July 3, 1997

The Clinton Tax Plan
by Robert Greenstein and Iris J. Lav

This analysis assesses three features of the Clinton tax plan unveiled on June 30 — its effects on different income groups, the extent to which its costs would grow after 2007 (i.e., in the years when the baby boom generation begins to retire), and the extent to which its child tax credit would assist low- and moderate-income working families. Its principal findings include the following:

The Clinton plan and the House and Senate bills also differ substantially in the degree to which the costs of their tax packages grow over time.

The Clinton plan differs from the House and Senate bills in the extent to which it assists near-poor and lower-middle-income families, in part because of differences in the design of the child tax credit. To assess the Clinton child tax credit proposal, it is helpful to compare it to current and earlier Congressional proposals.

These findings are discussed below.

 

Distributional Effects

In releasing its tax proposal June 30, the Administration emphasized that the middle three-fifths of the population would get twice as large a percentage of the tax cuts under its plan as under the House and Senate bills. The group among the middle three-fifths of the population that would do best under the Clinton plan is the next-to-the-top income fifth. This income group, which constitutes the core of the upper-middle-class, would receive 35 percent of the Clinton tax cuts.

Accordingly, it is of interest to examine the proportion of the tax cuts that the bottom three-fifths of the population would receive under the Clinton plan and also to compare this to the share of the tax cuts that wealthier individuals would receive. This analysis, based on the Treasury Department's distribution figures, shows the following:

How the Clinton, House, and Senate Tax Plans Distribute Their Tax Cuts

Income by Quintile

President Clinton

House

Senate

Lowest 1.2% 0.6% 0.4%
Second 10.1 2.5 2.7
Third 22.2 9.6 10.2
Fourth 34.6 20.0 21.3
Highest 31.5 66.8 65.0
Top 10% 11.7 47.3 42.3
Top 5% 6.5 34.9 28.2
Top 1% 2.6 18.8 12.5
Source: U.S. Department of Treasury

Citizens for Tax Justice Analysis Also Finds Substantial Differences
Between Clinton and Congressional Plans

An analysis that Citizens for Tax Justice issued July 2 of the distributional effects of the Clinton plan, the House and Senate bills, and the House Democratic tax bill also finds sharp differences in the degree to which the Clinton plan and the House and Senate bills favor those at the top of the income scale. According to the CTJ analysis — which includes the effects of the estate tax cuts and excise tax extensions and increases in the various proposals — the top 20 percent of households would receive 83 percent of the tax cuts in the House bill and 82 percent of the tax cuts in the Senate bill, as compared to 48 percent of the tax cuts in the Clinton plan. The top one percent of households would receive 38 percent of the House bill’s tax cuts and 33 percent of those in the Senate bill, as compared to nine percent of the Clinton tax cuts.

The inclusion of estate tax reductions in the CTJ analysis increases the proportion of the tax cuts the top 20 percent and top one percent of households would secure. The inclusion of the excise tax measures in the analysis appears to reduce the share of the net tax reduction going to middle- and lower-income groups and thereby further raise the proportion going to high-income groups.

In short, the differences between the Administration and Congressional plans in how the tax cuts would be distributed across the income scale are very large.

 

The Costs in the Second 10 Years

Unlike the House and Senate tax bills, the Clinton plan is not heavily backloaded. It does not grow in cost in future years at rates that exceed the rate at which the economy is expanding.

The House and Senate tax bills are designed in a fashion that keep their costs artificially low in the initial years. But a number of their tax cut provisions — especially those primarily benefitting higher-income taxpayers — mushroom in cost over time. Under the House and Senate bills, most of the costs of the capital gains and estate tax cuts and Individual Retirement Account expansions are delayed until the last few years of the 10-year period from 1998 through 2007.

The cost of these provisions would continue to grow rapidly in years beyond 2007.

The rapid growth of the high-income provisions drives up the cost of the House and Senate tax plans as a whole at the end of the first 10-year period and through much of the second decade. In the final three years of the initial period, from 2004 through 2007, the House bill is growing at a rate of more than 11 percent annually while the Senate bill is growing at a 13 percent annual rate. These growth rates are more than twice as high as the 4.6 percent annual rate at which the Congressional Budget Office forecasts the economy will be growing in those years.

