A UNIVERSAL EITC: SHARING THE GAINS FROM ECONOMIC GROWTH, ENCOURAGING WORK, AND SUPPORTING FAMILIES Leonard E. Burman May 20, 2019 ABSTRACT This report analyzes a straightforward mechanism to mitigate middle-class wage stagnation: a wage tax credit of 100 percent of earnings up to a maximum credit of $10,000, called a universal earned income tax credit. The child tax credit would increase from $2,000 to $2,500 and be made fully refundable. A broad-based, value- added tax of 11 percent would finance the new credit. The proposal is highly progressive and would nearly end poverty for families headed by a full-time worker. This report compares the proposal with current law, analyzes its economic effects, compares it to alternative reform options, and considers some complementary policy options. 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TAX POLICY CENTER | URBAN INSTITUTE & BR OOKINGS INSTITUTION ii CONTENTS ABSTRACT II CONTENTS III ACKNOWLEDGMENTS IV INTRODUCTION AND SUMMARY 1 MOTIVATION 4 Economic Inequality and Wage Stagnation 4 The Political and Ethical Rationale for Sharing the Gains from Economic Growth 7 Social and Political Benefits of Encouraging Work 8 Support Families 10 Universality 10 THE PROPOSAL 12 COMPARISON OF PROPOSED UEITC AND CTC WITH CURRENT LAW 14 DISTRIBUTIONAL ANALYSIS 18 REVENUE EFFECTS 23 ANALYSIS AND ISSUES 24 Economic Effects 24 Effects on Low-Income Families 24 Compliance Issues 25 Why Not Simply Expand the EITC? 26 Why Not Adopt a Universal Basic Income? 27 Why Propose a VAT? 28 Effects on the Social Security Program 29 Other Possible Enhancements 30 CONCLUSIONS 32 APPENDIX 34 Universal Earned Income Tax Credit 34 Child Tax Credit 34 Value-Added Tax 34 NOTES 36 REFERENCES 39 ABOUT THE AUTHOR 43 TAX POLICY CENTER | URBAN INSTITUTE & BR OOKINGS INSTITUTION i ii ACKNOWLEDGMENTS This report was supported by Arnold Ventures. The views expressed are those of the author and should not be attributed the Urban-Brookings Tax Policy Center, the Urban Institute, the Brookings Institution, their trustees, or their funders. Funders do not determine research findings or the insights and recommendations of our experts. Further information on Urban’s funding principles is available at http://www.urban.org/aboutus/our-funding/funding-principles; further information on Brookings’ donor guidelines is available at http://www.brookings.edu/support-brookings/donor-guidelines. I’m grateful to Rosanne Altshuler; Ellen Aprill; Reuven Avi-Yonah; Jerry Auten; Jared Bernstein; Karlyn Bowman; Kim Clausing; Chris Faricy; Melissa Favreault; Jonathan Barry Forman; Howard Gleckman; Dan Hiller; Janet Holtzblatt; Chris Hughes; Greg Leiserson; Elaine Maag; Mark Mazur; Ed McCaffery; Deirdre McCloskey; Madonna Harrington Meyer; Jim Nunns; Ben Page; Katie Pratt; Joe Rosenberg; Ted Seto; Robert Shiller; Marshall Steinbaum; Eric Toder; Steve Wamhoff; Bob Williams; Vanessa Williamson; and seminar participants at the Loyola Law School, Maurer School of Law at Indiana University, and the Tax Economists Forum for helpful comments and discussions. Philip Stallworth helped specify details of the proposal, estimated the revenue and distributional effects, and contributed to the appendix. Michael Marazzi edited the document, and Ann Cleven oversaw its production. TAX POLICY CENTER | URBAN INSTITUTE & BR OOKINGS INSTITUTION iv INTRODUCTION AND SUMMARY This report develops a straightforward mechanism to mitigate wage stagnation: a wage tax credit of 100 percent of earnings up to a maximum credit of $10,000—in other words, a universal earned income tax credit (UEITC). A dedicated, broad-based, value-added tax (VAT) of 11 percent would finance the new credit. The maximum credit would be indexed to economic growth. For the first time in decades, low- and middle-income workers would share in economic gains even if the factors suppressing market wages do not reverse. Workers at all income levels, rather than just the highest earners, would benefit from economic prosperity, finally fulfilling John F. Kennedy’s promise that “a rising tide lifts all boats.”1 Despite strong economic growth, middle-class wages have stagnated for four decades, barely keeping pace with inflation. Policy makers and presidential candidates are finally focusing on middle-class economic insecurity and rising economic inequality more generally, but many of the actual and proposed policy responses are likely to be counterproductive or infeasible. The trade and immigration restrictions favored by the Trump administration will harm the economy and likely make working people worse off (Clausing 2019). Proposals from the left for a much higher minimum wage and more regulation