We must understand basic facts about federal finance before we can act rationally

Contrary to what many expected just two weeks ago, Congress passed a tax bill and President Donald Trump signed it. So we face the largest changes in our tax system since the Reagan administration of the 1980s. My own opinion is that this was a rushed, haphazard set of miscellaneous provisions — taxes on the earning of grad students, deletion of the extra allowance for those over 65, lower taxes on craft beers — clothing a substantial cut, with precious little reform, of the corporate income tax. This was coupled with cuts in the overall bite into the personal income of the richest 10 percent of households.

The flaws are such that I think few years will pass before we revisit the issues. Hope that the next time we are more careful using “regular order” procedures of extensive public hearings and discussion. And let’s hope that the level of public discussion is higher next time. An overview of the basics is a small step toward that.

First, understand basic tax categories. The biggest and most familiar is the individual income tax. FICA taxes for Social Security and Medicare are equally known. These are combined with federal unemployment taxes in a rubric of “social insurance.” The third is the corporate income tax.

There are two additional but minor sets. One is excise taxes, which include that on motor fuels, alcohol and airline tickets and, at times on the rubber in tires to long-distance telephone calls and perfume. Gas taxes are most important for most households.
Finally, there is an “other” category of revenue which includes import duties, the estate tax and revenues from grazing permits, oil leases and sundry other fees.

The first three account for about 90 percent of all revenue.

Second, recognize that defense concerns played a big role in modern U.S. taxes. When instituted in 1914, the individual income tax was intended to hit only the very rich. For the first couple of years, they were owed by less than 1 percent of households. But rates were boosted and the threshold level slashed to raise money for World War I. The tax never returned to that originally intended. The same happened to the corporate income tax.

Both were reduced after the Armistice, although many elected officials wanted them kept high enough for revenues to reduce vast war debts. In the event, Franklin Roosevelt sought higher rates and all taxes were raised to fund World War II. Intent was to lower them postwar as the debt was reduced at least somewhat, but then the Korean War and fear of a nuclear-armed USSR intervened. The 90 percent nominal marginal rates first lowered by Kennedy Johnson and then by Reagan tax bills had not been instituted because of economists’ views on optimum levels. They were a perceived exigency of national survival. But once down, they were not raised again even when we got in significant wars in 1991 and after 2001.

Third, understand that tax U.S. revenues are remarkably stable. You can always find many in the public who are convinced that taxes “just keep getting higher and higher.” Republicans have demagogued on that for years as reliably as Democrats have on Social Security and Medicare. But it simply isn’t true.

Over the past 70 years, total federal revenues as a fraction of the value of output have averaged 18.2 percent. It has fallen below 15 percent only twice and exceeded 20 percent only once. The average for the first 10 years of that long span was 16.2 percent of GDP. For the past 10 it was 16.5 percent.

If one looks at trends over time, a few things are clear. First, revenue varies with the business cycle. It falls in recessions, as after the Paul Volcker- led high interest rates that began in 1980, after Sept. 11, 2001, and after the financial market collapse of 2008. It rises in expansions.

Moreover, despite much nonsense from supply-side economists and their followers, revenue falls after tax cuts. When Reagan tax bills cut corporate rates, it took 14 years for revenue from that tax to return to its pre-cut high under Jimmy Carter. And after George H.W. Bush and Bill Clinton sought and got tax increases in the early 1990s, revenues soared just as they had after Lyndon Johnson secured a temporary surtax to fund the Vietnam war in 1968.

In many cases, factors overlap. Revenues did fall because of a recession. In the early 1980s but also because the Reagan tax rate cuts hit. Relative to output, total federal revenue did not return to 1981 levels until 15 years later. Similarly, the rapid rises in revenue in the 1990s stemmed partly from tax rate increases, but also from an internet boom. They fell in the new millennium because of Bush 43 tax cuts. (Parenthetically, these cuts ostensibly were instituted because we were on track to pay off the national debt by 2012!). But the post 9/11 recession also was a major cause of lower revenues.

Revenues from the individual income tax have been as stable as overall revenue for decades. That is not true for FICA and for the corporate income tax. The first have increased notably, the second faded away. In 1947, corporate taxes made up a fourth of all federal revenue. Now it is about a tenth. The long-run trend is down. It began before the Reagan cuts in rates, but those accelerated the trend.

FICA has increased sharply and causes nearly all the rise in the “social insurance” rubric. This is due to increases in rates up to 1983 and, for many years, to the ongoing entry of baby boomers into the labor force. Since FICA withholdings apply from the first dollar earned, with no exemptions or credits, they always have been more important to low-income working households than income tax rates. In the 1990s there was a crossover, so that a majority of U.S. households pay more for Social Security and Medicare than they do in income taxes.

The upshot is that we get much less from taxing corporations, regardless of who bears the final burden of that, and much more from taxing lower-income people.

The last FICA increases were in response to the Greenspan Commission recommendations to put these programs on a sustainable footing for Baby Boomer retirements. But the workings of its recommendations were not obvious. Congress needed to pay down other debt as we increased a balance in FICA accounts. Instead we used FICA surpluses to hide large deficits in general categories for 30 years. That politically popular act of collective self-deception has now come around to bite us in our collective posteriors. That is the big issue that editorial writers blithely ignore and politicians to flee as if it were a vile disease. The wolf has finally come. But that is the subject for another column.