July 24, 1997

Roth Offer to Administration Is More Backloaded And at Least as Skewed
to Upper-income Taxpayers as House or Senate Tax Bills

by Iris J. Lav

As Congressional tax writers seek a tax deal with the Administration that will be acceptable to both the House and Senate, proposals may surface that appear to move toward Administration priorities but in fact only postpone costs of high-income tax cuts instead of paring them back. What appears to be a compromise may, in fact, be more costly when fully effective — and more tilted toward providing benefits to high-income taxpayers — than either of the Congressional bills. The offer that Senate Finance Committee Chairman William Roth presented to the Administration this past weekend, dated July 18, 1997, is a case in point.

The Roth offer combines tax cuts geared primarily to upper-income households that were present in the House bill but not the Senate bill with upper-income tax cuts that were part of the Senate bill but not the House bill. Most of the additional cost of including all of these provisions is accommodated, under the Roth offer, through increased reliance upon backloading devices that push the effective dates of various provisions farther toward the end of the initial 10-year period. As a result, the tax package that Mr. Roth offered would be more costly when fully in effect — and would explode in cost more sharply after 2007 — than either the House or Senate bills. The Roth offer is significant as it provides what is likely to be the basic structure of the tax offer the Republican leadership presents to the Administration in the next day or two.

• The House bill has larger upper-income tax cuts in the capital gains area; it includes indexing while the Senate bill does not. The House bill also has a substantial cut in the corporate alternative minimum tax, while the Senate bill does not. The Roth offer includes both indexing and a corporate AMT tax cut similar to the House provision.

• The Senate bill has substantially larger estate tax and IRA tax cuts than the House bill does. The Roth offer includes most of the Senate's additional estate and IRA tax cuts.

Because the Roth package combines House tax cut provisions primarily benefitting high-income taxpayers that the Senate bill omitted with upper-income tax cuts included only in the Senate bill, the Roth offer would direct as large or larger a proportion of its benefits to upper-income taxpayers than even the House bill would.

Major High-Income Provisions In House and Senate Bills and Roth Offer

The House bill is heavily skewed toward upper-income taxpayers; according to Treasury estimates, 67 percent of its tax benefits would go to the highest-income 20 percent of families. In addition, the one percent of families with the highest incomes would receive nearly one and one-half times as much in tax cuts under the House bill as the bottom 60 percent of the population.

As negotiations continue, Congressional negotiators may seek to make room for some Administration priorities within the package by increasing the degree to which upper-income tax cuts favored by the House or Senate are backloaded. For example, Congressional negotiators could find funds to provide a child tax credit to more moderate-income working families or increase the education tax credit by gradually phasing in the proposed reduction in the capital gains tax rate, phasing in the increase in the estate tax exemption over a longer period, or creating additional gimmicks to accelerate revenue collections into the budget window. Such moves would increase the degree to which the tax cuts are backloaded and grow in cost beyond 2007, and thus increase the ultimate cost of the bill. Depending on the extent to which the backloaded tax cuts are those that favor wealthy taxpayers, the tax package could become still further skewed toward providing the bulk of its benefits to the highest-income Americans.

Additional Backloading in Roth Offer Accommodates Indexing and Corporate AMT Break

The Roth offer makes few trade-offs among the tax cut provisions that are included in either the House or the Senate bill but not in both bills. The Roth proposal shoehorns additional tax cuts into the 1997-2007 period largely by postponing effective dates and lengthening phase-in periods, rather than by making substantial reductions in any specific tax cut provisions.

In fact, the Roth offer can be characterized as being very similar to the Senate bill with the addition of capital gains indexing and reductions in the corporate Alternative Minimum Tax that were included in the House bill but not the Senate bill. The Roth offer includes essentially all of the provisions benefiting higher-income taxpayers that were passed by either the House or the Senate.

The addition of capital gains indexing is particularly noteworthy. The Roth offer takes the already highly backloaded House indexing provision and makes it more backloaded. Under the House bill, indexing would raise money in 2001 and 2002 and not start losing significant revenue until 2004. Under the Roth offer, indexing would not start losing significant revenue until 2006. The indexing provision in the Roth offer is so heavily backloaded that it raises $4 billion over the 10 year period ending in 2007, even though indexing ultimately loses tens of billions of dollars. Furthermore, this $4 billion is then used to help pay for the addition to the Senate bill of yet another House tax break — the House corporate AMT provision.

The inclusion of the House corporate AMT tax break adds nearly $20 billion over 10 years to the cost of the Senate bill. This additional cost is "paid for" in the Roth offer in three ways:

• by stretching out the phase-in periods for the estate tax breaks and the increase in the income limits for deductible IRAs;

• by adding the backloaded capital gains indexing provision that raises $4 billion over the next 10 years; and

• by dropping the age limit for the child tax credit from age 18 (after 2002 in the Senate bill) to age 17 and denying the credit to more lower-income working families who owe federal taxes.⁽¹⁾

Degree of Backloading Increased

The Roth offer is more backloaded than either the House or Senate bills, which themselves are heavily backloaded.

