In recent weeks there has been much discussion of President Bush's proposal
that would cut federal taxes by at least $1.6 trillion dollars over this
decade. While there was initially some controversy over the necessity of a
large tax cut, Chairman Greenspan's contingent endorsement seems to have
largely attenuated criticism of the President's plan. Indeed, the only
substantive issues raised in the past few days concerns the size of the tax
cut (Democrats have advocated an amount equal to only about half of the
President's plan) and the beneficiaries of the proposed tax cut. In this fact
sheet, we will briefly examine the President's plan, we will argue that the
tax cut should be larger and should be phased-in sooner, and we will provide
supplements to the President's proposal that generate large tax cuts for most
working Americans.
Our most important conclusion is that while some critics of the Bush plan have
rightly pointed out that most of the tax relief provided under his proposal
goes to high income earners, they have overlooked the fact that a relatively
small percent of all taxpayers do account for most of the revenue coming from
the federal income tax. Indeed, we estimate that if the bottom 75% of all
taxpayers were exempted from the income tax entirely, this would have provided
less than $135 billion of tax relief—less than a third of what we believe is
required. In other words, it is really not possible to design an income tax
cut that provides a significant amount of tax relief without providing
most of the benefits to those who pay most of the tax—that is, to high income
households. Thus, we must look for other kinds of tax cuts in order to provide
tax relief to low and middle income taxpayers. As we show, a payroll tax cut
does target relief to the majority of households. Indeed, for the vast
majority of US households, the payroll tax is more burdensome than the income
tax. Hence, we propose to supplement President Bush's tax cuts with payroll
tax relief. This could take the form of a temporary, refundable tax credit
against OASDI taxes paid. We will also discuss some other, smaller, tax
credits and spending initiatives that together with income tax cuts and
payroll tax cuts could generate the size of fiscal stimulus that will be
required in coming months.
The President's Proposal
President Bush's plan would gradually phase-in a reduction of marginal income
tax rates, an increase of child tax credits, a reduction of the marriage
penalty, and elimination of the estate tax. As originally formulated during
his presidential campaign, most of the tax cuts would have come far into the
future—only a $21 billion reduction was slated for 2002, gradually rising to
$126 billion by 2005 and to $233 billion by 2010. (Source: Joint Committee on
Taxation, May 3, 2000) While the President now proposes to accelerate the
phase-in, the current proposal still requires five years before the tax cut is
fully phased-in. According to the White House, "Under the President's tax
relief plan, the typical American family of four will be able to keep at least
$1600 more of their own money" once the phase-in is complete. However, many
analyses have questioned this claim; one analysis shows that 27% of all
taxpayers would receive no tax cut under the Bush plan; another argues that
"when the tax-rate reductions and child credit expansion in the Bush plan are
fully in effect, 85 percent of families would either receive a nominal tax cut
of less than $1600 or receive no tax cut at all." (Center on Budget and Policy
Priorities, 2/9/01 and 2/14/01) The Democratic leader of the Senate, Tom
Daschle, argued that while a millionaire would receive a tax cut of $46,000,
"a typical working person" would get only $227. (NYT, Sanger, 9/2/01)
According to an analysis conducted for the New York Times by Deloitte
and Touche, Accountants, a single person earning $20,000 owes $1883 in federal
income taxes today; this would be reduced by $60 in the first year and by $300
per year once the Bush plan is fully phased-in. (See Table 1.) A married
couple with two children earning $60,000 currently pays $3050 in income taxes;
this family would receive first year savings of $380, rising to $1900 per
year. However, that same family earning $200,000 per year would have paid
$39,298 under current tax law, but will receive reductions of $1441 in the
first year and $6138 in the fifth year. Finally, a married couple with two
children earning a million a year would have paid $306,842 currently, and will
receive a tax cut of $11,421 in the first year, while saving $46,094 in the
final year. While savings under the Bush plan depend on family type, it is
clear that the savings reaped by upper-income families (for example, over
$45,000 per year for the family earning a million dollars a year) swamp the
meager savings of low income households—like the $168 savings accruing to a
married couple with two children trying to live on $20,000 per year. Thus, as
critics argue, most of the tax cut dollars will indeed flow to the highest
income earners, for the simple reason that they currently pay most of the
federal income taxes.
