Revised July 29, 1999
Analyses by Treasury, The Joint Tax Committee, And Citizens For Tax Justice All Show House Tax Bill Heavily Tilted Toward Wealthy
Share of Tax Cuts Given to Wealthy Substantially Exceeds Share of Taxes They Pay
by Isaac Shapiro, Robert Greenstein and Iris J. Lav
The Treasury Department, the Joint Committee on Taxation, and Citizens for Tax Justice have all issued analyses that examine who would receive the tax cuts the House tax bill provides. While the three analyses differ and the Joint Tax Committee analysis suffers from several deficiencies, discussed below, that cause it to underestimate the proportion of the tax cuts that high-income households would secure all three analyses show that a highly disproportionate share of the tax cuts would accrue to those at the top of the income scale. The proportion of the tax cuts that the well-to-do would receive would substantially exceed the proportion of federal taxes they pay. (Even if the tax cuts were proportional to the share of taxes paid, the distribution of the tax benefits in the bill would still be highly problematic. See the box below.)
- Congressional Budget Office analyses show that the top one percent of households pays 19 percent of federal taxes. But the Treasury Department's analysis of the House tax bill shows the richest one percent of taxpayers would get 33 percent of the bill's tax-cut benefits or nearly twice as large as a percentage when the tax cuts are fully in effect. The CTJ analysis finds an even higher percentage of the tax cuts going to this group. (This percentage is somewhat larger under the CTJ analysis primarily because it includes the effects of the bill's corporate tax cuts, while the Treasury analysis does not.)
- The Joint Tax Committee's analysis does not include the bill's elimination of the estate tax or its corporate tax reductions and stops in 2004, despite the fact that most of the upper-income tax cuts in the bill phase in largely between 2005 and 2009. This causes the Joint Committee analysis to understate the bill's tilt toward the well-to-do. (See appendix on page 4 for a discussion of this issue.) Even so, the analysis shows taxpayers with incomes over $200,000 the top 1.9 percent garnering 32 percent of the tax cuts by 2004, a larger share than the 25 percent of federal taxes the Joint Committee says this groups pays. Moreover, these individuals would receive a significantly greater share of the tax cuts in subsequent years when the bill's upper-income provisions take full effect.
- The same pattern applies if one looks beyond the top one percent of taxpayers. The Treasury estimates, for example, that the top five percent of households would secure 55 percent of the bill's tax cuts; the CTJ analysis indicates that about 60 percent of the tax cuts would go to this group. The data from the Congressional Budget Office on who bears the tax burdens show, however, that the top five percent of households pays 35 percent of the federal taxes, a considerably smaller proportion.
Disparate Treatment of Affluent and Middle-Class Households
The extent to which the House bill's tax cuts are skewed toward those at the top of the income scale becomes even more pronounced when one compares the tax cuts that high-income households would receive to those that other households would be given.
- The Treasury analysis finds that two-thirds of the tax cuts 66 percent would go to the most affluent 10 percent of the population and 80 percent of the cuts would go to the top 20 percent of households. But the 20 percent of Americans in the middle of the income spectrum would get just five percent of the tax cuts. The bottom 60 percent of the population combined would share just seven percent of the tax cut benefits, less than one-fourth what the top one percent would get.
- The average tax cut for the richest one percent of Americans would be $37,000 a year when the tax cuts are fully in effect, the Treasury estimates. The average tax cut for the bottom 60 percent of the population would be $134.
(The Citizens for Tax Justice estimates are similar. CTJ estimates that 69 percent of the tax cut would go to the top 10 percent of households, with just six percent going to the middle fifth of households and only nine percent going to the bottom 60 percent of households. Even the Joint Tax Committee estimates, with their understatement of the proportion of the tax cut going to high-income groups, are not very different. The Joint Tax Committee tables indicate that nearly 55 percent of tax cuts would go to the top 10 percent of households in 2004, while the bottom 60 percent of households would receive just 10 percent of the tax cuts.)
Should the Distribution of Tax Cuts Mirror the Distribution of Tax Burdens?
As this analysis indicates, the bill falls well short even under the fairness standard that the bills defenders choose to apply. Moreover, this standard that tax cuts should be apportioned in accordance with the share of taxes that various income groups pay is itself deeply flawed. Use of such a standard implies that the more income disparities widen in the United States and high-income individuals receive the lions share of the income gains (and thus pay more of the taxes), the more that tax cuts should be directed to the wealthy, making these disparities even greater.
Use of such a standard also overlooks the fact that the wages and living standards of much of the population, with the notable exception of upper-income households, are not much better than they were a decade or two ago. In fact, the hourly wage of the typical (or median) worker is slightly lower today than it was at the end of the 1970s, after adjusting for inflation. By contrast, both executive compensation and capital gains income have risen smartly for those on the upper rungs of the economic ladder.
These developments have multiple causes, including international competition, technological advances, the decline in unionization, other economic factors, and policy changes. Given these trends toward widening wage and income disparities, tax policy ought to compensate at least modestly. At a minimum, tax policy should not magnify these trends.
This is a matter of some importance, since the trend toward increasing income disparities has been quite marked. Congressional Budget Office data show that from 1977 to 1995 (the first and last years for which such data are now available), the average before-tax income of the top one percent of the population jumped 77 percent after adjustment for inflation. The average income of the top fifth of the population also rose substantially, climbing 29 percent. But the average income of the middle fifth barely changed during this period, rising only two percent, and the average income of the bottom two fifths of the population declined. A policy of distributing the lions share of tax cuts to those on the top rungs of the economic ladder, on the grounds that tax cuts should be conferred in proportion to taxes paid, would exacerbate rather than ameliorate these trends. It would increase further the growing disparities of income and wealth between the most affluent individuals and the rest of society.
