The President’s new tax proposals would raise revenues from high-income and wealthy filers and devote much of the savings to other tax proposals that would benefit low- and moderate-income filers. Estimates from the Urban-Brookings Tax Policy Center (TPC) show that the President’s proposals are quite progressive, but some readers are interpreting those estimates as meaning that low- and middle-income families get only modest benefits. There are two main reasons why that’s not the case:
1. For technical reasons, the TPC estimates classify as “middle-income” some affluent filers who would pay significantly higher taxes under the plan. This lowers the plan’s average gain for middle-class filers.
The estimates don’t count unrealized capital gains when measuring families’ incomes and ranking families on the income scale. So, affluent people who have moderate incomes other than unrealized capital gains but very large amounts of unrealized capital gains income show up in TPC’s tables in the middle of the income distribution.
That’s why the President’s proposal to tax unrealized capital gains after individuals die — a sound proposal that would affect only wealthy filers with large amounts of unrealized gains — appears in the TPC tables to hit a small number of middle-income families quite substantially.
For example, TPC’s tables show a tiny share of filers in the middle fifth of the income scale facing tax increases averaging almost $64,000 from the proposal. To face that amount of tax, such filers likely have average capital gains of more than $400,000. And if a filer’s capital gain totaled $400,000, the total value of his assets would likely exceed this amount substantially and likely be in the millions of dollars. If the capital gain were included in the filer’s income in the year in which the filer owed taxes on it under the President’s plan, the filer would likely be in the highest-income 1 or 2 percent.
By classifying these filers as middle-income, the TPC estimates essentially count the taxes they would pay under the proposal without counting as income the gains that give rise to those taxes. There are technical reasons underlying TPC’s approach. One approach that addresses this issues would be to count unrealized capital gains as income in the year in which they occur — that is, as the assets appreciate in value. But doing so is very difficult technically. A Treasury analysis of the President’s proposal took a different approach, by counting filers’ unrealized capital gains as part of their income in the year these gains would be taxed. It found that 99 percent of the new revenues would come from the top 1 percent of filers.
A related issue is that the TPC estimates assume the President’s proposal is fully phased in in 2016. This is informative because it shows the proposal’s ultimate impact. It means, however, that the estimates show more “middle-income” filers with large unrealized capital gains facing a tax increase than actually would in 2016. That reduces the average gain from the President’s plan for the middle class as a whole. It would take a number of years for the proposal to affect as many filers as the TPC tables show, because unrealized capital gains would be taxed only upon the death of the second spouse.
2. The TPC estimates don’t show the impact of the President’s proposal to make permanent the American Opportunity Tax Credit (AOTC) to help middle- and lower-income families pay for college. The AOTC is slated to expire at the end of 2017 and be replaced by the much smaller, non-refundable Hope Credit. Making the AOTC permanent would make a large difference for many middle- and low-income families, providing thousands of dollars more in aid toward college affordability. TPC’s distribution tables don’t show the benefit of making the AOTC permanent because they are for 2016, before the AOTC is slated to expire.
In short, the President’s tax proposals do substantially more for low- and middle-income people than a cursory examination of the TPC tables might suggest. (It should be noted that the TPC tables, themselves, show more significant gains for middle-income families with children.) Moreover, some of the revenues that these proposals would raise would go to investments in improving child care and access to community colleges. Those investments aren’t tax proposals so the TPC distribution tables appropriately don’t reflect them, but they, too, would significantly help middle- and low-income families.