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Thinking Through the Tax Options

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Thinking Through the Tax Options (C) Tax Analysts 2003. All rights reserved. does not claim copyright in any public domain or third party content. tax break TAX ANALYSTS ® by Leonard E. Burman, William G. Gale, and Peter R. Orszag Leonard E.Bum,WilGPtROszgkIxhvpfbyHSFcC Thinking Through the Tax Options cost: They would reduce long-term growth, exacerbate looming budget problems, and impose significant bur- The authors are codirectors of the Tax Policy dens on future generations. In addition, they would be Center (http://www.taxpolicycenter.org). Bur- regressive and would not only fail to meet their osten- man is a Senior Fellow at the Urban Institute. Gale sible goal of integrating the personal and corporate is the Arjay and Frances Fearing Miller Chair in taxes, but could also open up new sheltering activity. Federal Economic Policy at the Brookings Institu- Better alternatives would include substantial aid to the tion. Orszag is the Joseph A. Pechman Senior Fel- states, an extension of unemployment insurance bene- low at Brookings. The authors thank Deborah fits, and reform of the alternative minimum tax (AMT). Kobes, Matt Hall, Brennan Kelly, and Jeffrey Roha- Our specific findings include: ly for programming and other assistance. The • Revenue effects: Due to budget gimmicks, the views expressed are our own and should not be attributed to the trustees, officers, funders, or staff official revenue estimates understate the likely of the Brookings Institution, the Urban Institute, costs. If the tax cuts in the House plan other than the acceleration of the 2001 tax cuts were made or the Tax Policy Center. permanent, the 10-year cost would be about $1.6 trillion. The long-term costs would amount to about 0.5 percent of GDP, which is about two- I. Introduction thirds as large as the 75-year actuarial deficit in Social Security. The Senate Finance plan would In January, President Bush proposed a set of tax cuts create smaller long-term costs, especially if the in his “Growth and Jobs” package that would reduce offsets included in that plan were made per- revenues by an estimated $726 billion over the next manent. decade. On May 9, the House of Representatives passed a $550 billion version of the package and, on • Short-term stimulus: In the short run, in an May 8, the Senate Finance Committee approved a pack- economy operating with excess capacity, in- age of tax cuts, expenditure increases, and offsetting creases in aggregate demand can raise output revenue increases with a net cost of $350 billion. All and income even without raising the capital three proposals would accelerate some provisions of stock. Each of the proposals would boost ag- the 2001 tax cut and — in different ways — reduce gregate demand in the short term and thereby individual taxes on dividends. The first two proposals generate higher levels of income in classic would also reduce taxes on capital gains. This column Keynesian fashion, but the proposals would fail evaluates these proposals and considers alternatives. to stimulate the economy in the least expensive and most equitable manner. As shown below, the two principal components of the plans — Our overarching conclusion is that the acceleration of the 2001 tax cuts and dividend/ administration, House, and Senate capital gains tax cuts — would be regressive. Finance Committee proposals are This implies that they will be less effective in stimulating current activity, holding the size of seriously flawed and are strikingly the tax cut constant, than more progressive op- removed from the economy’s current tions, since high-income households are less and long-term problems. likely to spend available resources immediately than low- or moderate-income households. Al- ternatively, it would cost less to generate the Our overarching conclusion is that the adminis- same stimulus from a more progressive plan. It tration, House, and Senate Finance Committee pro- is ironic that tax cut advocates are selling divi- posals are seriously flawed and are strikingly removed dend and capital gains tax cuts, which are tradi- from the economy’s current and long-term problems. tionally associated with long-term, supply-side Although each of the proposals would provide a short- goals, as short-term stimulus for aggregate term economic boost, almost any increase in govern- demand. ment spending or cut in tax revenues would stimulate a sluggish economy (assuming the Federal Reserve cooperates). The three proposals on the table, though, would provide their stimulus at an unnecessarily high (Text continued on p. 1084.) TAX NOTES, May 19, 2003 1081 (C) Tax Analysts 2003. All rights reserved. does not claim copyright in any public domain or third party content. COMMENTARY / TAX BREAK Table 1: Side-by-Side of Major Proposals Administration