Revised March 15, 2000
Costly House Tax Bill That Accompanies Minimum-Wage Legislation
Would Largely Benefit High-Income Individuals
Legislation Would Do Little to Assist Small Businesses and Could Adversely
Affect Low- and Moderate-Income Workers
by Iris J. Lav, James Horney and Robert Greenstein
Tax legislation the House of Representatives approved March 9, in conjunction with a minimum-wage bill, contains an array of tax cuts that would cost $122 billion over 10 years and largely benefit high-income individuals, while likely leading to reductions in pension benefits for less well-paid workers.
This legislation (H.R. 3832) is promoted as easing the effects of a minimum-wage increase on small businesses. The connection of these tax cuts to the proposed minimum-wage increase, however, is tenuous at best. The estate tax reductions and pension provisions that make up the vast majority of the tax package bear little relationship to any possible effects of a minimum-wage increase on small business.
- The legislation includes the pension provisions of the tax bill that Congress passed and the President vetoed last summer, with minor changes. These pension provisions were among those cited as unacceptable in the President's veto message. The principal impact of these pension changes would be a major expansion of pension-related tax preferences for high-income individuals. Some of the provisions being considered could lead to a reduction in pension coverage among low- and moderate-income workers and those employed by small businesses.
- The estate tax reductions in the bill are large; they constitute nearly 65 percent of the legislation's total 10-year cost of $122 billion. Reducing the estate tax for all estates, as this legislation would do, has little connection to any claimed effects of a minimum-wage increase on small businesses. Only a tiny fraction of estate taxes are paid on small businesses included in estates. The overwhelming bulk of the generous tax reductions that would result from the expensive estate tax provisions of the pending legislation, all of which also were contained in last year's vetoed tax bill, would accrue to wealthy individuals who do not own small family businesses.
An analysis by Citizens for Tax Justice finds that 73 percent of the tax cuts the bill provides would go to the one percent of taxpayers with the highest incomes, with nearly 90 percent of the tax cuts (88.8 percent to be precise) going to the five percent of taxpayers with the highest incomes. The bottom 60 percent of the population would receive less than three percent of these cuts. The analysis estimates that the average annual tax cut when the bill's provisions are fully in effect would be more than $6,000 apiece for those in the top one percent of the population, while the average tax cut for those in the bottom 60 percent of the population would be four dollars.
The argument usually made for including tax measures as an accompaniment to a minimum-wage increase is that small businesses need to be compensated for the increased wages they would pay under a higher minimum wage. The support for this argument is not strong; the evidence does not indicate that modest minimum-wage increases have significant negative effects on small businesses. For example, recent research that examined whether minimum-wage increases contribute to the failure rate of businesses found "...there seems to be no discernible correlation between minimum wage increases and a rise in business failures, either in the year the increase occurred or in the following year." (1) Whatever the merits of compensating small businesses, however, the tax cuts the House passed March 9 go far beyond any reasonable bounds for what might be justified as measures to cushion the effects of a higher minimum wage on small business.
Moreover, these tax cuts are moving forward before Congress has agreed to a budget resolution that lays out a budget plan and sets the appropriate levels of revenues, spending, and surpluses for the coming fiscal year and at least the following four years. Although neither the House nor the Senate has begun consideration of the budget resolution for fiscal year 2001, the House and Senate have passed tax cuts that would cost $115 billion over the next five years and $443 billion over 10 years. This total includes the tax bill the House passed March 9 in conjunction with minimum-wage legislation, the marriage-penalty bill the House passed in February, and the health-care tax cuts contained in bankruptcy legislation the Senate approved February 2. (Education tax cuts the Senate passed March 2 would raise this total even higher; a cost estimate is not yet available for that measure.)
Even before formulating a plan that establishes priorities among debt reduction, various tax cuts, and initiatives such as a Medicare prescription drug benefit, the House and Senate are on the verge of using up for tax cuts nearly three fourths of the $171 billion in non-Social Security surpluses the Congressional Budget Office has projected for the next five years and 53 percent of the $893 billion projected for the next 10 years. (The surplus projections cited here are those CBO issued on March 9.) These amounts would be consumed for tax cuts generally skewed to higher-income individuals.
