Now that the election's over, we can just forget all that silly campaign rhetoric, right?
Well, yes, except that many of the controversial issues that animated the campaign will continue to divide politicians in Washington as they spar over important tax and spending policies. One of those issues—the "47 percent" who pay no federal income tax—is already a factor in the fiscal cliff negotiations that could make or break the economy in 2013.
Republican presidential candidate Mitt Romney put the 47 percent on the map by describing them to a group of donors as people who are "dependent on government" and, in general, freeloaders. Romney later recanted that characterization, yet the remarks, captured on videotape and made public less than two months before the election, ended up being one of Romney's most damaging gaffes.
Even though Romney lost, the 47 percent are still a problem—but not for the reasons Romney highlighted. Ample analysis has made clear that the 47 percent of households that pay no federal income tax aren't deadbeats or tax dodgers. For the most part, they're elderly folks exempt from income tax and low-income earners who simply fall below the tax threshold. Most pay other types of tax, such as sales tax or federal withholdings for Social Security and Medicare.
But those who do pay income tax have a valid point when they complain that something seems wrong when nearly half of the population can avoid one of the most elemental forms of tax. It stokes class resentment and creates the impression, accurate or not, that the government favors one group over another. That's why raising taxes on anybody—even those who can afford it—is likely to turn the fiscal cliff negotiations into a political bloodbath.
Obama could ease these tensions in a couple of ways. First, he could vow to make it a second-term priority to lower the proportion of people who don't pay income tax. That would probably be an easy win. Before the Great Recession began in 2008, the number was 40 percent, not 47 percent. It rose because two things pushed more people below the tax threshold: Temporary tax breaks passed in 2009 to ameliorate the effects of the recession, and layoffs that cut into people's income.
Those tax breaks have mostly expired, and the economy is recovering, which will naturally deflate the ranks of the 47 percent. The nonpartisan Tax Policy Center projects that the proportion of households paying no income tax will fall to 36 percent by 2016. If that happens and Obama fails to call attention to it, he'd be passing up free political points.
There's a bigger problem, though, because the portion of Americans exempt from income tax has been rising over time, due mostly to new deductions such as the earned-income tax credit (which generally has bipartisan support). Few economists think it would make sense to kill tax credits that basically encourage low-income people to work. But there's more support for axing loopholes if reforms also simplify and flatten out the tax code, which could make most Americans better off if done right.
The 2010 Bowles-Simpson commission, for instance, proposed lowering tax rates, eliminating most deductions and "broadening the base," which is Washington-speak for making more people pay taxes. Under that plan, the tax bill for low-income earners would go up by a little, while the tax bill for the wealthy would rise a lot more. But in general, taxes would go up for everybody, which would raise badly needed revenue in a way that seemed reasonably fair to everybody, while enhancing confidence in the tax code by removing a lot of the potential for trickery.
There's one final thing that could increase the ranks of those who pay taxes: Inflation. No president would openly call for high inflation, but it's not quite as evil as it sounds for an overindebted nation like America, since it deflates debt (which is usually denominated in past dollars) faster. And if incomes rose faster than tax brackets, more people would fall above the cutoff for income tax payments year after year. If that were to happen any time soon, candidates might be hollering about inflation in 2016, but they'd have little to say about the 47 percent.
Rick Newman is the author of Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.