How Do You Spell Relief?

Big tax cuts are in the
offing. The high priests of fiscal
discipline find their flocks deserting, egged on by
President George W.
Bush, the GOP, and the Janus-faced Federal Reserve Board
chairman. But
who will get the benefit?

Critics of Bush's tax-cut plan in both parties appear to be
at
something of a loss to propose alternatives that aren't
slightly
souped-up versions of Vice President Al Gore's proposals or
scaled-down
versions of Bush's. The possibility of tax cuts that are big
and good at
the same time seems to elude them, and time is running out.

Bush insists that it's only fair to give the most tax relief
to the
rich because they have most of the income and hence pay most
of the
income taxes. But this formulation leaves out the biggest
tax paid by
workers of moderate income--the payroll tax, which Bush
would leave
untouched. Because most workers with incomes under $35,000
pay little or
no income tax, Bush's plan gives them little or no relief.
Put
payroll-tax relief on the table, as we propose, and the
equation changes
dramatically. Since payroll-tax receipts are now being used
to pay off
federal debts incurred outside of the Social Security
program, it's
perfectly fair to add payroll-tax relief to any tax-cut
package.

The total tax cut seems to be converging on a point between
Bush's
proposal, which could cost $2 trillion over 10 years, and Al
Gore's
campaign proposal of $500 billion. So let's prudently
presume a total
tax-cut package of $1 trillion. Unlike the Bush package,
whose
provisions are backloaded to conceal long-term cost, our
estimate
reflects immediate and full phase-in, with a first-year cost
of $72
billion.

During the campaign, Bush proposed a reduction in marginal
income-tax
rates, a new two-earner deduction, a new 10 percent bottom
bracket, a
doubling of the Child Tax Credit, and the repeal of the
estate and gift
taxes. His cuts are spread broadly, but the top 1 percent of
taxpayers
get almost 43 percent of the money, according to an analysis
by Citizens
for Tax Justice
. During the campaign, Al Gore harped on this
theme, but
in doing so he glossed over the extent to which many
families of
moderate income would see some tax savings under Bush's
plan. So Bush's
cuts were seen as widely spread, or "general tax relief,"
while Gore's
were thought to be selective and narrow. Our approach, by
contrast,
would make clear that ordinary working families could get a
lot of
relief.

Here are four options for tax relief that are fairer, better
policy
than the Bush plan.

Option 1. Cut the payroll-tax rate. A rate cut reduces the
infamous
marginal tax rate on labor and therefore provides incentives
for
employers to create jobs and for employees to work harder or
longer and
reap more rewards from work. By far the simplest, this
option is also
controversial since it diverts revenue from the Social
Security trust
fund. But we could easily dedicate sufficient revenue from
the more
progressive income tax to replace lost payroll-tax proceeds.

This sort of interfund transfer is not well regarded in
Congress.
Still, it is less politically controversial than other
options, such as
using trust fund surpluses to purchase stocks and bonds or
adopting a
privatization plan that diverts payroll-tax revenue into
individual
investment accounts.

Though straightforward, a simple cut in the payroll-tax rate
fails to
target enough relief to those who need it. A trilliondollar
tax cut
would finance a payroll-tax cut of 1.9 percentage points. So
a minimum
wage worker would realize not quite $200, an average-wage
worker about
$600. There are better ways to target a trillion dollars of
tax relief.

Option 2. Exempt a portion of wage income from payroll
taxes. A
trillion dollars of relief would allow us to exempt the
first $7,700 of
wage income from the payroll tax. This would save wage
earners almost
$600 a year in payroll taxes. The simplest approach would be
to give
workers a refundable credit against income-tax liability for
payroll
taxes paid, up to a fixed dollar amount. It would be
available to all,
regardless of whether or not the taxpayer claims dependents.

This approach resembles option 1, but targets more relief to
lower-wage workers. Earnings over $7,700 would subject to
the current
payroll-tax rate of 7.65 percent. There are limits to this
sort of tax
relief because taxable payroll is not progressively
distributed.

