Why Schumer is (Mostly) Right on Taxes

Senator Schumer offered a much needed intervention in the tax debate in a speech on Tuesday. What Schumer said is that revenue-neutral tax reform was a fantasy and that any big Congressional deal on tax reform had to include higher rates on the wealthy, as well as more revenue overall.

Yes and yes to both points.

As Schumer pointed out, one major distortion in today's tax code that needs to be fixed is its favorable treatment of the wealthy, particularly through the historically low rate of taxes on capital gains --- the source of much income for the wealthiest Americans:

Over time, our tax code has widened the nation’s wealth gap. Reversing this trend ought to be a top goal of tax reform; at a minimum, we certainly should not make the tax code any less progressive than it would be if the high-income tax cuts expired.

The basic goal of several tax reform plans, including Mitt Romney's, is to lower top rates and make up lost revenue by closing loopholes. But Schumer rightly points out that this is difficult to do without hitting the middle class, which benefits from tax expenditures for home mortgages, pensions, healthcare, and college costs.

For instance, according to the Tax Policy Center, the lower tax rates proposed in Romney's tax plan would reduce revenue by $900 billion in 2015. Yet every tax expenditure in existence costs $1.1 trillion annually. And the three biggest tax expenditures -- for health insurance, pensions, and mortgage interest -- amount to just over $400 billion a year.

In other words, even if Congress took a meat ax to tax expenditures -- effectively turning our healthcare, pension, and housing systems upside down -- it would probably still be far away from making up the revenue lost from higher rates.

Schumer is right to label this thinking as "happy talk."

And if Congress lowers rates but doesn't drastically reduce tax expenditures, deficits will only get bigger, Schumer points out:

It is an alluring prospect to cut taxes on the wealthiest people, reduce the deficit and hold the middle class harmless, but the math dictates you can’t have it all.

The reality is, any path forward on tax reform that promises to cut rates will end up either failing to reduce the deficit or failing to protect the middle class from a net tax increase. You can, at most, achieve two of these goals; anyone pushing a plan purporting to accomplish all three isn’t telling the truth. The sooner we are honest with ourselves about this, the easier it will be to negotiate a compromise on taxes.

Schumer's solution: Raise rates on the wealthy and also close some loopholes as well, thus making a serious dent in the budget deficit.

Thanks for the reality check, Senator.

Unfortunately, though, Schumer didn't go far enough: The harder truth to swallow -- and what nobody in Washington wants to admit -- is that taxes on the middle class also need to go up. Most of the revenue lost from the Bush tax cuts is from tax cuts to the bottom 98 percent of households. Anyone who is really serious about solving the revenue problem should be advocating a full repeal of the Bush tax cuts -- or some comparable outcome via tax reform. Ideally, such a repeal would be phased in slowly so it doesn't disrupt the fragile recovery. But that's where we need to go. Otherwise big spending cuts are inevitable and those cuts will mainly hurt lower income groups.

It's hard to know whether Schumer might agree with this, since no Democrat wants to advocate higher taxes on the middle class before an election -- or maybe ever.

One way to read Schumer's proposal for both higher rates on the wealthy and some trimming of tax expenditures is that he would accept a bigger tax burden for the upper middle class, in addition to the affluent. One could imagine both returning to higher Clinton-era rates for the top 2 percent of households, while also scaling back tax expenditures for the top 20 percent of households overall.

That would make a lot of sense. What's less clear is how much revenue it would raise. Senator Schumer should ask the CBO or CRS to answer that question.

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