President George W. Bush is in Europe trying to craft a transatlantic relationship of legacy quality. Still, his domestic legacy also needs attention. Indeed, if Mr Bush does not act fast, he will be too late to stop damage to the single most important element of that legacy: a relatively competitive US economy.
A single phrase - "good ideas" - created the problem. The president is leading the charge to reform and privatise Social Security, the US pension plan. Like the tax cuts that came earlier, these are both measures that would strengthen his economic legacy. After all, with a solvent pension system and dropping tax rates, the latter a "W" trademark, the US would be better positioned than most developed nations to handle growing challenges from developing ones (read, China). Things were looking especially good in midweek, when Alan Greenspan, the Federal Reserve Board chairman, blessed the main components of the Bush plan. Looking good, that is, until Mr Bush allowed that he might consider raising pension taxes on higher earners to fund his changes, among other "good ideas".
Currently, each worker pays 6.2 per cent of wages in social security taxes; his employer pays another 6.2 per cent. But that total 12.4 per cent tax applies to only the first $90,000 of income. Mr Bush suggested to the New Haven Register that he would be open to removing that $90,000 cap so that all the income of higher earners would be subject to this payroll tax. He may have elaborated on his thoughts the next day, but no one heard him. The roars of rage from the Republican base drowned out all conversation.
Mr Bush's concession is being played as a political story and it certainly is one. His friends say he moved for tactical reasons, merely to woo Democrats - whose support is necessary - to the table. Nonetheless, tax-cutting is to Republicans what tourism is to the Caribbean: without it they lose their focus. Every Republican party official recalls the moment when George H.W. Bush, the president's father, first hinted that he would betray repeated pledges not to increase taxes. In a similar moment of fiscal tension - the 1990 budget negotiations - Mr Bush senior let drop the thought that he might allow "tax revenue increases" to narrow a deficit.
He went on to tarnish not only his legacy but Ronald Reagan's as well by raising rates and undoing the historic tax reform of 1986. The salient feature of the Bush change was an increase in the progressiveness of the rate structure. Mr Bush senior and his advisers wagered that by taking this action in 1990 they might be able to recover by 1992. But not even the Gulf War victory of 1991 nor German reunification could save him.
The most avid student of that bitter experience was the current President Bush, who went on to campaign as a tax cutter. Now he is also mooting an increase in progressiveness. The Republican blogosphere is already trying out the narrative. If Mr Bush repeats his father's error, the pair will go down in history as the two book-ends to an era of Republican fiscal hypocrisy. The symmetry is so neat as to terrify. Screen rights, anyone?
But the political drama obscures something more important - the economic consequences of cap lifting. It is possible, as even Charles Grassley, the Republican chairman of the Senate Finance Committee, is saying, that lifting the cap makes sense. After all, the federal budget is in trouble, with alarming numbers, just as in 1990. In a static and nominal sense, capturing more of the revenue from higher earners would do something for balance sheets.
Still, such calculations omit what the payroll tax increase would mean to the culture of entrepreneurship. Fewer than one in ten workers earns enough to be affected by a lifting of the cap. But many of those earners are job creators - lawyers, doctors and, most importantly, small businesses. The potential tax increase for these productive earners is enormous.
Last year, a couple earning $90,000 faced a marginal income tax rate of 25 per cent. If all of their wages (including the employer side) beyond the $90,000 mark were also subject to the payroll tax of 12.4 per cent, that would represent a significant increase in the household marginal tax rate. Since income tax rates are higher for higher earners, some households could see a tax rate approaching the 50 per cent line.
But of course they will not go quite that far, comes the standard rebuttal. The cap will not be lifted, it will merely be adjusted upward to cover, say, the first $200,000 in income. Or it will only be lifted on one marriage partner. And so on.
These arguments, however, miss a crucial point. National economies are just like markets: change matters on the margin, and one change begets similar changes. To lift the cap once is probably to lift it again. And to give in on this one tax is to open the door to raising other taxes - that, at least, was what happened to Mr Bush senior.
What is more, increasing such an important tax on labour signals that the US is open to heading in the European direction. This at a time when the only chance of sustaining US growth rates is for the country to become more like Asia. Mr Bush should cough twice, clarify and apologise. Apologies hurt, but even a thousand are worth it when it comes to preserving such a strong legacy as this one.
© Copyright 2005 Financial Times
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