Table 1 [1]
|
George W. Bush's Tax Cut Plan
|
|
Family Type
|
taxes owed under current law
|
savings, 1st year of cuts
|
savings, cuts fully phased in
|
|
Single, $20K
|
$1,883.00
|
$60.00
|
$300.00
|
|
Head of Household, 1 Child, $20K
|
($691.00)
|
$176.00
|
$633.00
|
|
Married, Filing Jointly, 2 children, $20K
|
($2,553.00)
|
$33.00
|
$168.00
|
|
Single, $60K
|
$8,272.00
|
$211.00
|
$752.00
|
|
Married, Filing Jointly, no children, $60K
|
$5,880.00
|
$180.00
|
$900.00
|
|
Married, Filing Jointly, 2 children, $60K
|
$3,050.00
|
$380.00
|
$1,900.00
|
|
Married, Filing Jointly, 1 child, $100K
|
$13,308.00
|
$633.00
|
$2,603.00
|
|
Married, Filing Jointly, no children, $200K
|
$39,298.00
|
$1,441.00
|
$6,138.00
|
|
Married, Filing Jointly, 2 children, $200K
|
$36,565.00
|
$1,408.00
|
$7,480.00
|
|
Single, $500K
|
$173,175.00
|
$5,933.00
|
$23,621.00
|
|
Married, Filing Jointly, 2 children, $500K
|
$138,542.00
|
$4,621.00
|
$18,044.00
|
|
Single, $1,000,000
|
$311,997.00
|
$11,542.00
|
$46,758.00
|
|
Married, Filing Jointly, no children, $1,000,000 |
$306,842.00
|
$11,655.00
|
$47,114.00
|
|
Married, Filing Jointly, 2 children, $1,000,000
|
$306,842.00
|
$11,421.00
|
$46,094.00
|
[1] Source: New York Times:
www.nyt
imes.com/images/2001/02/09/national/taxtable_010209.html, Calculations by
Deloitte & Touche use estimated itemized deductions based on I.R.S. data
for incomes greater than $50K. Standard deductions are used for incomes less
than $50K.
As Table 2 below shows, about half of all US taxpayers had an unadjusted gross
income below $25,000 in 1998; fully 75% had an unadjusted gross income below
$50,000. Only 4% of all federal income tax was paid by the half of the
population with unadjusted gross income below $25,000; only 17% of all income
tax was paid by the three-quarters of all taxpayers earning under $50,000. By
contrast, only 13% of all taxpayers earned more than $75,000, but they paid
almost 70% of all federal income tax. Clearly, any tax cut proposal that
focuses on the income tax must give most of the relief, in terms of dollars,
to high income earners. Indeed, the half of all taxpayers who earn under
$25,000 paid just under $32 billion in income taxes. In other words,
completely eliminating all income tax liability for half of all taxpayers
would generate only $32 billion of tax relief—clearly insufficient to
accomplish much fiscal stimulus. Eliminating income taxes on the bottom 75% of
taxpayers (those earning less than $50,000) would generate a fiscal stimulus
of only $134 billion. According to our analysis, the fiscal stimulus required
is about $450 billion. To achieve that much stimulus, we would have to
completely eliminate income taxes on all but the top 2% of all income earners.
Further, as the tax due for the average taxpayer does not reach $1600 until
unadjusted gross income exceeds $22,000 per year, it is impossible to give
taxpayers with earnings below this a simple tax cut of $1600. True, expansion
of the Earned Income Tax Credit as well as refundable tax credits can target
more tax relief to those with little tax liability. However, if we are to
provide significant fiscal stimulus through an income tax cut, it will be
necessary to cut marginal tax rates at the top—as President Bush has
proposed.
Table 2[2-a]
|
CUMULATIVE
|
INCOME CLASSES
|
Size of adjusted gross income
1998
|
total income tax
(thousands)
|
% of total income tax
|
% of total income tax returns
|
Size of adjusted gross income
1998
|
total income tax
(thousands)
|
% of total income tax
|
% of total income tax returns
|
|
$1 under $25,000
|
31,650,337
|
4.01
|
49.30
|
$1 under $25,000
|
31,650,337
|
4.01
|
49.30
|
|
$1 under $50,000
|
133,805,834
|
16.97
|
74.58
|
$25,000 under $50,000
|
102,155,497
|
12.96
|
25.29
|
|
$1 under $75,000
|
242,726,962
|
30.79
|
87.42
|
$50,000 under $75,000
|
108,921,128
|
13.81
|
12.83
|
|
$1 under $100,000.
