A little noted aspect of the tax and spending debate taking place in Washington this week is the remarkable symmetry between the cost of extending the Bush-era tax cuts and the amount of deficit reduction the president’s fiscal commission seeks in the coming decade.
If the Bush tax cuts are renewed indefinitely, the Treasury will forego a projected $4 trillion in the coming decade, an amount that will be added to the national debt unless Congress cuts the budget. The fiscal commission’s goal, meanwhile, is to reduce deficit spending by roughly $4 trillion over the same period.
“The impact of the tax cuts and the impact of [commission] package are the same,” said Rep. John M. Spratt, D-S.C., the chairman of the House Budget Committee who lost his bid for reelection in November. “That has to strike you as ironic.”
In addition, the presidential fiscal commission’s final report, formally issued on Friday, would nearly nullify the Bush-era tax cuts for most Americans, raising the average household’s tax burden by $1,746 a year. That proposed tax hike would have the effect on households of offsetting about two-thirds of the Bush tax cuts passed in 2001 and 2003, assuming Congress decides to renew them for the coming years.
“The Bowles-Simpson plan is a small tax cut for
those in the lowest [income] quintile and a tax
increase for everybody else.”
The commission’s roadmap was designed by co-chairmen Erskine Bowles, a Democrat, and Alan Simpson, a Republican, to eliminate $3.9 trillion from the federal budget deficit over the next 10 years, “more than any effort in the nation’s history,” its authors noted. While approximately 70 percent of the savings would come from reduced federal spending, the remaining 30 percent would come from higher taxes, which would be paid by almost everyone.
Households would actually pay significantly higher taxes under the Bowles-Simpson plan than what would otherwise be necessary to cover a 30 percent reduction in the projected deficit. That’s because its reforms also include a lower tax rate on all businesses and no taxes on corporate income earned overseas.
“The Bowles-Simpson plan is a small tax cut for those in the lowest [income] quintile and a tax increase for everybody else,” said Benjamin Harris, a senior research associate at the Tax Policy Center. “The top 80 percent of earners would see a tax increase.”
On the other hand, if the Bush-era tax cuts were eliminated and tax rates reverted to their 2000 levels, it would generate enough revenue to trim the deficit by $3.7 trillion over the next decade, according to government projections. That’s nearly as much deficit reduction as the Bowles-Simpson plan would achieve.
Allowing the Bush tax cuts to expire now is also
troubling to many liberal economists, who worry
that it would hurt the middle class.
While letting the Bush tax cuts expire would lead to higher taxes for most households, they would only be about a third higher than the Bowles-Simpson plan, without the deep cuts in federal spending. But failing to cut government spending is anathema to conservatives on the fiscal commission, who attacked the commission report for not going far enough in limiting the size of government.
Allowing the Bush tax cuts to expire now is also troubling to many liberal economists, who worry that it would hurt the middle class and might lead to a double-dip recession. Many are pushing for a temporary extension of the cuts, and revisiting the issue in a year or two when unemployment is lower and the recovery is on firmer footing.
“There’s a good argument for not raising taxes now because the economy is in bad shape,” said Paul Van de Water, a tax analyst at the liberal-leaning Center for Budget and Policy Priorities. “But if in the long run you need to get to a higher level of revenue, you don’t want to build in the lower rate on a permanent basis.”
The core element in the Bowles-Simpson tax reform plan is elimination of most tax loopholes. Middle-class tax breaks include deductions for mortgage interest, health insurance benefits, retirement savings, and charitable giving. While tens of millions of households use these deductions, most of the tax savings accrue to the top third of earners.
Higher-income households tend to live in more expensive houses, so they have more mortgage interest to deduct, for instance. Although their tax rates are higher, they get a bigger reduction in taxes for every dollar they can deduct from income, whether it is a charitable donation or a dollar paid in interest.
That appears to be a major driver in the redistribution of tax burden under Bowles-Simpson. According to figures provided by the Tax Policy Center, people in the second-lowest quintile of taxpayers (those earning on average $31,685 a year) would see their taxes go up by $464 a year under the Bowles-Simpson plan. If the Bush tax cuts were repealed, their taxes would go up $613.
On the other hand, those in the second-highest quintile of taxpayers (those earning $99,859 on average) would see taxes rise by $1,193 under Bowles-Simpson. Repeal the Bush tax cuts and their tax bill increases by $2,724. The average taxpayer would see taxes rise by $1,746 under Bowles-Simpson and $2,418 by repealing the Bush tax cuts.
Average Tax Rates
All Bush Tax Cuts Expire
All Bush Tax Cuts Extended (no deficit reduction)
Source: Tax Policy Center
Two things stand out from the above chart. First, the biggest breaks under the Bush-era tax cuts went to those earning the most money, both as a percentage and in terms of total dollars. Second, for those in the bottom half of the income distribution, who tend to rely more on government services, the Bowles-Simpson plan provides only minor relief from higher taxes compared to eliminating the Bush tax cuts entirely.
Perhaps the best way to measure the rival approaches is to look at the average income tax rates for all households under the two scenarios. Each group represents a fifth of all federal income tax payers, or about 52 percent of the adult population in the U.S.