Director of Federal Tax Policy
With Tax Day approaching, it’s a good time to examine our federal tax system and proposals to reform it.
Republicans have placed tax reform at the top of their legislative agenda. As our first chart shows, their proposals will likely be consistent with their proposed bill to repeal the Affordable Care Act: a focus on large tax cuts for the richest people in the country instead of helping workers and their families. Households with annual incomes above $1 million — less than 1 percent of households — would receive a disproportionate share of the tax cuts under both the Trump campaign plan and House Republicans’ “Better Way” plan.
The “Better Way” plan would deliver massive tax cuts to the wealthiest. Millionaires would receive $302,000 in 2025, on average, boosting their after-tax incomes by 11 percent, the Tax Policy Center (TPC) estimates. By contrast, low- and middle-income households would get relatively small tax cuts or small tax increases, as our second chart shows. President Trump’s campaign tax proposal is also heavily skewed towards the top.
As a result, both plans violate the “Mnuchin Rule” — Treasury Secretary Steven Mnuchin’s promise that “there would be no absolute tax cut for the upper class” in tax reform — and Trump’s promise to “ benefit American workers and American families” on every decision related to taxes.
Both President Trump and House GOP leaders want to repeal the estate tax, which only affects the very wealthiest estates due to its high exemption level of $5.49 million per individual ($10.98 million per couple). As our third chart shows, only the top 0.2 percent — 2 out of every 1,000 — estates nationwide will pay any federal estate tax in 2017, and only about 50 of them would be small farms and businesses.
The effective tax rate is also much lower than the top statutory rate of 40 percent. Taxable estates in 2017 will pay 17 percent of their value in tax on average, and small farms and businesses will owe less than 6 percent, TPC estimates. The claim by repeal proponents that the tax unduly burdens small farms and businesses is therefore a myth.
In addition, a centerpiece of both the Trump and “Better Way” tax plans is a special, much lower top rate for “pass-through” business income, now taxed at owners’ individual income tax rates. About half of pass-through income flows to the top 1 percent of households. Both plans would cut the top rate on this income sharply, from 39.6 percent to 15 percent and 25 percent, respectively — well below the plans’ top individual income tax rate of 33 percent.
This would overwhelmingly benefit high-income people, while doing nothing for most true small business owners, since — as our fourth chart shows — they’re already taxed at rates much lower than the top rate in the Trump and “Better Way” proposals.
The pass-through proposal also would spur large-scale tax avoidance by high-earners, who would have a major incentive to reclassify their wages and salaries as “business income” to get the lower pass-through rate. More than 40 percent of the $1.5 trillion cost of the Trump plan’s pass-through provision would come purely from such tax avoidance, according to TPC. The provision would lose $650 billion to tax avoidance by high earners alone, easily exceeding its total tax cuts for the bottom 99 percent of the population.
Addressing these avoidance opportunities would be particularly difficult because the IRS budget has been cut by 18 percent since 2010, adjusted for inflation, which has weakened enforcement efforts, along with taxpayer services and efforts to address identity theft. The combination of more tax avoidance opportunities and less IRS enforcement capacity would further reduce revenues and undermine the integrity of the tax system. Despite this, and despite Treasury Secretary Mnuchin’s call for additional IRS resources, President Trump’s budget proposed more IRS cuts, as our fifth chart shows.
While House Speaker Paul Ryan has said that tax reform can generate “the kind of economic growth we need which will solve so many problems we have in this country,” there’s no evidence that tax cuts — particularly those aimed at high-income people, as the GOP plans are — would produce this growth. Trickle-down economics has repeatedly failed. As one review of the economic literature concludes, “growth rates over long periods of time in the U.S. have not changed in tandem with the massive tax changes in the structure and revenue yield of the tax system that have occurred.” In fact, employment and gross domestic product both grew faster after President Clinton’s 1993 tax increase than after President Bush’s 2001 tax cut, as our sixth chart shows.
Both the House GOP and Trump campaign tax plans would cost trillions of dollars over the next ten years, which could create pressure for cuts in critical programs that federal revenues support. As our seventh chart shows, federal revenues support a wide range of programs, including Social Security, Medicare and Medicaid, transportation infrastructure, national defense and diplomacy, the safety net, education, and medical and scientific research.
Calls for costly tax cuts also ignore the fact that, contrary to President Trump’s claims, the United States is a relatively low-tax country. The United States has lower taxes as a share of the economy than nearly all other members of the Organisation for Economic Co-operation and Development, as our eighth chart shows.
Rather than hoping high-income tax cuts will produce growth that trickles down to low- and moderate-income people, policymakers should focus on boosting two tax credits that are proven to encourage work and reduce poverty: the Earned Income Tax Credit (EITC) and Child Tax Credit (CTC). As our ninth chart shows, they lifted nearly 10 million people out of poverty in 2015, including 5 million children. They also made 22 million people less poor, including 8 million children. Also, income from these credits encourages work and can lead to improved maternal and infant health, stronger school performance, higher college enrollment, and increased work and earnings in adulthood.
In particular, policymakers should address the glaring hole in the EITC for “childless” workers and non-custodial parents, as our tenth chart shows. Their EITC is very small, averaging just $293, compared to an average of $3,186 for workers with children. As a result, childless workers are the lone group the federal tax code taxes into, or deeper into, poverty. Fixing this should be a top tax policy priority.