|
327,936,319
|
41.59
|
93.25
|
$75,000 under $100,000
|
85,209,357
|
10.81
|
5.83
|
|
$1 under $200,000
|
471,657,013
|
59.82
|
98.32
|
$100,000 under $200,000
|
143,720,694
|
18.23
|
5.06
|
|
$1 under $500,000
|
583,202,259
|
73.97
|
99.61
|
$200,000 under $500,000
|
111,545,246
|
14.15
|
1.30
|
|
$1 under $1,000,000
|
641,685,103
|
81.39
|
99.86
|
$500,000 under $1,000,000
|
58,482,844
|
7.42
|
0.25
|
|
All income earners
|
788,451,907
|
100.00
|
100.00
|
1,000,000 and above
|
146,766,804
|
18.61
|
0.14
|
[2-a] Source: Calculations based on I.R.S. data;
http://ftp.fedworld.gov/pub/irs-soi/98in03at.xls
A proposal to supplement President Bush's plan
This discussion should make clear that if additional stimulus is desired—as we
discuss in the next section—it should pursue an alternative direction. For
three-fourths of all Americans, the payroll tax (OASDI plus HI) is more
burdensome than the federal income tax. Furthermore, unlike the federal income
tax, it is regressive because income above a limit ($68,400 in 1998) is
excluded from the OASDI tax rate of 6.2%. This "payroll" tax has additional
undesirable features. It is levied on both employees and employers, both
reducing the benefits to working and increasing labor costs to employers. It
thus encourages employers to substitute labor for capital and to locate plant
and equipment in countries with lower overall labor costs. Because it
increases labor costs, it tends to be inflationary. The main point, however,
is that a payroll tax cut would provide significant tax relief to the vast
majority of Americans, while it would also reward work and make American labor
more competitive. Further, while much has been made of the growing federal
budget surpluses, most of the surplus achieved to date is due to huge
surpluses run in the Social Security program. Indeed, Social Security now runs
a surplus of about $150 billion per year; on current projections, this grows
to more than $300 billion per year by the end of the decade. Reducing payroll
taxes in order to bring the Social Security budget back into balance would
actually achieve as much fiscal stimulus over the next few years as
elimination of the income tax for the bottom 75% of all
taxpayers!
Table 3 provides an analysis of the OASDI portion of the payroll tax. In some
ways, it presents a mirror image to the income tax incidence presented above
in Table 2: those who earn less than $75,000 (87% of all taxpayers) account
for 73% of all OASDI taxes paid by individuals (we are ignoring the portion
paid by employers, however, the incidence would be similar). Thus, reducing
payroll taxes in order to bring OASDI back into balance would generate
significant tax relief that would be targeted mainly to the low and middle
income Americans who pay most of the tax. This supplements the Bush tax cut
plan, which targets tax relief to those who pay most of the income tax. We
suggest that payroll tax relief could come in the form of a fully refundable
credit against payroll taxes paid. We would further suggest that both
employees and employers would share in the tax relief. Given a current OASDI
surplus in the range of $150 billion, this would generate approximately $75
billion of tax relief for each employees and employers; of this about
three-quarters would go to taxpayers earning under $75,000 per year and to
their employers. We would make this tax credit temporary, to expire in three
to five years, after which permanent changes to the payroll tax would take
effect.
Table 3 [2-b]
|
CUMULATIVE
|
INCOME CLASSES
|
Size of adjusted Gross income
1998
|
total OASDI tax estimates*
(thousands)
|
% of total OSADI tax
|
% of total income tax returns
|
Size of adjusted gross income
1998
|
Total OASDI tax estimates*
(thousands)
|
% of total OASDI tax
|
% of total income tax returns
|
|
$1 under $25,000
|
44,996,741
|
18.66
|
49.30
|
$1 under $25,000
|
44,996,741
|
18.66
|
49.30
|
|
$1 under $50,000
|
114,928,295
|
47.67
|
74.58
|
$25,000 under $50,000
|
69,931,553
|
29.01
|
25.29
|
|
$1 under $75,000
|
175,055,406
|
72.61
|
87.42
|
$50,000 under $75,000
|
60,127,112
|
24.94
|
12.83
|
|
$1 under $100,000
|
205,679,508
|
85.31
|
93.25
|
$75,000 under $100,000
|
30,624,102
|
12.70
|
5.83
|
|
$1 under $200,000
|
232,253,455
|
96.33
|
98.32
|
$100,000 under $200,000
|
26,573,947
|
11.02
|
5.06
|
|
$1 under $500,000
|
239,064,969
|
99.16
|
99.61
|
$200,000 under $500,000
|
6,811,514
|
2.83
|
1.30
|
|
$1 under $1,000,000
|
240,366,979
|
99.70
|
99.86
|
$500,000 under $1,000,000
|
1,302,010
|
0.54
|
0.25
|
|
All income earners
|
241,096,414
|
100.00
|
100.00
|
$1,000,000 or more
|
729,435
|
0.30
|
0.14
|
[2-b] Source: Calculations based on I.R.S. data.
