Democrats Put Tax Proposals In Context of Systemic Change

Candidates Try to Wrest 'Reform' Tag From GOP Activists

Author: Jonathan Weisman

Published: January 12, 2004

Driven by President Bush's steep tax cuts and a burgeoning budget deficit, Democratic presidential candidates have seized on an issue that Republicans have largely owned for a decade -- tax reform.

The new push goes beyond the tussle over the level of taxation that roiled the campaign for the Democratic nomination last week. One by one, candidates are embracing fundamental changes to the tax system -- from eliminating the need for tax returns for most Americans to consolidating the bewildering plethora of tax credits -- likely making the issue unavoidable during the general election campaign.

"This should be a very important issue in the fall election," said one of the contenders, Sen. Joseph I. Lieberman (D-Conn.). "It says on the merits that Democrats are for tax cuts, too, but it also gets to the issue of tax equity -- we're not going to give tax cuts to people who don't need them. Both messages can be defining in the general election campaign against George Bush, who has proven that he can cut taxes, but can only do so in the most irresponsible way."

Republican tax-cutting activists say the gambit is destined to fail, and could prove politically disastrous for Democrats.

"We'll just stand up and say, 'It's a tax increase,' and people are willing to believe us because they've seen it before," said Grover Norquist of the conservative Americans for Tax Reform. "There will not be a discussion of tax reform in the 2004 election. There will be a discussion of who wants to increase taxes and who wants to lower taxes. That will be fatal."

But Democrats insist that they can credibly reclaim the mantle of tax reform because voters have become increasingly dubious of the changes imposed on the system by three consecutive years of tax cutting under Bush.

The last major tax reform legislation was shepherded through Congress in 1986 by Democrats. But for more than a decade, Republican tax activists have dominated the tax reform debate, making the term synonymous with their calls for a radically simplified tax system, either a flat tax with a single income tax rate, or a national sales tax that would replace the income tax system altogether.

Most Republican reform proposals say that income from savings and investment -- interest payments, capital gains and dividends -- should be largely exempt from taxation, a move advocates say would boost the economy. Bush, while never overtly embracing the cause, has moved significantly toward that goal.

Bush's 2001 tax cut would eliminate taxation of inherited wealth, phasing out the estate tax by 2010. The 2003 tax law reduced the tax rate on dividends from a top rate of 39.6 percent when Bush entered office to 15 percent. The tax rate on most capital gains, from the sale of stocks and other assets, dropped to 15 percent from 20 percent.

Bush's fiscal 2004 budget and his upcoming budget for fiscal 2005 would go still further, proposing to create a new "Lifetime Savings Account" that would allow a family of four to shield as much as $30,000 a year from investment taxation. Because few families could ever save more than that, the proposal would effectively end capital gains, dividends and interest taxation.

Once fully implemented, the three tax cuts passed in 2001, 2002 and 2003 will offer the greatest tax relief to the wealthiest Americans -- those earning $337,000 or more -- and also significant advantages to low-income families, according to the Tax Policy Center, jointly run by the Brookings Institution and the Urban Institute. But a broad swath of lower-middle, middle- and upper-middle-income people will carry a greater share of the federal tax burden. Although taxes are scheduled to decline for all income groups, those earning more than $28,000 but less than $337,000 a year will end up paying a greater share of the taxes than they did before the changes.

Democratic candidates, who traditionally have avoided tax issues, now want to push the system in the opposite direction.

"My belief is that President Bush is shifting the tax burden in America from wealth to work, trying to reduce or eliminate dividend taxes, capital gains taxes, taxation of large estates," said Democratic presidential hopeful John Edwards, a North Carolina senator. "It is the opposite of what we should be doing."

Campaign aides say record budget deficits had posed a dilemma for most Democrats, who wanted to excoriate Bush for his fiscal management but did not want to be tagged as tax hikers. "Tax reform" gets them out of that box, said Jason Furman, a domestic policy aide of retired Gen. Wesley K. Clark, by allowing them to raise some taxes, cut others and put it into an ideological framework.

Edwards's plan would shift taxation back onto investment -- what he called "unearned wealth" -- by retaining taxation on affluent estates, raising capital gains taxes to 25 percent for the wealthy and making dividend tax rates equal again to upper-income tax rates.

Lieberman would go further, coupling increases in investment tax rates with cuts to middle-class income tax rates.

Clark focused his plan on tax cuts and tax simplification for middle- and lower-income families. In perhaps the most dramatic proposal, Clark would eliminate income taxation for more than half of the country's households and excuse them from even filing a federal tax return. He would also consolidate four tax credits offered to poor and middle-income families into a single credit, a proposal nearly identical to one offered earlier by another candidate, Rep. Dennis J. Kucinich (Ohio).

Goaded by other candidates, former Vermont governor Howard Dean promised last week that he would eventually announce his own "tax reform" plan that would make the system fairer and simpler. Dean economic aides promised the plan that ultimately emerges would be dramatic enough to keep the shape of the tax system front-and-center in the general election, should Dean secure the Democratic nomination.

Even Democratic economists concede the plans are not nearly as fundamental as flat tax or national sales tax proposals. William Gale, a tax economist at the Brookings Institution, called them "pretty timid."

But, Gale said, "they're really the first baby steps to what's going to be a much broader discussion. This will be a new stage in the tax debate, going back to structural issues in the tax system, simplification, and ultimately a push for more revenues" to balance the budget.

Far from welcoming the proposals, conservative tax reform activists are livid.

"What these guys have done is hijacked the term," fumed Ernest S. Christian, a former Treasury official in the Reagan administration who now heads the Committee for Strategic Tax Reform. "They're trying to take as many of their own perceived constituents off the tax roles as they can, and it's true, if you don't pay taxes, it's simpler. But tax reform is supposed to mean removing barriers to economic growth, making the tax system impact the economy in the least onerous way."

Norquist agrees.

"They're going to going to make the word 'tax reform' into what they did with that other otherwise decent word, 'liberal,' " he said. "They're going to make it a dirty word."