Howard Gleckman’s August 4 TaxVox post on tax increases and small business reminds me of the debate over the Clinton deficit reduction proposals in 1993.  Then, as now, a new Democratic President proposed to raise tax rates on the highest individual income taxpayers.  Then, as now, Republican opponents portrayed the proposal as a tax increase on small business that would kill jobs and stop the recovery.  A June 24, 1993, Washington Post story by David Hilzenrath headlined, “Income Tax Hike Stirs a Debate on Jobs Impact; Administration Rejects Claims Small Business Would Be Hurt,” reported, “As the Senate began considering President Clinton’s deficit-reduction plan yesterday, Republicans charged that the income tax increase he says is aimed at the rich would hit small businesses and jeopardize their growth.”

Hilzenrath went on to cite then Senate Minority leader Robert Dole (R-Kan), who claimed that “half the tax increase because of the rate increases is going to be paid by small business and they’re not rich.”  And, added, Senator Conrad Burns (R-Mont), “the bill takes away any incentive that small businesses have to create their jobs or even give an excuse to expand.”

In a similar vein, David Wessel and Jeanne Saddler reported in the July 20, 1993 Wall Street Journal that  “a Washington group headed by James Miller, President Reagan’s former budget director … is running ads … that label the tax bill a ‘job tax” that ‘crushes small business’.”

If the charges by opponents of the tax increase sound familiar, so do the Clinton Administration’s then responses.  Hilzenrath reported Assistant Treasury Secretary for Tax Policy Leslie Samuels (who supplied me with the articles I cite) as responding “What the Republicans are saying is what they’ve always said: Don’t tax wealthy people.”

Wessel and Saddler noted that “the Treasury doesn’t dispute the fact that well-off small-business owners will pay higher income taxes, just as will well-off bankers, orthodontists, and Exxon Corp executives.”  But “only 4 percent of those taxpayers who report some business income on their tax returns – and that includes partners in law firms and investment banks as well as owners of small manufacturing companies – make sufficient money to be hit by the higher tax rates.”  (The current figure that Howard cites from TPC data is 2.5 percent.)

What followed is well known to everyone.  Congress narrowly enacted the Clinton budget proposals.  The following year, Republicans won control of both houses of Congress, capturing the House for the first time in 40 years.   But the economy boomed.  The 1990s saw one of the strongest economic expansions in U.S. history, with over 20 million new jobs created.  And the federal budget moved into surplus for the first time since 1969. 

We can debate endlessly whether the Clinton tax increases helped promote this recovery or just prevented it from being even stronger.  And today’s economic and budgetary situation is far worse than what the country faced in 1993.  But one thing is for sure – the dire warnings that the 1993 tax increases would “crush small business” and “kill jobs” – never materialized.

As I contemplate the furor over the Tax Policy Center’s calculation that 47 percent of Americans owed no income tax in 2009, I am reminded of Don Alexander, who was an IRS Commissioner during the Nixon and Ford Administrations. For decades Don, who passed away last year, argued passionately that the IRS’s job is to collect tax revenues, and not administer social programs. And that conflict is at the root of the 47 percent controversy.

The share of Americans owing income tax has dropped so much in recent years mainly because of increased spending through the tax code – expansion of the earned income credit, introduction and expansion of the child credit, and President Obama’s making work pay credit. All of these programs are defensible – but as spending programs to achieve public policy objectives, not as measures to promote a fair distribution of the tax burden based on ability to pay. 

In 2002, Don and I served on a working group that produced a Century Foundation-sponsored report called “Bad Breaks All Around.”  The study critiqued tax expenditures – provisions in the revenue code that provide special benefits for certain industries or activities.

The panel agreed that tax expenditures in general are problematic. They distort economic decisions, often benefit high-income individuals and corporations disproportionately, and subvert the budget process by enabling backdoor spending through the tax code. But most members liked some tax expenditures – especially the earned income credit (EITC), a substantial benefit for low-income working families. Several reasons, including administrative convenience, were advanced as to why it is best to administer this assistance through the tax code.  I am among those who have asserted that a tax incentive is sometimes better than a direct outlay as a way to administer a government subsidy program.

Don disagreed. He was not opposed in principle to federal subsidies for low-income working families.  But he believed that the purpose of the tax code was simply to raise revenue to fund public programs and that it was not the IRS’ job to administer social programs. Don argued with Milton Friedman about this when the EITC was first proposed in the 1970s – and lost when President Ford backed the EITC.

Perception matters.  Tax wonks can argue until they are blue in the face that these programs are spending and that recipients of these subsidies are really paying positive taxes before getting their benefits. I totally agree with this logic, but it is a tough sell.

I recall an equally tough sell when President Reagan greatly expanded investment tax incentives in the 1981 tax cut bill.  Some smart tax lawyers realized that corporations in a loss position could not use these benefits, so they persuaded Congress to enact a “safe harbor leasing” provision that effectively enabled these companies to sell their tax benefits to profitable corporations that could use them. The result that large profitable corporations ended up paying no income tax generated a public uproar, not unlike today’s, although it was driven by very different political forces and directed at a much different target. It did not matter how much Treasury tried to explain the logic of allowing these transactions. Nor did it matter that the sellers of the tax benefits, not the profitable companies buying them, reaped most of the benefits. Safe harbor leasing was repealed in 1982.

So we may have to reconsider how we provide benefits to low-income and other households. People will look at how much different taxpayers remit to the IRS – no matter how much we explain that some provisions are really spending, not taxes, or that the real beneficiaries are not always those who send a smaller check to the IRS.  As the behavioral economists now remind us, perception often counts as much or more than reality.

By the way, Don Alexander should be remembered mainly for his courageous efforts to resist efforts by the Nixon White House to use the tax agency to punish the president’s perceived enemies. Don reminded me that Nixon was not the first president to do this. But thanks to Don’s efforts, he may turn out to have been the last.