By contrast, the President's budget proposes to use 53 percent of the projected non-Social Security surpluses over the next 10 years to pay for all of its tax and program initiatives combined, including tax cuts targeted at low- and moderate-income taxpayers, a Medicare prescription drug benefit, and a major expansion of the Child Health Insurance Program to provide health insurance to large numbers of low-income working parents and children who remain uninsured. The President's budget devotes the remaining 47 percent of the projected non-Social Security surpluses to paying down the debt and shoring up Medicare.(3)
The Tax Cuts That Add Up to $470 Billion Over 10 Years
The House has passed a "marriage-penalty" tax bill that reduces revenues by $182 billion over the next 10 years, while the Senate has passed a bankruptcy bill that includes tax cuts totaling $103 billion over the next 10 years. The tax legislation the House approved March 9 in conjunction with a minimum-wage increase would cut revenues by $122 billion over 10 years and another bill that provides education-related tax cuts totaling $21 billion over 10 years. Taking into account the overlapping provisions in that legislation and the Senate-passed bankruptcy bill, the reduction in revenues from these three bills would total $384 billion over 10 years.(2)a Together with the resulting higher interest payments on the debt, these reductions in revenues would reduce the surplus by about $470 billion over 10 years. (Lower revenues leads to smaller surpluses and less debt reduction, and as a result, to higher interest payments on the debt.)
a These calculations do not include tax cuts contained in patients bill of rights legislation that the House and Senate have passed and that is now in conference. Those tax cuts are not included here because most, although not all, of them also are contained in the Senate bankruptcy bill.
None of the tax bills moving through Congress can be said to respond to an emergency situation that warrants action in advance of a budget resolution. Nor are these changes of so high a priority as to take such clear precedence over other needs including greater debt reduction, strengthening the Medicare trust fund, establishing a Medicare prescription drug benefit, expanding health care coverage for low-income working parents through a CHIP expansion, reducing the number of middle-class families that will be affected by the Alternative Minimum Tax in coming years, and other proposals that no sorting out of priorities is needed. Committing the federal government to these tax cuts would mean that $443 billion over the next 10 years would not be available for any of these other purposes.
As the analysis in this paper suggests, it is difficult to argue that the principal tax provisions in the tax bill the House approved March 9 should make any list of priorities. Indeed, some of these provisions represent unsound policies that could adversely affect low- and middle-income workers. At a minimum, considering these large tax cuts before a budget resolution is debated deprives Congress and the public of the opportunity for a meaningful debate over appropriate budget priorities for the nation in the years ahead.
The Legislation's Estate Tax Reductions
Under current law, estate taxes are paid only by the estates of the wealthiest two percent of all people who die. The estates of individuals of lesser wealth incur no estate tax liability.(4) In addition, only a tiny proportion of the revenues the estate tax produces comes from taxes paid on small businesses that are included as part of estates.
Nevertheless, the estate tax provisions of the legislation the House passed March 9 would reduce taxes for all estates. As a result, the overwhelming bulk of the generous estate tax reductions the bill provides would accrue to wealthy individuals who are not owners of small family businesses.
IRS data clearly show that individually-owned or family-owned small businesses account for a small fraction of the assets subject to the estate tax. Analysis of IRS data on estate tax returns for 1995 shows that business assets such as closely-held stocks, limited partnerships, and non-corporate businesses accounted for only 9.7 percent of the value of all taxable estates. Moreover, these assets accounted for just 2.7 percent of the value of smaller estates, those with a value of less than $2.5 million.(5)
Furthermore, several provisions of tax legislation enacted in 1997 are already reducing estate taxes on small family farms and businesses. The amount of an estate that is exempt from taxation is now substantially higher for family-owned businesses and farms than for other types of estates. In place of the $650,000 general estate tax exemption (which is scheduled to rise to $1 million in 2006), the 1997 tax law increased the total exemption for most estates that include family-owned businesses to $1.3 million. In other words, most estates including a family-owned business that are worth less than $1.3 million already entirely escape the estate tax. The 1997 law also liberalized various other estate tax provisions that help small businesses, including rules that reduce the taxable value of such businesses.
Arguments are sometimes made that the 1997 law fails to go far enough in reducing the estate tax burden on family-owned businesses and farms. Proponents of additional relief claim that if heirs want to continue operating the farm or business, they may not have the cash to pay the estate tax. If Congress wants to address this issue, however, it can further increase the exemptions and other provisions of the estate tax law that are specifically targeted to family-owned businesses and farms. There is no need to provide general estate tax relief, only a small fraction of which would go to family-owned businesses and farms, in order to grant further relief to small family-owned enterprises.
As noted, the House-passed legislation ignores this rather obvious point and further reduces the taxation of all estates. The bill would reduce the top marginal tax rate that applies to the largest estates from 55 percent to 48 percent. It also would reduce all other graduated marginal estate tax rates by two percentage points and eliminate a surtax that applies solely to estates valued at more than $10 million. Still another proposed change would substitute a deduction for the credit that implements the general estate tax exemption (the exemption scheduled to rise to $1 million in 2006), a change that would confer the largest dollar tax cuts on large estates.