• Like the House bill, the Roth offer would allow capital gains income to be indexed for inflation. As noted, the Roth offer postpones the first revenue loss from this provision to 2006 — two years later than the first revenue loss from indexing under the House bill.
  
  In both the House bill and the Roth offer, indexing would take effect in 2001. But by lengthening the number of years an asset must be held to qualify for indexing to five years (from the House bill's three years), the Roth offer moves the first revenue loss back in time from 2004 to 2006.
  
  Under the House bill, the cost of the capital gains tax cuts, including indexing, rises at a clip of nearly $2 billion a year after 2004, according to estimates by the Joint Committee on Taxation. Once effective, the cost of indexing rises sharply each year as the period for which assets qualify for indexing lengthens.
  
  This also would be true under the Roth plan. Under the Roth indexing provision, profits could be adjusted for five years of inflation in 2006; by 2010, adjustment for nine years of inflation would be permitted. For this reason, the provision would rise in cost for a number of years after 2006. While the Roth indexing provision would have modestly lower long-term costs than the House provision because it has a five-year rather than a three-year holding period, the rate of growth in annual cost after 2006 is likely to be similar to the rate of growth under the House bill.

• The Roth offer would postpone the effective date of estate tax breaks for family farms and businesses. The Senate bill would allow estates that include family farms and businesses to exclude $1 million of the value of the farm or business, in addition to the enhanced exclusion that both the House and Senate bills would provide for all estates. The House bill does not include this special exemption for farms and businesses.
  
  The Roth offer proposes a $900,000 exclusion for these farms and businesses, nearly as large as the $1 million exclusion in the Senate bill. But while the Senate exclusion for family farms and business property would take effect in 1998, the Roth exclusion would phase in slowly between 1998 and 2004. The ultimate cost of the exclusion would be only slightly lower under the Roth offer than under the Senate bill, but the cost under the Roth proposal would be $2.5 billion less over the first ten years, primarily because of the slow phase-in.

• The Roth offer retains the backloaded IRA provisions in the same form as in the House and Senate bills. These provisions are among the most backloaded of any provisions in the tax bills; they have little cost in the first five years but have an annual cost of $4.6 billion by 2007 and ultimately reach an annual cost of $10 billion to $11 billion when fully in effect.
  
  The Senate bill contains an additional IRA provision not in the House bill, which raises the income limits below which taxpayers who also are covered by an employer-sponsored retirement plan may elect to make deductible deposits to IRAs, in lieu of deposits to backloaded IRA accounts. Under the Senate bill, the income limits below which married taxpayers could make deposits to deductible IRAs would be phased up from $50,000 in 1997 to $100,000 in 2004. The Roth proposal would increase the limit to $60,000 in 1998 and by $1,000 in each subsequent year.
  
  The very slow phase-in of this additional Senate IRA provision increases the backloading of the IRA tax cuts as a whole. In 2004, taxpayers covered by employer-sponsored retirement plans could make deductible IRA deposits if their incomes were below $100,000 under the Senate bill; the income limit would be $66,000 that year under the Roth offer. But taxpayers in the $66,000 to $100,000 range could, under the Roth offer, deposit funds in backloaded IRAs instead. Due to greater use of backloaded IRA accounts, a larger share of the IRA revenue loss would be pushed outside the initial 10-year period.

In these three areas — capital gains, estate taxes, and IRA provisions — the Roth offer increases the degree to which costs are backloaded relative to the House and Senate bills. Since there are no provisions for which backloading is reduced under the Roth offer, the effect is to create an overall proposal that is more backloaded — and explodes in cost more severely in years outside the budget window — than either the House or Senate bill.

Distribution of Tax Cut Benefits Under Roth Offer
Likely to be at least as Skewed as Under the House Bill

The provisions that primarily benefit higher-income taxpayers are at least as generous in the Roth offer as in the House bill. The capital gains provisions are similar to the capital gains provisions in the House bill. The IRA provisions and estate tax cuts are significantly more generous than those in the House bill and closer to those in the Senate bill

As a result, when the tax plans are fully in effect, the distribution of the benefits under the Roth offer is likely to be slightly more tilted to high-income individuals than the distribution of the benefits of the House tax bill, which itself is heavily tilted toward the well-to-do.

End Note

1. Over 10 years, the "savings" relative to the Senate bill from these changes are: $12 billion from the stretched-out phase-ins, $4 billion from the capital gains indexing gimmick, and $12 billion from the child tax credit reductions, for a total of $28 billion. Of that amount, $20 billion is used to pay for inclusion of the corporate Alternative Minimum Tax reduction. The other $8 billion reduces the total cost of the Roth offer relative to the Senate bill over the next 10 years, although the total gross cost of the Roth offer is $5.7 billion above that of the House bill.