As we close in this year’s mid-term elections, we hear a lot of claims that are fairly outrageous on both sides, but at least the Democrats are being honest:  they want to increase taxes.  If elected, they would like to raise capital gains taxes, corporate taxes, small business taxes, and more.  Yet being honest on tax increases wasn’t always that way for Democrats, as today’s walk down memory lane shows.  I’m teaching Public Finance this semester, and as we study tax systems, we generally find the least excess burden (or loss in social welfare from people changing their behavior to avoid taxes) with an income tax that is proportional.  And in an era where politics corrupts almost all possibilities to do the right thing, the 1986 tax reform was arguably the best tax legislation ever from an economic point of view.  Most deductions were eliminated, and while we didn’t get to a true proportional (or flat) tax, the principles in that bill were to have two rates:  15% for most Americans, and 28% for the rich.  Yet as part of the negotiations, progressives and big spending Republicans like Sen Finance Committee chairman Bob Packwood from Oregon insisted that we actually have a higher 33% rate for income above a certain amount that would offset the benefits higher income taxpayers would receive from having some of their income taxed at only 15%.  So a 33% rate would capture that until every rich taxpayer had an average tax rate of 28%, not merely a marginal tax rate of 28%. But then once the average was 28%, the marginal tax rate (the tax on the last dollar of income earned) reverted back to 28%. As we read in an older article from that era,

“The irony is that the reformers who built more progressivity into the code are now being attacked for doing the right thing,” said Norman Ornstein, a congressional scholar at the American Enterprise Institute here. “But few people understand that this was not some crazy anomaly put in there to give an extra break to the rich.”  Despite all that, the bubble still has become a symbol of unfairness in the tax code. While Republicans would like to leave income tax rates alone in the current budget negotiations, Democrats believe that the bubble provides them the most powerful lever for extracting a tax increase from the well-to-do.

So in the spirit of what’s mine is mine, what’s yours is negotiable, it didn’t take long for progressives to being talking about a “bubble” in the tax code.  It was almost as if, Shazam!, how did this happen?  We accidentally created a tax code where middle class taxpayers have to pay 33%, while rich only have to pay 28%.  We have to fix this problem that we created!  Now aside from the deceitful rhetoric, you’ll notice the key thing–the bubble could have been fixed by eliminating the 33% bracket.  Yet the solution, of course, was to raise taxes on the rich for fairness sake!  As Democratic Speaker of the House Tom Foley said,

“The highest-income people should be paying the highest tax rate, and not the people who are a step below,….In correcting that, we are not creating a new tax.”

There were honest Democratic politicians who correctly called it as they see it, such as Senator Bill Bradley of New Jersey:

”Many people believe-incorrectly-that taxpayers (now) subject to the 33 percent rate are being treated unfairly compared to higher-income taxpayers whose top marginal rate is 28 percent,” said Sen. Bill Bradley (D-N.J.), who helped write the bubble into law.  ”In fact,” he added, ”the bubble does not reward the rich. It enhances the tax system`s progressivity.”

But in a world of rational ignorance, and a world of complicated tax policy,

Byrle M. Abbin, the top tax specialist in the Washington office of Arthur Andersen, the accounting firm, captures the full irony of today’s debate. “The bubble,” he said, “may be the first tax provision ever repealed simply because it was hard to explain why and how it works.”

So the lesson for today is that as in years past, the rhetoric from Washington DC is likely to be disingenuous at best.  Especially when it comes to separating you from your money!