Big tax cuts are in the offing. The high priests of fiscaldiscipline find their flocks deserting, egged on by President George W.Bush, the GOP, and the Janus-faced Federal Reserve Board chairman. Butwho will get the benefit?
Critics of Bush's tax-cut plan in both parties appear to be atsomething of a loss to propose alternatives that aren't slightlysouped-up versions of Vice President Al Gore's proposals or scaled-downversions of Bush's. The possibility of tax cuts that are big and good atthe 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 therich because they have most of the income and hence pay most of theincome taxes. But this formulation leaves out the biggest tax paid byworkers of moderate income--the payroll tax, which Bush would leaveuntouched. Because most workers with incomes under $35,000 pay little orno income tax, Bush's plan gives them little or no relief. Putpayroll-tax relief on the table, as we propose, and the equation changesdramatically. Since payroll-tax receipts are now being used to pay offfederal debts incurred outside of the Social Security program, it'sperfectly fair to add payroll-tax relief to any tax-cut package.
The total tax cut seems to be converging on a point between Bush'sproposal, which could cost $2 trillion over 10 years, and Al Gore'scampaign proposal of $500 billion. So let's prudently presume a totaltax-cut package of $1 trillion. Unlike the Bush package, whoseprovisions are backloaded to conceal long-term cost, our estimatereflects immediate and full phase-in, with a first-year cost of $72billion.
During the campaign, Bush proposed a reduction in marginal income-taxrates, a new two-earner deduction, a new 10 percent bottom bracket, adoubling of the Child Tax Credit, and the repeal of the estate and gifttaxes. His cuts are spread broadly, but the top 1 percent of taxpayersget almost 43 percent of the money, according to an analysis by Citizensfor 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 policythan the Bush plan.
Option 1. Cut the payroll-tax rate. A rate cut reduces the infamousmarginal tax rate on labor and therefore provides incentives foremployers to create jobs and for employees to work harder or longer andreap more rewards from work. By far the simplest, this option is alsocontroversial since it diverts revenue from the Social Security trustfund. But we could easily dedicate sufficient revenue from the moreprogressive 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 asusing trust fund surpluses to purchase stocks and bonds or adopting aprivatization plan that diverts payroll-tax revenue into individualinvestment accounts.
Though straightforward, a simple cut in the payroll-tax rate fails totarget enough relief to those who need it. A trilliondollar tax cutwould finance a payroll-tax cut of 1.9 percentage points. So a minimumwage 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. Atrillion dollars of relief would allow us to exempt the first $7,700 ofwage income from the payroll tax. This would save wage earners almost$600 a year in payroll taxes. The simplest approach would be to giveworkers a refundable credit against income-tax liability for payrolltaxes 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 tolower-wage workers. Earnings over $7,700 would subject to the currentpayroll-tax rate of 7.65 percent. There are limits to this sort of taxrelief 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 canonly be used to offset positive income-tax liability. This grosslyviolates candidate Bush's promise to "leave no child behind." The Centeron 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 noincome could file an income-tax form and get a check from thegovernment. This is tantamount to cash welfare, however, and is thuspolitically improbable.
More likely, a refundable Child Tax Credit could be phased inaccording to some definition of qualifying income. This option simplyexpands an existing feature of the tax system. Also, it provides equalrelief per child regardless of income level once the credit is fullyphased in. A further advantage is that it can take the Bushproposal--for a larger, nonrefundable credit--as a point of departure.
We estimate that a refundable Child Tax Credit of $1,800 per childcan be financed with a trillion dollars over 10 years. A family wouldneed at least $10,000 of income to receive the full credit for eachchild. Such an approach, by definition, concentrates relief onhouseholds that have children
Option 4. Simplify and integrate existing tax credits. Our favoriteplan--dubbed the Simplified Family Credit--would integrate the EarnedIncome Tax Credit (EITC), the Child Tax Credit, the Additional ChildCredit, and the dependent exemption into a single, expanded, simplifiedcredit. None of the preceding options does anything to simplify orrationalize the tax code. Neither does the Bush proposal. It would be apity to spend a trillion bucks and not accomplish some taxsimplification and improvement in incentives for work and marriage.
For technical details about the Simplified Family Credit, see thepaper "Giving Tax Credit Where Tax Credit Is Due" by Max B. Sawicky andRobert Cherry [available through the Economic Policy Institute atwww.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'searnings increase, the credit phases in, starting at a rate of 50percent of earnings. It "maxes out" at a level that exceeds that of thecurrent EITC. For example, a family with two children and an income of$25,000 could get a refundable credit of $4,600, given ourtrillion-dollar budget constraint. The benefits go to almost allfamilies with children, including those who qualify for the presentEITC.
The phase-down of the credit as income continues to increase is moregradual 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 iswell over the present value of the dependent exemption and Child TaxCredit in the 28 percent income-tax bracket, which is $1,284. It alsoexceeds the benefits of Bush's proposed $500 increase in the Child TaxCredit. Unlike the EITC, the Simplified Family Credit increases if thereare more than two children in the family.
In contrast to any of the foregoing options, the Simplified FamilyCredit significantly reduces marginal tax rates and marriage penaltiesfor many families currently eligible for the EITC. In addition, thesimplified credit means that a number of worksheets, forms, tax tables,and instruction books can be replaced with a single page that consistsof a 12-line worksheet and a simple table.
The Simplified Family Credit can be targeted in a more progressivefashion than any of the options above, since the phase-in, phase-down,maximum, and minimum benefits can be adjusted to suit equity criteriawithout destroying the overall design. Combinations of these options areconceivable. There is not much in the Simplified Family Credit or in arefundable child tax credit for persons without children; andconversely, persons with children are not helped as much by apayroll-tax rate cut or refundable payroll-tax credit.
Whatever final decisions Congress makes, the Bush administration isjust wrong to assert that we can't have greater tax relief for workingfamilies because they simply don't pay enough taxes. Once we putpayroll-tax cuts on the table, that premise changes. Any of these fouroptions is preferable to the Bush proposal on equity grounds. And anyfailure to devote a tax cut to working families with children will be afailure of politics, not technical economics.