Taking account of the pattern of growth that each bill's tax cuts likely would follow in the second decade, we estimate the cost of the House bill will rise to more than $700 billion over the second 10 years the provisions are in effect, from 2008 to 2017. The Senate bill would have modestly lower — but still quite high — costs of approximately $650 billion in the second 10 years. (See the box below for an explanation of the methodology used in computing these estimates.)

In contrast to the House and Senate bills, the cost of the Clinton proposal is not substantially backloaded.

The House and Senate plans would explode in cost at about the same time that the baby boom generation reaches retirement age. As a result, the House and Senate bills would cause revenues to shrink as a percentage of GDP just when the retirement of the baby boom generation causes federal expenditures for Medicaid, Medicare, and Social Security to begin to rise sharply as a percentage of GDP. The House and Senate bills would make the deficit problem the nation is expected to face at that time more serious and more difficult to solve.

The cost of the Clinton tax cuts would rise at a rate similar to economic growth at the end of the initial 10-year period and throughout the subsequent 10 years, a rate of about five percent per year. Revenues would not continue to shrink after 2007 as a percentage of GDP under the Clinton plan.

 

The Child Tax Credit

Under the 1995 reconciliation bill that Congress passed and President Clinton vetoed, a family would have needed to owe income tax before the Earned Income Tax Credit is applied in order to qualify for the child credit. Under that bill, more than 20 million children — about one-third of all children — would not qualify for the child credit because their incomes are too low to owe income tax.

The Cost of the Tax Plans in the Second 10 Years

The cost of the House, Senate, and Clinton tax plans in the second 10 years after enactment — from 2008 through 2017 — was estimated based on two sets of factors: the cost and growth patterns of each plan in the latter part of the first 10 years, and the types of tax cuts each plan includes.

According to the Joint Committee on Taxation’s revenue tables, the cost of the Senate tax bill is growing at an annual rate of 13 percent in the years between 2004 and 2007, with the cost increasing an average of $4.3 billion a year during these years. The estimate for the subsequent 10 years used in this analysis assumes that the average rate at which the tax cut grows from 2004 through 2007 would continue through 2009. After that time, the growth rate would taper downward through 2012, falling back to the rate of GDP growth in 2013. (GDP growth is assumed to be 4.6 percent per year in line with the Congressional Budget Office forecast.) This is a conservative methodology, because the cost of the IRAs and several other tax breaks is likely to continue to grow at rates exceeding GDP throughout most of the second decade after enactment. Nevertheless, under these assumptions the cost of the tax cut would rise from $41.8 billion in 2007 to $81 billion in 2017, and the cost in the 10-year period would be $660 billion.

The cost of the House bill is growing at an annual rate of 11.4 percent from 2004 through 2007, with the cost increasing during those years an average of $3.7 billion year. Although the growth rate appears lower than in the Senate bill, the House bill is likely to have higher long-term growth than the Senate legislation. The House bill has the same backloaded IRA as the Senate bill. In addition, the capital gains indexing provision in the House bill is only beginning to phase in by 2007, at which time a maximum of six years of inflation adjustment can be taken into account. The cost of capital gains indexing would continue to increase at a rapid rate beyond the middle of the second decade and perhaps thereafter. Thus, to estimate the cost of the House bill in the second 10 years, the average rate at which the tax cut grows from 2004 through 2007 is assumed to continue through 2012. The growth rate is then assumed to taper gradually, falling back to the rate of GDP growth by 2017. Under these assumptions, the cost of the House tax cut would rise from $40.4 billion in 2007 to $99 billion in 2017, and the cost in the 10-year period from 2008 through 2017 would be $725 billion.