*Our OASDI tax estimates use reported IRS income data. For classes with
adjusted gross income of $75,000 and above, we have estimated the size of the
income, which is subject to OASDI tax by multiplying $68,400 by the number of
the returns for that income class. Individual incomes above $68,400 are not
subject to OASDI. The OASDI tax for different income classes is estimated by
multiplying the resulting taxable income by 6.2%, which is the OASDI rate for
1998.
There are two factors that are not accounted for in our estimates. Firstly, a
portion of the income tax returns is filed by self-employed individuals who
pay an OASDI rate of 12.4%. IRS aggregate data shows that self-employed
individuals pay only 1.8% of the total OASDI taxes. There is no breakdown for
separate income classes and hence we have not used the 12.4% in our
calculations, which biases them slightly downward. Secondly, people earning
$75,000 and above receive a significant portion of their income from property
income, which causes our numbers to be slightly underestimated. A comparison
of our aggregate data with IRS reported OASDI collections shows that these two
effects are not huge.
How large a fiscal stimulus is needed?
Most analysis has justified tax cuts on the basis of what can be "afforded"
given projected fiscal surpluses over the next decade. While many proponents
of tax relief have also argued that tax cuts will help to restore growth, or
at least to cushion the coming hard landing, most of these have constrained
their proposals to some portion of the projected surplus. However, as
Galbraith and Wray (NYT 5 February 2001) argued, "The purpose of a tax cut in
the face of risks of recession this year should be to support personal incomes
and economic growth this year, not to match hypothetical revenues to spending
needs over the decade ahead. Cutting taxes mainly for the sweet hereafter
could actually delay private spending plans and make our immediate economic
problems worse." In other words, one must project not budget surpluses but
rather the size of the fiscal stimulus that will be required. Based on careful
research conducted by Wynne Godley of the Jerome Levy Economics Institute, we
believe that the size of the fiscal adjustment required is at least 4.5% of
GDP. While we will not repeat the analysis here, this figure is obtained by
looking at the current size of the deficit spending of the private sector
(that is, spending in excess of income by households and firms)—which is over
6.5% of GDP. If the private sector were to bring its spending back into line
with its income (in other words, balance its budget), a demand gap of 6.5% of
GDP would open up, all else equal. As the economy slows, the trade deficit
will probably improve while state and local government surpluses will
disappear (together these changes will reduce the demand gap). Thus, we
conservatively estimate that a demand gap of 4.5% of GDP will remain to be
filled by federal government fiscal stimulus. In a ten trillion dollar
economy, this amounts to $450 billion.
President Bush's tax cut plan would provide an average of only $160 billion
per year of tax relief over the next decade. The actual stimulus that will
come in the near future will be lower because his plan is only phased-in over
the next five years. Even if his plan could be substantially accelerated, the
economy will still need another $300 billion, annually, of fiscal stimulus
(assuming that the total tax cut achieved under the Bush plan remains at about
$1.6 trillion over the next decade). Returning the Social Security budget to
balance would add $150 billion of tax relief annually to the President's plan.
Doubling the Earned Income Tax Credit would provide an additional $30 billion
annually, well-targeted to low income working families. Additional tax credits
could be provided for health care, educational, and child care expenses. A
temporary, fully refundable tax credit for every American (say, $250 for each
permanent resident, totaling about $70 billion based on an analysis done by
Appelbaum and Freeman, EPI Issue Brief #150) would provide substantial
and immediate stimulus, with the advantage that it could be made retroactive
to 2000. Together, these proposals might achieve close to $400 billion of tax
relief, buying time for Congress to find worthwhile spending programs to
supplement tax relief. The President has proposed additional educational
spending, and we would add substantial increases to public infrastructure
investment—on the order of $70 billion per year—to be phased-in over the next
half decade.
Some have objected that such large tax cuts will "cripple" future fiscal
policy by reducing future budget surpluses. On current projections, budget
surpluses will rise to 5.3% of GDP by 2011—even as economic performance
deteriorates relative to the robust growth we've seen in the past five years.
(See Table 4.) We do not believe these projections for a minute—the downturn
will eliminate the surplus and restore budget deficits if nothing is done
immediately to relax the fiscal stance. However, they demonstrate just how
imbalanced the current fiscal stance is. Taxes are simply far too high
relative to spending: federal taxes are currently at about 20.6% of GDP, while
spending is only 18.2%. By 2011, taxes will have fallen only slightly to 20.4%
of GDP while spending will have collapsed to just over 15% of GDP. A long-term
readjustment of federal spending and taxing must be undertaken to restore
balance.