for employers might, similarly, help some low- skilled workers, but such policies risk harming others while doing little for middle-income workers. Enacting a universal health insurance program such as Medicare for All would translate into higher wages if employers passed their premium savings on to workers, but it would be an expensive and controversial new entitlement. A substantial wage subsidy is more efficient and direct, and it fits with Americans’ values. Polls show that the public strongly supports assisting working people. The existing earned income tax credit (EITC), which provides a substantial wage subsidy for lower-income families with children, has garnered broad bipartisan support. But the EITC provides little or no support for workers without children at home or for families with somewhat higher earnings. The proposed UEITC would replace the EITC and provide meaningful assistance for low- and middle-income workers whether or not they have children living with them. Unlike the EITC, the UEITC would not directly penalize two-earner couples. The new wage credit and the corresponding VAT would phase in over four years to minimize disruptions. After the phase-in period, the maximum wage credit would grow with per capita gross domestic product (GDP). Because VAT revenue tends to grow with GDP, the policy would be fiscally sustainable over the long run with little or no adjustment in VAT rates. Because the credit is universal and refundable (that is, it does not phase out with income and workers can receive it even if they do not owe income taxes), workers could safely request an advance payment from one employer (limited to one per year to avoid the risk of excess advance credits that would have to be repaid at tax time). Self-employed workers and those with multiple employers would ultimately claim the credit less any advance payments on income tax returns.2 Like other income, but unlike the EITC and most other tax credits, the UEITC would be subject to income taxes. TAX POLICY CENTER | URBAN INSTITUTE & BROOKING S INSTITUTION 1 To partially offset the loss of the EITC, which increases in value with the number of qualifying children (up to three), the current-law child tax credit (CTC) would increase from $2,000 to $2,500 and be made fully refundable—that is, available to people even if they have no income tax liability. (The CTC currently phases in with earnings; thus, low-income families may receive only a partial credit or none at all.) The proposal would be easier for taxpayers to comply with and for the Internal Revenue Service (IRS) to administer than the current EITC and CTC. All adults with earnings would be eligible for the UEITC, and all low- and middle-income families with qualifying children would be eligible for the full CTC. Although the VAT is regressive—falling disproportionately on those with lower incomes—the overall proposal is quite progressive. Low- and middle-income workers would receive far more in tax credits than they would pay in additional taxes. The program is similar in design to the Social Security system, which pairs a dedicated regressive tax—the payroll tax—with progressive retirement benefits. Social Security is extremely popular, and the payroll tax is viewed more favorably than other more progressive taxes because voters support what the payroll tax finances. I assume the UEITC and VAT would phase in between 2020 and 2023. In 2023, when fully phased in, the proposal would cut average tax bills for most people in the four lowest income quintiles. The federal tax cut for the bottom quintile would average almost $3,890, or 24 percent of after-tax income. The middle quintile would average a tax cut of almost $2,800, or 4.5 percent of after-tax income. The top quintile would face a tax increase averaging over $12,000, or almost 5 percent of after-tax income. Primarily because of the VAT, the tax burden on the top 1 percent of earners would increase by over 7 percent of after-tax income (averaging $125,000). The proposal is similar in some ways to a universal basic income (UBI)—an unrestricted cash grant—in that the UEITC is universal and highly progressive; however, the UEITC is only available to adults over age 16 who have earned income. This is based on my judgment that the primary failure of the market economy is not that jobs aren’t available—unemployment as of March 2019 was 3.8 percent—but that many jobs pay poorly. The proposal has strong political advantages. The UEITC and enhanced CTC are targeted at workers and families with children, two groups that many Democrats and Republicans are willing to support. The public is wary of assisting able-bodied adults who do not work.