Better To Tax Energy Usage Than Payrolls

Unveiling its recommendations last week, the president’s Tax Reform Commission took two swings at fundamental tax reform . . . and missed. The commission proposed substantial changes in the tax code, but missed the opportunity to address what’s fundamentally wrong with the American economy.
The more radical of the two basic proposals, a consumption tax, is essentially an income tax that substantially reduces taxation of earnings that are saved. At best, this might give personal savings a marginal boost. The more modest proposal would scrap many itemized deductions in order to eliminate the alternative minimum tax, which seeks to limit the size of itemized deductions.
There may be merit in both proposals, but they notably omit cuts in the largest tax paid by more than 80% of Americans, the regressive and job-killing payroll tax. As such, they ignore the fundamental direction of our economy and our workforce. That direction, due to several dangerous trends, is toward a perfect storm: First, baby boomers will soon begin retiring; by 2031 it’s estimated that there will be just 2.1 workers for every retiree. Second, experts increasingly project world oil production will peak within a decade or two, with sharp, sustained increases in energy prices.
Third, our dependency on foreign oil will continue to rise; by 2025, the Energy Department projects that we will import 70% of our oil, most of it from potentially unstable countries. Fourth, if concerns about global warming continue to mount, the U.S. may be forced to take draconian steps to reduce greenhouse gas emissions. Fifth, and perhaps most important, high labor costs in this country are contributing to the outsourcing of American jobs and the relocation of U.S. manufacturing to other countries.
If these trends converge, saddling our economy with rising budget deficits, crippling energy costs, a rapidly diminishing industrial base and a shrinking work force, a simplified tax code and a marginal boost in national savings will not fix it.
What could help is fundamentally shifting the tax burden away from employment (which we need to increase)and toward unsustainable consumption of nonrenewable energy and other natural resources (which we will have to tighten). In other words, cut payroll taxes. After decades of runaway payroll tax growth, we tax employment far too heavily. Seventy years ago, payroll taxes accounted for only 1% of federal revenues, but grew to 32% by 2000. Last year, they reached 39% percent of federal revenues — almost as much as individual income taxes.
The payroll tax is highly regressive—burdensome on low-income households and inapplicable on income above $90,000. Worse, it’s a job killer. It inflates hiring costs, reducing job creation and take-home pay, and discourages marginal workers from working. Meanwhile, we continue to tax consumption of scarce natural resources, like oil, far too lightly.
We should reverse those polarities by cutting payroll taxation and substituting higher taxes on the consumption of nonrenewable energy, like oil. That would lower the cost of labor, making U.S. workers more competitive and ultimately increasing the number of working, taxpaying Americans.
Leading labor economist Daniel Hamermesh estimates that a 10 percentage point drop in the payroll tax rate would boost employment by 3% in the short term and 10% in the long term. More workers would reduce projected budget deficits. A corresponding increase in taxes on consumption of oil and other fossil fuels would lower greenhouse gas emissions and boost renewable energy development, leading to leaner, greener industries adapted to the coming energy- and pollution-constrained world. It would also reduce dependence on foreign oil, making us less vulnerable to supply disruptions.
All this could be achieved without the heavy hand of government regulation or a net increase in taxes, simply by decreasing taxes on labor and increasing taxes on nonrenewable energy (and other scarce natural resources). That would create a tax revenue-neutral shift in price signals that now guide employers, workers and consumers. It would end distortion of market forces through undue taxes on employment, letting the market strike a more optimal balance between human and natural resources, hiring people vs. consuming things. That would be truly fundamental reform.
Support for this idea is growing among organized labor, business, policymakers and think tanks from the left and right alike, though the Tax Commission failed to reflect it. It’s time to listen to them and stop distorting the economy with our undue tax burden on employment.
Robert Walker is the president of Get America Working!,
www.getamericaworking.org, an employment policy group