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August 7, 2006
What's a New Democrat to Do?
by Joseph J. Thorndike
Article originally published in
Tax Notes
The Politics of Federal Taxation
Tax Notes, Aug. 7, 2006.

Full Text Published by Tax Analysts®

Democrats have a problem. Well, they have several problems, but arguably their biggest and most intractable is how to respond to economic globalization. To the extent that they have a response, it tends to be inconsistent, anachronistic, and often irrelevant.

To be fair, Republicans have many of the same issues. Both parties are riven by internal dissent when it comes to hot-button topics like immigration and trade. But the problem is more serious for Democrats, since they want to — and indeed, must — preserve the social safety net that globalization seems poised to destroy. If Democrats can't find a way to keep the world safe for the American middle class (let alone the working class), they don't have much of a future.

And they know it. As they prepare for this fall's congressional elections and 2008's presidential contest, two Democratic factions are struggling for the soul of their party. In a recent article for The New Republic, Thomas B. Esdall describes the tension as a battle between Hillary Clinton and Howard Dean, which it surely is. But that particular fracas is about electoral strategy as much as ideology. The broader debate pits self-styled Democratic moderates against the party's so-called netroots — activists defined by their penchant for liberal blogs.

In late July, the moderates took another shot at drafting a substantive response to global economic competition — and the insecurity that seems to flow from it. On July 24 the Democratic Leadership Council (DLC) released its "American Dream Initiative," a collection of policy nostrums designed to assuage the burgeoning insecurity of a broadly defined middle-class electorate. "At the core of the American Dream is the proposition that working hard and playing by the rules is the ticket to prosperity and security," the DLC declared. And apparently the tax code is a great way to keep that dream alive.

The Democratic Problem

In a recent article for The Democratic Strategist, a new online magazine, Harold Meyerson nicely captured the Democratic quandary. "At bottom," he wrote, "the Democrats — and parties of the left and center-left across the planet — are parties of broadly shared prosperity." In the decades after World War II, as median income and productivity rose together, Democrats were able to consolidate and expand the social safety net first created in the 1930s. Global economic pressures, while not absent, were not the destabilizing force they are today.

In recent decades, competitive pressures have brought an end to that happy era. Increasingly, productivity gains have gone to the rich, Meyerson contends, and income gaps have grown dramatically. No longer can Americans lay claim to the notion of shared prosperity and economic security. "Globalization, immigration, deunionization, the decline of manufacturing, and the rise of a financial sector and culture enamored solely of shareholder value have combined to imperil one of America's defining achievements — the creation of the world's first majority middle-class economy," he says.

Meyerson is not a fatalist; he believes that if Democrats ever return to power, they can make things better by nationalizing healthcare, raising the minimum wage, and encouraging unionization. "But none of these changes," he warns, "would basically alter the DNA of American financial and corporate institutions, which ceaselessly impels them to disaggregate firms, out-source work, and find the cheapest labor in a world brimming with cheap labor."

The real hope for the middle class, Meyerson believes, depends on an almost hopeless task: Corporate and financial institutions must be brought to heel and forced to acknowledge their responsibilities to their communities, not just their shareholders. "Doing that will take a reform and redefinition of corporate power at least as sweeping as that of the New Deal," he predicts. And given the influence of Wall Street leaders on the Democratic establishment, it won't be easy.

Meyerson does a great job laying out the Democrats' problems, but his confrontational approach to Wall Street is unpopular in many wings of the party. William Galston of the Brookings Institution, for instance, accepts Meyerson's diagnosis but offers a different prescription. "One possible strategy is to use public power to force the private sector to resume its post-World War Two role," he says. "There is, for example, no good reason why the minimum wage shouldn't be raised and then indexed so that its purchasing power doesn't undergo extended periods of decline."

But more generally, Galston maintains, Democrats should emphasize cooperation, not confrontation, with the private sector. Rather than trying to force companies to provide economic security, we should look to government as a guardian for the middle class. "We should free up the private sector to promote economic growth while using public instruments to foster economic security and equal opportunity," he writes. "We will need a rejuvenated public sector to pick up economic security responsibilities that the U.S. private sector assumed almost by accident, as an outgrowth of World War Two-era wage and price controls."

