Income taxes may hold, but don't count out a new tax on sales
The outcome of last week's election will not make management of economic policy easier. President Reagan won an impressive personal victory, coming close to a record in the percentage of the popular vote and a record high in the electoral college vote. But Republicans scored no such triumph in Congress, losing a net two seats in the Senate and gaining only 14 in the House, about half their '82 loss.
Some kind of tax package will go before Congress next year. The Treasury will report on its tax simplification proposals in December. It is widely felt that the President will propose some version of a flat tax, which, while revenue-neutral in theory, would be the Trojan horse of tax increase. That perception is not necessarily correct, since Mr. Reagan still appears to be standing by his campaign pledge not to raise individual income taxes.
There are, in fact, three reasons that taxes may not get raised in 1985. The first is that the President is not yet convinced of the need for making faster progress in reducing the federal budget deficit, with its causative links to high real interest rates and an overvalued dollar on foreign-exchange markets.
The second reason is that Democrats in Congress have little incentive to take the lead in trying to increase taxes, especially when it would take the President off the hook he put himself on during the campaign.
The third reason is that, if the economy continues to soften, a tax increase could be even worse than the deficit. One can hope that a tax increase would coincide with a push by the Federal Reserve to bring down interest rates. The size of any tax hike that could be agreed upon by both parties, however, is not likely to be significant enough to cause a drastic change in Fed policy.
This line of reasoning may be leaving something out - but it isn't clear what that ''something'' is. One may have to face the possibility, therefore, that the federal deficit will continue at the $175 billion level or even rise from there again.
But there is one ray of hope in all this. In a television interview used on the MacNeil/Lehrer TV show last Thursday, White House Chief of Staff James Baker said three things regarding the deficit. The first was that the President will continue to push for budget cuts. The second was the well-advertised plan for some kind of tax simplification. The third was that the tax base needs to be broadened.
By calling for a broadening of the base, Mr. Baker may have only meant eliminating more loopholes and legal tax shelters. These, however, would presumably be eliminated in any tax simplification.
So I would conclude that when he refers to broadening the base, he must be referring to taxing the income that now escapes taxation - the so-called underground economy. This income can be taxed as it is spent by means of a value-added tax or a national sales tax. And such a tax could be revenue-neutral for honest taxpayers if they adjust their allowable personal income deductions. It could also, in effect, be rebated for the poor who do not pay personal incomes taxes by not collecting it on essentials such as food and rents.
The Democrats in the House have little reason to cooperate on a tax increase, in view of the President's strong campaign language on the subject. But Mr. Reagan could sell Congress by going to the people on a VAT or national sales tax on grounds of fairness - making those who now escape taxes illegally pay their fair share. Therefore, it seems logical that part of the tax program for '85 will be built around this kind of consumption tax.