overtaxed. (The middle class, too, got a slight tax hike as part of the budget deal.) It does make good sense to reduce payroll taxes. The trick is to achieve payroll-tax relief without raiding Social Security.
The payroll tax currently assesses earnings at a flat rate of 15.3 percent, half paid by worker, half by employer, on wages up to $51,300.
Because of this cap on the taxable-wage base, payroll taxes are by far the most regressive part of our tax system. A worker earning $51,000 pays taxes at twice the rate of one earning $102,000, and four times the rate of one earning $204,000.
Social Security is advertised as a "contributory" pension program, but in truth it is really a much broader form of social insurance. The payroll tax now finances Medicare for the elderly, as well as pensions for the retired and the disabled, based in large part on need. And though higher-paid workers do get more generous pensions, the actual formula is fairly redistributive.
It therefore makes no sense to impose an arbitrary ceiling on income covered by the payroll tax -- any more than it would be sensible to subject only the first $51,000 of earnings to the income tax. Tax rates should rise with ability to pay, not fall. Congress recognized this in a token way in the budget agreement, when it raised the earnings base of the health insurance portion of the payroll tax from $51,300 to $125,000.
Here is my own version of a "Moynihan II": Convert the current payroll tax for a generalized Social Insurance Tax. Lower the rate. And pay for the lower rate by getting rid of the income ceiling and taxing all income.
How much could the rate be lowered? If the cap were eliminated on wage and salary income, the rate could be cut by at least 15 percent.
If we subjected all personal income to a Social Insurance Tax -- income from dividends, interest or capital gains as well as wages we could cut payroll tax rates by about 40 percent!
This reduction would give a worker earning $35,000 per year a tax cut of $1,052. It would produce a net tax cut on all workers earning less than about $85,000 a year, and a tax increase for those above that level.
A more finely tuned variation of the same approach would keep the same payroll tax rate, but add an exemption on, say, the first $8,000 of earnings. That would produce a 50 percent tax cut for someone earning $16,000 a year, and a 25 percent tax cut for someone earning $32,000, and so on.
In a recession, a cut in payroll taxes would have two further virtues. It would put more money into the pockets of hard-pressed working families, which would stimulate the economy. It would also lower the employer's cost of labor, which would create more jobs.
Sen. Moynihan is said to be weighing his options. New York Gov. Mario Cuomo declared in his recent National Press Club address that if there is to be further tax relief, it should be a payroll tax cut.
A "Moynihan II" would be a wonderful alternative to the capital gains tax cut, which many people in the Bush administration still favor. It would pose a stark choice between further tax relief for the rich versus overdue tax relief for wage and salary workers.
Payroll tax reform, further, would be self-financing. It wouldn't raid the Social Security trust funds. A capital gains tax would reduce revenues in the short run, and hope to make them up through the same dubious supply-side alchemy that failed so palpably in the 1980s.
In the budget debates, the Democrats belatedly restored "soak the rich" from a feared epithet to a popular badge of principle. If taxing the rich to provide deficit relief proved to be acceptable politics, tax relief for working people should be even better.
Robert Kuttner writes regulary on economic matters. 1/2