Beware of Tax Reform That Promises Deep Rate Cuts

By :: August 8th, 2013

Two new studies show just how hard a time Congress will have trying to slash tax rates without adding trillions of dollars to the budget deficit and producing a massive tax windfall for the highest-income American households.

Last week, the congressional Joint Committee on Taxation estimated that a tax plan that cuts individual rates to 10 percent and 25 percent and repeals the Alternative Minimum Tax would add almost $3.8 trillion to the budget deficit over 10 years. A plan to cut the corporate rate to 25 percent and repeal the corporate AMT would add another $1.3 trillion to the deficit.

Now the Tax Policy Center has looked at how the individual design would affect households in various income groups. Not only would such a rewrite dig a deep fiscal hole but it would also be extremely regressive. In 2015, it would cut taxes for those households in the lowest 20 percent of income (who will make roughly $25,000 or less) by an average of $3. By contrast, those in the top 1 percent (who will make an average of $2.1 million) would get an average tax cut of almost $145,000, a 10 percent boost in their after-tax income.

Middle income households (who will make an average of about $66,000) would get about $700, boosting their after-tax income by about 1.2 percent.

To put it another way, the top 20 percent of households would get nearly four-fifths of the tax cut. The top 1 percent would get more than half.

The TPC estimates use our new expanded cash income measure and thus are somewhat different than earlier estimates of similar proposals.

Keep in mind: No one has proposed a plan exactly like this. While many top congressional Republicans favor a similar rate strucure, they also say they’d pay for these rate reductions by curtailing (yet-unspecified) tax preferences.

The JCT revenue estimate and the TPC distributional analysis describe the challenges of enacting such a rate-cutting plan in a way that collects the same amount of money and maintains the same distribution as current revenue law.

Can this problem be solved?  Honestly, with rates this low, probably not. True, Congress could generate the $3.8 trillion in revenue it needs by slashing tax preferences. But since tax expenditures amount to about $1.4 trillion-a-year, popular preferences would have to be cut to the bone to fund a $3.8 trillion tax cut. We’re not talking about loopholes anymore.

Finding this much money would be especially hard since eliminating deductions and exclusions generates less revenue at lower rates (The unforgiving math of tax reform: When the top rate is 39.6 percent, eliminating a deduction yields 39.6 cents on the dollar. If the top rate is 25 percent, eliminating the same deduction yields just 25 cents).

But if Congress aims to maintain the current distribution of tax burdens, finding $3.8 trillion solves only half the problem.

Trouble is, many tax breaks benefit low- and middle-income households, not the rich who’d be big winners from the rate cuts. For instance, the biggest beneficiaries of popular tax preferences such as the mortgage deduction and the exclusion of retirement savings and employer-provided health insurance are middle-and upper-middle income households, not the very rich.

To take just one example, TPC estimates employer-paid health benefits represent about 10 percent of income for middle-income households. Yet they represent only 0.6 percent for those in the Top 1 percent.

There is really only one place Congress can go to significantly trim tax preferences for the highest-income households. And that is capital gains, dividends, and other investment income.

The lesson from these two studies is not new, but it bears repeating:  Cutting tax rates is a great idea in theory, but it is very tough to pull off.


  1. Michael Bindner  ::  10:25 pm on August 8th, 2013:

    The only rationale for a progressive tax simplification is to put in a floor on Social Security employee contributions and eliminate the EITC, while consolidating the child exemption, home mortgage deduction and property tax deduction into a much larger child tax credit (say $500 per month per child with states more or less matching that amount). The credit would be delivered with pay and be against a VAT-like Net Business Receipts Tax, which is not border adjustable because the goal is that it all will be offset with credits for such things as the Child Credit, the Health Insurance Exclusion and other state and federal credits for education at all levels, The credits could also include extension of the Child Tax Credit for adult education participants, who would be paid to become literate and who would be covered under the health plans of the education providers. One would think that libertarians the world over would jump at such a plan – but many simply hate the poor.

    While the very rich would still pay income taxes, most taxation would be paid by employers through Value Added Taxes (to cover domestic discretionary spending – both civil and military) while any NBRT collected would fund social programs. Social Security’s Employer contribution, which would be equalized for each worker, would be NBRT funded if personal retirement accounts holding insured employer voting stock are used and VAT funded if there are no personal retirement accounts – although the employer contribution would still be credited equally.

    The income surtax would fund net interest, transfer costs for creating Social Security personal retirement accounts – essentially paying down the trust fund much faster than planned – and for sea and overseas military deployments. Pay off the debt, create personal accounts and quit being the world’s policeman and the income tax goes away.

    This plan would stop the poor and middle class from paying more – mostly because it would be tied to a $12 minimum wage with an automatic COLA and a one time boost in “net income” at the VAT rate – and because of the addition of the expanded Child Tax Credit. The rich would pay much more, but would not file income taxes for their business affairs. Business taxation would be much simpler as profits and wages would be taxed at the same rate with no fancy shelters for profit. Goods imported would pay full VAT – and goods with overseas patents would be considered imports. Repatriated cash would not be VATed, but may have to face an NBRT levy, as well as taxation upon distribution to wealthier investors. Note that tax rates are a bit in flux in my plan – but the rates would be set so that the math worked out and TPC input would not be ignored in doing this.

  2. Tax Roundup, 8/9/2013: Another international tax enforcement milestone. And don’t count on the ex for a character reference. « Roth & Company, P.C  ::  10:20 am on August 9th, 2013:

    […] Gleckman, Beware of Tax Reform That Promises Deep Rate Cuts.  I worry more about tax reform that doesn’t promise rate cuts at […]

  3. Eugene Patrick Devany  ::  7:09 pm on August 9th, 2013:

    Let the rich pay 26% or the same rates as the poor?

    I enjoyed the hypothetical about the 10% and 25% tax rates. Sadly I assume the workers would still pay the payroll taxes making the combined rate higher than the rate for the rich.

    You might find the 2-4-8 Tax Blend of interest. It eliminates payroll taxes and has either an 8% or 26% income tax rate and actually gives the taxpayer the choice of which one to pay. The catch is that the 8% income tax rate comes with a 2% net wealth tax (excluding $15,000 cash and $500,000 retirement savings). The 26% income rate also retains capital gains, estate and gift taxes.

    Business tax reform consists of a 4% VAT and 8% C corporation income tax rate.

    The math works because tax expenditures are not needed with very low rates. Most taxpayers gain across different wealth and income levels providing a nonpartisan political.


  4. STEVEN J. FROMM, ATTORNEY, LL.M. (TAXATION)  ::  11:36 am on August 10th, 2013:

    The problem here as you so aptly point out is that the numbers just do not work. This whole exercise in futility is not worth the time and effort. Cutting taxes in this manner is just misguided and is a result of uninformed Congressman talking about stuff they know nothing about.

  5. Weekly Round-Up: August 10 | Mike LaSusa  ::  1:24 pm on August 10th, 2013:

    […] Tax Policy Center: Like breaking up, cutting taxes is hard to do. […]

  6. Robert Salzberg  ::  7:46 pm on August 14th, 2013:

    The Joint Committee on Taxation estimates that the mortgage interest deduction will cost $70 billion in 2013, 77% of which will go to families with incomes above $100,000. When people learned how much of the mortgage deduction goes to individuals and families making over $100,000, support for the mortgage deduction plummeted. (Detailed by Suzanne Mettler in The Submerged State)

  7. Patrice  ::  10:54 pm on May 30th, 2014:

    I really like it whenever people come together and share opinions.

    Great blog, continue the good work!