The Tax Policy Answer

Galston's approach finds more concrete expression in the DLC's American Dream Initiative. The plan stresses the obligatory buzzwords — there's lots of talk about "security" and especially "opportunity" — but it avoids contentious ideas that might threaten the relationship between Democrats and the business community. To be sure, the DLC program includes some tough talk about "wasteful corporate subsidies," but it emphasizes the creation of new programs and "opportunities" — government innovation rather than corporate regulation.

The American Dream Initiative is heavy on the sort of tax policy that President Bill Clinton made his hallmark — it's all about targeted tax credits. It includes, for instance, a new, refundable $3,000 college tuition tax credit that would replace a range of existing higher education credits, including at least two championed by Clinton in the 1990s. It would make the existing savers credit both permanent and refundable and add a 50 percent match for annual contributions up to $2,000. The program would also create a tax credit for companies that enroll employees in new, tax-preferred retirement accounts.

But wait — there's more. The plan also would provide:

    • a $500 savings bond for every new baby, allowing families earning less than $75,000 per year to add their child tax credit to this nest egg, tax-free;
    • a $5,000 refundable tax credit for down payment assistance on the purchase of a home;
    • an "affordable homes tax credit," patterned after the low-income housing tax credit, to encourage the construction of moderately priced housing;
    • an extension of the home mortgage interest deduction to nonitemizers; and
    • a 50 percent tax credit for qualified employers that offer employee housing-assistance programs.

And if all that isn't enough, the DLC program calls for third- party information reporting for capital gains. Now there's a good idea, a worthy proposition to be sure. It's also long overdue, given the capacities of our modern, computerized information age. But it's a strange addition to this collection of crowd-pleasing proposals — an oddly specific, even technocratic, idea no doubt designed to help pay the bills for the rest of the agenda.

On most of the major tax issues of our day, the DLC program remains silent. That is no small achievement, given the plan's emphasis on fiscal responsibility. Taxes will certainly play a starring role in future efforts to stanch the red ink that flows from Capitol Hill. But the DLC has nothing substantive to say about revenue, and even less to say about tax reform.

The DLC largely ignores the most fundamental question of federal tax reform — the treatment of capital income. To be sure, it includes provisions that seek to encourage tax-preferred saving by the middle class. That's a laudable goal, since the gap in capital ownership is growing prodigiously. As University of Chicago economist Austan Goolsbee points out in an article for the DLC's in-house magazine, Blueprint, "The average net worth of the top 10 percent of American families is almost 30 times greater than the average net worth of families in the middle 50 percent of the spectrum — and these disparities in net worth have been growing even faster than the disparities in income."

But if the DLC wants to answer Goolsbee's call to "democratize capital ownership," it needs to address the tax treatment of some forms of capital income, including capital gains and dividends. Rate cuts backed by the Bush administration have made the problem worse, not better. "Rather than encourage capital ownership among the middle and working classes," Goolsbee claims, "the Bush administration's dividend tax rate cuts for high-income people have further skewed the incentives in the wrong direction." The preferential rate for capital gains has had a similar effect.

The American Dream Initiative takes note of those facts, suggesting that the tax system "is upside down, giving the most benefit to the most fortunate — who do not need an incentive to save — and too little to families that desperately need a boost." But the DLC would correct that imbalance by adding goodies for the great unwashed, not by curbing incentives for the nation's upper crust.

The DLC also has nothing to say about corporate income taxes, although its indictment of "wasteful corporate subsidies" might be construed to include the issue. But more substantive discussion of the corporate tax burden is nowhere to be found.

Generally speaking, the DLC plan never really addresses the fundamental issue of tax policy in a global economy: the future of progressive taxation in a world of mobile capital. Taxes on capital income have long been regarded as a vital component of tax fairness. But in recent decades, experts have begun to question whether capital income should be taxed at all. Even more striking, some economists have suggested that taxes on capital income can't be made to work, at least not over the long term.

That's bad news for Democrats. Over the course of its long history, the party has stood for a lot of things: enhanced social spending, regulation of private enterprise, and — as Meyerson notes — a platform of shared prosperity. But for more than a hundred years, it has also stood for progressive taxation, defending it as a fiscal necessity and a moral imperative. Although the DLC plan offers some lip service to that ideal, it never really engages it directly. If the tax burden on capital income is low — and likely headed lower — Democrats need to figure out how to defend and preserve progressive taxation in our new, globalized world.

Joseph J. Thorndike is a contributing editor with Tax Analysts. E-mail:

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