House Ways and Means Senate Finance Committee Provision Cost, 2003-2013 Provision Cost, 2003-2013 Provision Cost, 2003-2013 Reduce tax rates on dividends and capital gains: Dividends that $396 billion Tax dividends $276 billion Exclude first $500 $81 billion are fully taxed at and capital gain of dividends the corporate at a 15% rate (5% received by in- level would be ex- for those in the dividuals, plus empt from in- lowest two brack- 10% of dividends dividual income ets). Sunsets at in excess of $500 tax. Earnings the end of 2012. for 2004-2007 and that are fully 20% for 2008- taxed at the cor- 2012. Sunsets at porate level but the end of 2012. not distributed as dividends would result in a basis adjustment for shareholders. Accelerate upper-bracket rate cuts: Top four $74 billion Same as adminis- $74 billion Same as adminis- $74 billion statutory tax tration. tration. rates would be immediately re- duced from 27, 30, 35, and 38.6 percent to 25, 28, 33, and 35 per- cent, respectively. The change would be retroac- tive to January 1, 2003. Accelerate marriage penalty relief: Effective 2003, $55 billion Same as adminis- $43 billion Same as adminis- $51 billion the standard tration for 2003- tration. deduction for 2005. Sunsets at joint filers is set end of 2005. equal to twice that for singles. The beginning of the 25 percent bracket for couples is set equal to twice the threshold for singles. EITC mar- riage penalty relief is not ac- celerated. Accelerate expansion of the 10 percent tax bracket: The beginning of $45 billion Same as adminis- $19 billion Same as adminis- $45 billion the 15-percent tax tration for 2003- tration. bracket is in- 2005. Sunsets at creased from end of 2005. $6,000 to $7,000 for singles in 2003, and from $12,000 to $14,000 in 2003. Thresholds are in- dexed for infla- tion starting in 2004 (rather than in 2009). (Table continued on next page.) 1082 TAX NOTES, May 19, 2003 (C) Tax Analysts 2003. All rights reserved. does not claim copyright in any public domain or third party content. COMMENTARY / TAX BREAK Administration House Ways and Means Senate Finance Committee Provision Cost, 2003-2013 Provision Cost, 2003-2013 Provision Cost, 2003-2013 Accelerate child credit increase to 2003: Child tax credit $90 billion Same as adminis- $45 billion Same as adminis- $93 billion is increased from tration for 2003- tration, but ac- $600 per child to 2005. Sunsets at celerates increase $1,000 per child end of 2005. in refundability in 2003. rate to 15%. Scheduled in- crease in refund- ability rate is not accelerated. Temporary AMT relief: The alternative $37 billion Exemption in- $53 billion Exemption in- $49 billion minimum tax creases by $7,500 creases by $6,000 (AMT) exemp- for singles and for singles and tion is increased $15,000 for joint $12,000 for joint by $4,000 for filers through filers through singles and 2005, then reverts 2005, then reverts $8,000 for joint to current law. to current law. returns through 2005 (so that the threshold is $39,750 for singles and $57,000 for joint returns). The thresholds return to their current- law levels of $33,750 for singles and $45,000 for joint returns in 2006. Increase expensing limit for small businesses: Increase the $29 billion Increase deduc- $3 billion Same as adminis- $23 billion amount of invest- tion limit to tration, but sun- ment by small $100,000 and set at end of 2012. business that phaseout may be deducted threshold to currently (instead $400,000; include of amortized) software; index from $25,000 to deduction and $75,000, starting phaseout limit in 2003. The ex- after 2003; sunset pensing limit after 2007. phases out dollar for dollar with in- come about $325,000 (com- pared with $200,000 under current law). The deduction and threshold are in- dexed for infla- tion after 2003. In- cludes software in section 179 property. (Table continued on next page.) TAX NOTES, May 19, 2003 1083 (C) Tax Analysts 2003. All rights reserved. does not claim copyright in any public domain or third party content. COMMENTARY / TAX BREAK Administration House Ways and Means Senate Finance Committee Provision Cost, 2003-2013 Provision Cost, 2003-2013 Provision Cost, 2003-2013 Bonus depreciation: No provision Increase share of $21 billion No provision qualified invest- ments that can be immediately deducted to 50% and extend through 12/31/05, for property placed in service after 5/5/03. Extend 5-year net operating loss carryback: No provision Extend through $15 billion No provision 2005 and waive the AMT 90% li- mitation on the allowance of losses. Other provisions: Not applicable Shift some corpo- $0 billion State fiscal relief. $20 billion rate tax pay- ments from 2003 to 2004. Simplification $4 billion measures, includ- ing unifying definition of qual- ifying child. Offsets, including -$92 billion customs users fees and taxation of foreign earned income.
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