Illustrative Estate Tax Reductions Included in the Legislation
the House Approved March 9
Proposed Tax Cut
Tax Cut as a Percent of Estate Value
Calculations by Center on Budget and Policy Priorities. Shows effects when provisions are phased in fully.
Table 1 provides illustrative examples that shows the effect of the proposed changes in the estate tax on estates of different sizes. As the table indicates, an estate worth $1.5 million would receive an estate tax reduction of approximately $64,000. An estate worth $20 million would get an estate tax cut of $1.75 million.
Even in percentage terms, the estate tax reduction would favor large estates over smaller ones. The estate tax on the $1.5 million estate would be reduced by an amount equal to 4.3 percent of the estate's value. The tax on the $20 million estate would be sliced by an amount equal to 8.8 percent of the estate's value, more than twice as large a percentage.
In short, the evidence suggests that most of the benefits of the estate tax reductions in the House-approved legislation would go to the estates of individuals who were wealthy investors with extensive holdings in real estate and/or stocks or other financial instruments and who were not owners of small businesses. A general estate tax reduction of this type cannot be justified as an offset for the effects of a higher minimum wage on small businesses. Moreover, to the extent that an argument can be made that the treatment of small family-owned businesses under the estate tax still poses problems, those problems can be identified and addressed at a small fraction of the cost of the estate tax provisions in the House legislation.
Pension Provisions Are Poorly Targeted
The legislation also includes the provisions of the tax bill the President vetoed last year that relate to employer-sponsored pensions, with only minor changes. These provisions have, at most, a tenuous connection to any problems that small businesses may be said to face as a result of a minimum-wage hike.
The proposed pension changes would relax various provisions of current law that limit the contributions that highly paid individuals may make to pension plans, as well as the amount of the pension payments that such high-income individuals may receive when they retire. For example, the bill would increase the maximum tax-favored contribution that an employed individual is permitted to make to a 401(k) plan to $14,000 a year by 2004. (The maximum contribution is $10,500 today; CBO inflation forecasts suggest this limit will reach $11,500 in 2004 under current law, as a result of inflation indexing.) This change would primarily benefit the fewer-than-five-percent of individuals covered by a 401(k) plan who make the maximum $10,500 contribution today; this is a group that receives average pay of $130,000. The bill also would increase the maximum benefit that a retiree can receive under a defined benefit pension plan from $135,000 a year to $160,000. That change would benefit only those at the very top of the income distribution whose salaries are so large that they would be able to qualify for annual pension payments of more than $135,000 when they retire.
These and the other pension-related tax breaks in this bill have little to do with assisting small businesses in offsetting any increased labor costs that may result from a higher minimum wage; instead, these tax breaks would primarily boost pension tax benefits for business owners and executives. Ironically, the only way these provisions would reduce labor costs would be if employers used these provisions to reduce the pension contributions made on behalf of their employees.
Furthermore, it appears that most small businesses would not be affected by these provisions because they do not offer pension plans. In 1993, only 13 percent of full-time workers in firms with fewer than 10 employees and 25 percent of workers in firms with between 10 and 24 employees had pension coverage. By contrast, 73 percent of workers in firms with 1,000 or more employees had pension coverage.(6) Most of the benefits from the pension provisions in the House bill apparently would accrue to highly-salaried executives of larger businesses and corporations who already have generous pension coverage.
An analysis by Citizens for Tax Justice of the pension provisions in the vetoed tax bill shows how skewed these provisions are. The analysis shows that 96.5 percent of the tax benefits from these pension provisions would go to the 20 percent of Americans with the highest incomes. Indeed, 87 percent of these pension benefits would go to the top five percent of the population. By contrast, the bottom 60 percent of Americans would receive less than one percent of these tax benefits. These pension provisions were among the provisions the President cited as inequitable when he vetoed last year's tax bill.