The cost of the Clinton plan is growing at a rate of 5.2 percent per year from 2003 through 2007, with the cost increasing an average of $1.6 billion a year. (The growth rate was calculated from 2003 rather than 2004 because the lower 3.8 percent growth rate from 2004 through 2007 did not seem to be representative of the plan’s longer-term growth potential.) All provisions in the Clinton plan are fully phased in by 2003. Thus, the costs in the second 10-year period were estimated by assuming the rate of growth from 2003 through 2007 would continue through 2017. Using that procedure, the cost of the Clinton tax cut would increase from $34.1 billion in 2007 to $57 billion in 2017, and costs would total $455 billion in the 10-year period from 2008 through 2017.1
__________
1 It should be noted that the cost estimates for the period from 1998 through 2007 for the Congressional bills is from the Joint Committee on Taxation, while the cost estimate for the Clinton bill was made by the Treasury.

The low-income children who would not have qualified under the 1995 legislation fall into three categories:

The child tax credit in the Contract with America, unveiled in September 1994, would have covered most of the first of these three groups of children. It would have provided the child credit to families that owe no income tax before the EITC is computed but that still pay taxes because their payroll taxes, including both the employee and the employer share of the tax, exceed their EITC. (Most economists believe that workers effectively pay both the employer and the employee share of the tax, with the employer share of the tax being passed through to employees in the form of lower wages than would otherwise be paid.)

In writing tax legislation to implement the Contract in early 1995, the House Ways and Means Committee eliminated coverage for this group of families (i.e., for families that do not owe income tax but have a net federal tax liability because their payroll tax exceeds their EITC). At that time, the Ways and Means Committee dropped coverage for these families to free up funds in the tax bill for larger corporate tax cuts. The Senate Finance Committee then adopted the Ways and Means Committee's approach to the child credit in this area. As a consequence, the 1995 legislation provided the child credit only to families that owed income tax before the EITC is taken into account. It did not take payroll taxes into account.

The Senate Leadership tax plan that Senate Majority Leader Trent Lott introduced in January 1997 followed the same approach as the 1995 legislation. It would provide the child credit to families that owe income tax before the EITC is computed.

In recent weeks, however, a plethora of different child tax credit proposals have emerged. Some are more restrictive than the 1995 legislation. Others are more expansive.

Table 1
Income Thresholds for Child Credit
(For a Two-Parent Family of Four 1997 Dollars)

 

Contract with America/ Daschle

1995 Reconciliation Bill and January 1997 Senate Republican Leadership Tax Bill

Current Senate Bill

Current House Bill

Clinton Plan

House Democratic Plan (Rangel)

Income Level at Which Family Begins to Get Child Credit

$16,965

$17,500

$22,360

$24,385

$17,500

$10

Income Level at Which Family Gets Full Child Credit

19,068

24,165

26,280

27,158

22,405

$13,070

The Clinton plan charts a course between the current House and Senate bills on the one side and the Democratic alternatives on the other. It provides the credit to the same number of low- and moderate-income children as would have received it under the 1995 legislation that Congress passed and the President vetoed. The Clinton plan covers more of these children than the current House and Senate tax bills would, while covering fewer such children than the House and Senate Democratic tax bills and the original Contract with America would.

Table 2
Child Credit For Near-Poor and Lower-Middle-Income Families
Under Various Tax Plans

(For a Two-Parent Family of Four)

Family Income Level

Contract With America/ Daschle Bill

1995 Reconciliation Bill/January 1997 Senate Leadership Bill

Senate Bill

House Bill

Clinton Plan

House Democratic Bill (Rangel)

$17,500

$ 195

$ 0

$ 0

$0

$0

$1,000

20,000

1,000

375

0

0

375

1,000

22,000

1,000

675

0

0

823

1,000

24,000

1,000

975

418

0

1,000

1,000

26,000

1,000

1,000

929

582

1,000

1,000

28,000

1,000

1,000

1,000

1,000

1,000

1,000


End Note

1. The Rangel credit would allow the credit to offset the employee share of the payroll tax, up to the maximum credit of $500 per child.


Related Center analyses:

The Senate Tax Bill

The House Tax Bill

The Child Tax Credit Provisions in the Senate Bill

The Child Tax Credit Provisions in the House Bill