Table 4 [3]
|
CBO's Baseline Budget Projections (By fiscal year) As a Percentage of
GDP
|
|
|
2000
actual
|
2001
|
2002
|
2003
|
2004
|
2005
|
2006
|
2007
|
2008
|
2009
|
2010
|
2011
|
|
|
Total tax revenues
|
20.6
|
20.7
|
20.5
|
20.4
|
20.3
|
20.3
|
20.2
|
20.2
|
20.2
|
20.3
|
20.3
|
20.4
|
|
Individual income
|
10.2
|
10.4
|
10.3
|
10.2
|
10.2
|
10.2
|
10.2
|
10.2
|
10.3
|
10.3
|
10.4
|
10.5
|
|
Social insurance
|
6.6
|
6.6
|
6.7
|
6.6
|
6.6
|
6.6
|
6.6
|
6.6
|
6.6
|
6.6
|
6.6
|
6.6
|
|
Corporate and other income
|
3.7
|
3.6
|
3.6
|
3.6
|
3.6
|
3.4
|
3.4
|
3.4
|
3.4
|
3.4
|
3.3
|
3.3
|
|
|
Total outlays
|
18.2
|
18
|
17.7
|
17.3
|
17.1
|
16.9
|
16.4
|
16.1
|
15.9
|
15.6
|
15.4
|
15.1
|
|
|
Surplus
|
2.4
|
2.7
|
2.9
|
3.1
|
3.3
|
3.4
|
3.8
|
4.1
|
4.3
|
4.6
|
4.9
|
5.3
|
|
On-budget
|
0.9
|
1.2
|
1.3
|
1.5
|
1.6
|
1.7
|
2
|
2.3
|
2.5
|
2.7
|
3
|
3.3
|
|
Off-budget
|
1.5
|
1.5
|
1.6
|
1.6
|
1.7
|
1.7
|
1.8
|
1.8
|
1.9
|
1.9
|
1.9
|
2
|
[3] Source: Congressional Budget Office
While it is not necessary for all of the adjustment to take place through the
tax system, it takes time to plan and undertake spending programs. Hence it is
wise to use tax cuts today and spending increases in the future to try to
eliminate the projected long-term demand gap created by the restrictive
fiscal stance—which amounts to more than 5% of GDP. By 2011, the $450 billion
in tax cuts and spending enhancements that we recommend for today would amount
to little over 2.6% of projected GDP. In other words, based on current
projections, our economy will still need a substantial spending "correction" a
few years down the road just to remove fiscal imbalances. And all of this
presumes that a recession can be avoided! The fiscal stimulus that will be
required could be much greater than this if economic growth falters.
Conclusion
In conclusion, the Bush plan targets much-needed tax relief to those who
account for most income tax revenue. However, his tax relief is too modest to
achieve the level of fiscal stimulus required. Further, it can be criticized
because it provides little relief for most Americans. Supplementing the
President's plan with tax relief for most taxpayers can be achieved through a
payroll tax cut. In addition to equity considerations, this can be defended on
the grounds that most of the budget surplus achieved to date results from a
payroll tax that is far too high relative to Social Security expenditures.
Indeed, the Social Security surplus will continue to grow in the years to
come. We realize, of course, that over the past two years there has been a
great deal of discussion over the "need" to run Social Security surpluses in
order to provide for future retirees; Candidate Gore went so far as to make
"lock-boxes" the central feature of his campaign. While we do not have the
space here to adequately deal with this issue, many analyses have concluded
that the Social Security Trust Funds are nothing more than an accounting
gimmick that cannot provide for retiring baby-boomers. (See the analysis by
Wray and Bell, CFEPS Policy Note 1/2000.) In any case, given that there
are large surpluses today and for the foreseeable future, a temporary payroll
tax cut will buy time during which analysis of the Social Security program can
continue. We believe that given the highly regressive feature of the payroll
tax (as demonstrated in the Table above, as well as other highly undesirable
features of the payroll tax—also discussed above), Social Security reform
should and probably will take the form of a broadening of the tax base—beyond
payrolls in order to include all personal income. However, the immediate
problem is that the overall fiscal stance is both structurally and cyclically
imbalanced. A large, temporary, payroll tax cut supplemented by a reduction of
marginal income tax rates can provide immediate fiscal stimulus and bide time
during which other forms of more permanent, structural, budget changes can be
discussed. 
|
