HISTORY OFFERS INSIGHT INTO CURRENT ECONOMIC CLASS WARFARE

Keith Russell, Phd., C.M.A., is professor of Finance in Accounting, Southeast Missouri State University.

To better understand why the United States is engaging in economic class warfare, it is educational to look back in history.

To finance the Civil War, an income tax was passed in 1862. The tax was challenged on constitutional grounds. The Supreme Court found the tax valid. However, the tax was repealed in 1872. In 1894, Congress again passed legislation to enact an income tax. Under challenge, this time the Supreme Court found the tax to be unconstitutional.

The Congress amended the Constitution in 1909 to specifically allow for an income tax. In 1913, this amendment, the 16th, became law. Again, the Supreme Court listened to arguments against the income tax (progressive rates) but supported the language and intent of the 16th Amendment.

The Internal Revenue Code was established in 1939 with a complete codification of the rules and procedures. In 1954, another complete revision of the tax code was passed by Congress. Once Congress saw how easy it was to change the tax code, such changes have occurred with increasing regularity: 1962, 1964, 1969, 1976, 1978, 1981, 1986, 1987...

The capital gains tax has a shorter but more intense history. Prior to 1922, capital gains were treated the same as ordinary income. Individuals were given preferential treatment on capital gains between 1922-1942. The years 1943-1987 saw preferential treatment for capital gains for both individual and corporate tax payers. In 1988, preferential tax treatment for capital gains was disallowed.

Enough of the history lesson! Capital gains tax cuts and middle income tax cuts are both preferential in intent and, occasionally, impact. Both cuts provide specific tax dollar benefits to taxpayers at the "expense" of other taxpayers.

The earliest days of the income tax saw a tax with a specific purpose. Today's debate centers on redistributing wealth from the "haves" to the "have nots": tax policy has become an instrument of social activism. As this happens, it is easy to see how tax policy and impact have become so convoluted as to diminish their economic potential.

Presidential candidate Bill Clinton's middle income tax cut of "a dollar a day" for middle income families would come at the expense of upper income taxpayers. Their tax rates would increase. Meanwhile, President Bush has proposed a capital gains tax cut from 28 percent to 15.4 percent for assets held three years. He is accused of "favoring" the upper class who are seen to benefit most from a capital gains tax cut.

Who really wins, though, from tax cuts/changes? The answer is lawyers, accountants, legislators, AND the recipients of the preferential treatment.

Who loses? Everyone else. The middle income tax cut, if enacted, is projected to add $120 billion, yes BILLION, to the budget deficit over the next five years.

What is in the best economic interest of the United States then? A study by the American Council for Capital Formation (August, 1990) found the United States to be one of the least competitive industrialized countries in terms of capital gains taxation. That fact should concern a "capitalist" country and its voters more than which percentage of taxpayers benefit most or least from a cut in the capital gains tax. A high capital gains tax leads to a high cost of capital which in turn leads to a loss of competitiveness in the global capital arena.

Losing Jobs

Why do we lose jobs to international firms? The answer is non-competitive economic and tax policies such as capital gains and middle income taxes. Any market, other than a free market, pits one group of economic interests against another. Again, consumers/voters lose in the long run.

Jerry Brown has struck a responsive chord with voters who have listened to his 14 percent "flat-tax" proposal. He has a few "sacred cow" deductions, i.e., charitable contributions, home mortgage interest, and government transfer payments, however; voters instinctively understand the "fairness" of a flat tax. Their ability to make individual economic decisions is enhanced.

Detractors of a flat tax speak to its regressive nature. Lower income tax payers will pay a higher share of their income to meet the tax. However, it would be possible to set the floor for a flat tax at a high enough income so as to avoid disadvantaging low income taxpayers.

The real beauty of a flat tax is that higher income taxpayers/corporations would be able to figure their own tax, take those dollars currently involved in tax computation, and invest those dollars in an activity that would be economically beneficial to all citizens. The time and energy savings of such a flat tax would be large.

Rattling War Drums

What other alternatives involving tax policy changes would stimulate economic growth? At a minimum, index capital gains to inflation to insure that when such gains are realized, they are real. Also, it would be helpful if capital losses were fully allowed and not limited.

Furthermore, an end to the current favoring of debt financing over equity financing would slash the debt-to-asset ratio for U.S. corporations by seven percent, while adding approximately $25 billion to Gross National Product each year. Can you hear the war drums rattling, though? I can. These proposals would "favor" the corporations in this country.

So what! We need to "favor" corporations if we expect them to be competitive internationally and keep jobs and capital investment dollars in the U.S.

Middle income versus capital gains tax cuts, actually, are non-issues in the overall battle to re-energize the U.S. economy. This type of class warfare discussion does not shift the paradigm, which is currently that the U.S. is over-taxed and over-regulated. It is time to shift this paradigm: stop fine tuning the economy and let a free economy work.