Option 3. Increase the Child Tax Credit and make it fully
refundable.
Current law provides a $500 tax credit per dependent child,
but it can
only be used to offset positive income-tax liability. This
grossly
violates candidate Bush's promise to "leave no child
behind." The Center
on Budget and Policy Priorities
says 24 million children do
not benefit
from this provision of the Bush package. The reason is that
12 million
working families with children do not owe enough income tax
to take
advantage of the child credit. But most of them do pay
payroll taxes.

Some advocates propose a pure refundable credit. A family
with no
income could file an income-tax form and get a check from
the
government. This is tantamount to cash welfare, however, and
is thus
politically improbable.

More likely, a refundable Child Tax Credit could be
phased in
according to some definition of qualifying income. This
option simply
expands an existing feature of the tax system. Also, it
provides equal
relief per child regardless of income level once the credit
is fully
phased in. A further advantage is that it can take the Bush
proposal--for a larger, nonrefundable credit--as a point of
departure.

We estimate that a refundable Child Tax Credit of $1,800 per
child
can be financed with a trillion dollars over 10 years. A
family would
need at least $10,000 of income to receive the full credit
for each
child. Such an approach, by definition, concentrates relief
on
households that have children

Option 4. Simplify and integrate existing tax credits. Our
favorite
plan--dubbed the Simplified Family Credit--would integrate
the Earned
Income Tax Credit (EITC), the Child Tax Credit, the
Additional Child
Credit, and the dependent exemption into a single,
expanded, simplified
credit. None of the preceding options does anything to
simplify or
rationalize the tax code. Neither does the Bush proposal. It
would be a
pity to spend a trillion bucks and not accomplish some tax
simplification and improvement in incentives for work and
marriage.

For technical details about the Simplified Family Credit,
see the
paper "Giving Tax Credit Where Tax Credit Is Due" by Max B.
Sawicky and
Robert Cherry [available through the Economic Policy
Institute at
www.epinet.org]. The
proposal is an effort to fulfill a range of aims:
general, progressive tax relief; tax simplification;
enhancement of work
incentives; and reduction of marriage penalties. The plan is
a bit more
complicated than the three options outlined above, but this
at once
reflects its virtues as much as weakness. Simplifying taxes,
paradoxically, raises some complicated issues. In
particular, replacing
four provisions with one is not as easy or simple as adding
a new
provision to the tax code or expanding an existing one.

Here's how the Simplified Family Credit would work. As a
taxpayer's
earnings increase, the credit phases in, starting at a rate
of 50
percent of earnings. It "maxes out" at a level that exceeds
that of the
current EITC. For example, a family with two children and an
income of
$25,000 could get a refundable credit of $4,600, given our
trillion-dollar budget constraint. The benefits go to almost
all
families with children, including those who qualify for the
present
EITC.

The phase-down of the credit as income continues to increase
is more
gradual than that of the EITC, and there could be a minimum
credit of
$1,900 per dependent child available to all taxpayers with
kids. This is
well over the present value of the dependent exemption and
Child Tax
Credit in the 28 percent income-tax bracket, which is
$1,284. It also
exceeds the benefits of Bush's proposed $500 increase in the
Child Tax
Credit. Unlike the EITC, the Simplified Family Credit
increases if there
are more than two children in the family.

In contrast to any of the foregoing options, the Simplified
Family
Credit significantly reduces marginal tax rates and marriage
penalties
for many families currently eligible for the EITC. In
addition, the
simplified credit means that a number of worksheets, forms,
tax tables,
and instruction books can be replaced with a single page
that consists
of a 12-line worksheet and a simple table.

The Simplified Family Credit can be targeted in a more
progressive
fashion than any of the options above, since the phase-in,
phase-down,
maximum, and minimum benefits can be adjusted to suit equity
criteria
without destroying the overall design. Combinations of these
options are
conceivable. There is not much in the Simplified Family
Credit or in a
refundable child tax credit for persons without children;
and
conversely, persons with children are not helped as much by
a
payroll-tax rate cut or refundable payroll-tax credit.

Whatever final decisions Congress makes, the Bush
administration is
just wrong to assert that we can't have greater tax relief
for working
families because they simply don't pay enough taxes. Once we
put
payroll-tax cuts on the table, that premise changes. Any of
these four
options is preferable to the Bush proposal on equity
grounds. And any
failure to devote a tax cut to working families with
children will be a
failure of politics, not technical economics.

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