At a time of budget surpluses, America's families need and deserve tax relief. But President Bush's tax cut proposal is the wrong approach. With a price tag of over $1.6 trillion, his plan is a threat to the nation's hard-won fiscal discipline and the economic policy framework that has produced unprecedented prosperity. As legislators weigh alternatives, they should remain focused on the big prize: the continued well-being of the economy, over the next 10 years and in the more distant future when the baby boom generation retires.
The Bush proposal is also an attack on America's progressive tax code, because it disproportionately reduces tax rates on the wealthy and skews its benefits to those who need them least. Over 40 percent of the tax cut would benefit taxpayers with incomes above $300,000 a year; by contrast, the average benefit for most middle-class taxpayers would be less than $500 a year.
Congress should enact a more fiscally responsible and progressive tax cut package based on the following principles:
- Maintain Fiscal Discipline. At the end of fiscal year 2000, the national debt was $3.4 trillion. Paying down the debt remains sound economic policy as the nation prepares for the huge costs that will be required as the baby boom generation reaches retirement age. By reducing interest rates and spurring investment, debt reduction provides an indirect tax cut now and in the future.
- Prepare for the Baby Boomers' Retirement. Social Security, Medicare, and Medicaid will need significant reforms to meet the needs of future retirees without placing politically unsustainable burdens on future taxpayers. A key to entitlement reform will be tax policies that bolster private savings for retirement.
- Invest in Progress and Productivity. Public investments in civilian research and development, education and training, information, transportation, and other public infrastructure are vital in the technology-led New Economy. We should also increase some key social investments -- for example, in welfare-to-work programs, retirement and health care access and portability, and so on -- aimed at empowering low- and moderate-income Americans to contribute to and share in the nation's prosperity.
- Defend the Progressive Tax Code. The economic success of the 1990s has proven that a progressive tax system is consistent with robust economic growth. Indeed, by helping turn chronic deficits into government surpluses, progressive taxation has helped spur the economy while simultaneously turning the tide of income inequality.
Tax cuts can and should be both broad-based and progressive -- reductions in tax rates should not be concentrated at the top of the income scale. Taxes should be cut from the bottom up and the middle out, rather than from the top down.
Here is a set of ideas for large-scale, progressive tax cuts. None of these proposals approaches the cost of Bush's proposals to eliminate gift and estate taxes and to reduce income tax rates for high-income people.
Payroll taxes are the largest tax paid by more than three-quarters of Americans. Payroll taxes amount to about 15 percent of most employees' wages, when the employer share (which ultimately comes out of employees' compensation) is included. A simple, refundable income tax credit of a percentage of the amount of payroll taxes paid (which is already printed on taxpayers' W-2 forms) would be an easy way to reduce tax rates. For example, a tax credit of 15 percent of employee-paid payroll taxes would reduce average and marginal tax rates for most workers.
To stimulate savings, tax credits based on payroll taxes could be shifted easily to personal retirement accounts, which would help ease the fiscal transition as the baby boomers retire without causing unnecessary economic disruption. Cutting the tax on work would provide a greater benefit for more Americans than almost any other tax cut idea.
An alternative way to provide tax relief to working Americans would be to establish a refundable income tax credit of 100 percent of payroll taxes up to a maximum amount, say $500. That would be highly progressive; it would dramatically reduce marginal tax rates for those just starting out in the workforce, and it would reduce average tax rates for all workers.
The maximum amount of the refund could be set each year by Congress in accordance with real progress on reducing the national debt. That would align the incentives of taxpayers and their representatives: continued fiscal discipline now would lead to more room for tax cuts later.
Another option is for Congress to dedicate a share of surplus funds to personal retirement accounts. This would give families of modest means strong incentives to save for retirement, strengthening the economy for the long run by boosting national savings. On the campaign trail, Al Gore proposed a refundable tax credit to match contributions to new Retirement Savings Accounts. The matching funds would be means-tested, with higher matching rates for lower-income workers' savings than for those with higher incomes. For example, for couples earning $30,000 a year, each spouse could save $500 and receive a government match of $1,500 per spouse. Couples earning $60,000 could save $1,000 each and receive a match of $1,000 per spouse. Couples earning $90,000 could save $1,500 each and would receive a match of $500 per spouse.
The long-standing progressive goal of universal health coverage should not be forgotten in this year's tax debate. PPI has proposed a significant tax cut for those who purchase health insurance (see A Progressive Path Toward Universal Health Coverage, PPI, December 2000, at www.ppionline.org). The PPI proposal includes tax credits of up to $2,500 to help low- and middle-income families obtain and secure health coverage. The tax credits could be used to help people pay their share of the premium when they purchase health coverage at work or to help them purchase coverage on their own if an employer-sponsored health plan is not available. The proposal builds a better infrastructure for purchasing health insurance by empowering states to improve choices and employers to make sure everybody gets the word. This tax policy would reward people who have made sacrifices to purchase health insurance, whether they acquired coverage at work or on their own.
The EITC has won support across the political spectrum for creating incentives for people to move from welfare to work and by helping to boost low-income workers into the middle class. The EITC amount increases as a worker begins to earn money, reaches a brief plateau, and then starts phasing down toward zero as earned income starts to exceed about $13,000. The phase-down rate is approximately 21 percent for a taxpayer with two or more children and 16 percent for taxpayers with one child. (A very small EITC is available to some workers with no children.) Like the payroll tax credit, lowering or eliminating the EITC phase-down rate would reduce marginal tax rates for working people. This would be a simple way to reward work, mitigate or eliminate the marriage penalty, and offer everyone a tax cut of roughly equal size.
