How Do You Spell Relief?
Max B. Sawicky and Robert Denk
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.epi.net.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.