Furthermore, as noted above, some of these pension provisions could lead to reduced coverage among low- and middle-income workers. For example, the bill would raise the amount of salary on which pension contributions may be made from $170,000 to $200,000. This would enable business owners and highly-paid executives to maintain contributions for their own pension plans while saving money for the firm by reducing the firm's contributions for other employees. Consider, for instance, the case of a business owner with compensation of $250,000 who wants to have the firm contribute $11,000 a year to his pension. Under current law, the owner would have to set the firm's pension contribution rate at 6.5 percent of pay (6.5 percent of the $170,000 limit is $11,000). Both the owner and the employees would receive contributions equal to 6.5 percent of their compensation. Under the higher $200,000 limit the legislation would set, however, the business owner could reduce the firm's contribution rate to 5.5 percent and still have the firm contribute $11,000 to his own pension (5.5 percent of $200,000 is $11,000). Meanwhile, the employer contribution for an employee who earns $40,000 would drop from $2,600 (6.5 percent of $40,000) to $2,200 (5.5 percent of $40,000).(7)
Provisions in the House-passed legislation also would relax pension non-discrimination rules and "top heavy" rules that are designed to prevent firms from skewing too great a proportion of pension contributions to highly paid owners and executives at the expense of ordinary employees. The dilution of these protections could induce further erosion in coverage among low- and moderate-income workers.
In a November 1 letter to House Ways and Means Chairman Bill Archer when the House appeared ready to consider these pension provisions as part of a minimum-wage bill, Treasury Secretary Lawrence Summers and Labor Secretary Alexis Herman sharply criticized the key pension provisions in the package. Summers and Herman warned that the pension provisions that "...raise the maximum retirement plan contribution and considered compensation for business owners and executives and weaken the pension anti-discrimination and top-heavy protections for moderate- and lower-income workers....are regressive, would not significantly increase plan coverage or national savings, and could lead to reductions in retirement benefits for moderate- and lower-income workers."
In considering any tax proposal promoted as offsetting the effects of a minimum-wage increase on small businesses, it is important to consider whether the proposed tax change is reasonably targeted to offset some demonstrable adverse effect from a minimum-wage hike. It also is important to consider whether any of the proposed tax changes have the potential to harm low- and moderate-wage workers. The tax provisions in the legislation the House approved March 9 fail both of these tests.
1. Jerold Waltman, Allan McBridge, and Nicole Camhout, "Minimum Wage Increases and the Business Failure Rate," Journal of Economic Issues, March 1998.
2. The President's budget would transfer $300 billion in non-Social Security surpluses over 10 years to the Medicare Hospital Insurance trust fund. Since this additional $300 billion would not affect Medicare spending, it would add to projected Medicare surpluses over the next 10 years. These additional surpluses would be handled in the same manner that other Medicare surpluses, as well as Social Security surpluses, are handled the Medicare trust fund would loan these funds to the Treasury in return for Treasury bonds. The Treasury bonds, in turn, would increase the trust fund's assets, thereby making Medicare solvent for a longer period. The Treasury would take the funds it received from the Medicare trust fund and use them to pay down debt (since there would be no budget deficits to which these funds had to be applied). The proposed transfer of $300 billion to the Medicare trust fund would both help shore up the Medicare trust fund and pay down more of the debt.
3. A recent Treasury Department analysis also examined the incidence of the estate tax by the income of those who effectively pay the tax, rather than by the size of the estates that are affected. The analysis found that 91 percent of estate taxes are paid by the five percent of taxpayers with the highest incomes, a group with incomes exceeding $190,000 a year. See Julie-Ann Cronin, U.S. Treasury Distributional Analysis Methodology, OTA Paper 85, September 1999.
4. Internal Revenue Service, Statistics of Income Bulletin, Winter 1996-97.
5. U.S. Department of Labor, Social Security Administration, Small Business Administration, and Pension Benefit Guarantee Corporation, Pension and Health Benefits for American Workers, 1994.
6. The pension tax provisions in the vetoed tax bill, which also are included in the Senate bankruptcy legislation, are explained more fully in three Center reports by Peter Orszag, Iris Lav, and Robert Greenstein; Exacerbating Inequities in Pension Benefits: An Analysis of the Pension Provisions in the Tax Bill, October 8, 1999; Criticism of CBPP Pension Analysis Rests on Selective Use of Data And Leaves Misleading Impressions, October 28, 1999;and Pension Provisions of Tax Bill Coming to House Bill Would Heavily Benefit Highly Paid Executives and Business Owners But Could Jeopardize Pension Benefits for Ordinary Workers, March 6, 2000. (The third of these papers is a revised version of the first.) The tax bill vetoed last year also included provisions that would make Individual Retirement Account tax breaks more generous; these IRA changes are not included in the Senate bankruptcy bill or H.R. 3081. The distributional data cited here do not cover the IRA expansions of the vetoed bill. (For data on the distributional effects of the full package of retirement tax benefits contained in the vetoed bill, including the IRA expansions, see Exacerbating Inequities in Pension Benefits.)