Finally, there is the issue of priorities. There is not an economic need for tax cuts geared to the high end of the income spectrum the economy is running at full tilt with the current tax rates, the stock market is booming at the current capital gains rates, high-income households are already much better off than in the past, and Federal Reserve chairman Alan Greenspan has cautioned that tax cuts in general may be ill-advised at this point. Thus, the question arises as to whether tax cuts of this nature should take precedence over other needs. Should tax cuts that provide the lion's share of their benefits to the most affluent members of society be accorded priority over greater debt reduction, strengthening the long-term financial security of Medicare and Social Security, public investments that hold promise for improving long-term productivity growth (such as investments in education and training, infrastructure, research, and early intervention programs for children), and even tax cuts in which a greater share of the tax reductions go to the middle class and the working poor?
Why the Joint Tax Committee Estimates Understate the Proportion of the Tax Cuts that Would Go to High-Income Households
The Joint Tax tables suffer from three significant shortcomings. All three deficiencies result in an understatement of the degree to which the bill tilts toward those at the top of the income scale. Specifically, the Joint Tax Committee's distribution tables:
- do not include the effects either of the estate tax repeal or the large corporate tax cuts in the bill, both of which primarily benefit high-income taxpayers;
- only go through the year 2004, while several of the key provisions of greatest benefit to high-income taxpayers do not take full effect until a number of years later at which point these tax cuts are much larger in size; and
- only partly account for the benefits from the capital gains tax cut, another provision of principal benefit to those at high-income levels. The Joint Tax methodology used to assess the distributional effect of the capital gains tax cut reflects an approach most economists reject, as it effectively counts a portion of the capital gains tax reduction as a tax increase.
Tables Ignore Estate and Corporate Tax Cuts
The Joint Tax Committee distribution tables do not include the effects of reductions in estate and corporate taxes. The Joint Committee did not examine the distributional effects of those tax changes. Estate and corporate tax cuts, however, are about one-fourth of the entire tax cut package from 2000 to 2004, the years the Committee's distribution analysis covers.
- The bill's repeal of estate taxes costs, phased in over 10 years, would be of almost exclusive benefit to high-income individuals. The estate tax cuts would apply only to the largest one to two percent of estates; all other estates are already exempt from taxation.
The Citizens for Tax Justice finds that 91 percent of the benefits of eliminating the estate tax would go to the highest-income one percent of taxpayers, a group with incomes exceeding $300,000 a year.
- The House bill includes an array of corporate tax reductions, such as a cut in the corporate capital gains tax rate and elimination of the corporate alternative minimum tax. These corporate tax reductions amount to about $26 billion between 2000 and 2004.(1)
Most economists, including those at the Congressional Budget Office, believe both that the federal tax on corporate profits ultimately is paid by individuals who hold capital assets such as stocks, bonds, or other forms of capital, and that ownership of capital is concentrated among higher-income taxpayers. While middle-income families generally have some capital assets, the assets held by middle-income families are a small fraction of the total capital assets in the economy. More than three-fourths of taxable capital assets are held by those with incomes greater than $100,000.
The combined revenue loss from the estate and corporate tax cuts is about $42 billion over the 2000 to 2004 period, or more than one-fourth of the total tax cuts in this period. As the next section shows, moreover, the size of these and other upper-income cuts grows sharply thereafter.
Upper-Income Tax Cuts Swell After 2004
The Joint Tax tables understate the average tax cut received by high-income taxpayers as well as the share of the overall tax cut received by these households not only because the tables ignore estate and corporate taxes, but also because these and other tax cuts that are of particular benefit to high-income taxpayers ramp up dramatically after 2004. For example:
- The estimated cost of the estate tax reductions is $16 billion over the first five years but will ultimately reach more than $40 billion a year when fully phased in.
- The corporate alternative minimum tax reductions total just $721 million over the first five years but will equal $3.8 billion in 2009 alone.
- The phased-in repeal of the alternative minimum tax for individuals, whose benefits also will go disproportionately to high-income taxpayers, reduces revenues by $7.3 billion from 2000 to 2004. But in 2009 alone, its cost will be $22.5 billion. That is, this provision of great benefit to high-income taxpayers will cost more than three times as much in 2009 alone as it will in the five-year period from 2000 to 2004.
The individual AMT is a provision intended to insure that high-income taxpayers cannot use a combination of special deductions and credits to avoid paying taxes. While the level at which the AMT begins to take effect needs to be increased somewhat so that it does not affect the middle class, its outright repeal the approach taken by the Archer bill will be of disproportionate benefit to high-income taxpayers.
- The 10 percent across-the-board income tax rate cut grows in size from $18.4 billion in 2004 to $111.6 billion in 2009 as it is phased-in. Some 60 percent of the benefits of the rate cut would go to the highest-income 10 percent of taxpayers; 29 percent would go to the richest one percent.
By contrast, the tax cut of most benefit to the middle class the increase in the standard deduction takes full effect before 2004. So the distribution of the tax package as a whole will grow more unequal over time.
Benefits of Capital Gains Tax Cut Understated
In estimating the tax cut that taxpayers at different income levels would secure from a capital gains tax rate reduction, the Joint Tax Committee uses a methodology that is rejected by leading analysts and that the Joint Committee itself rejected until late 1994. The methodology the Committee now employs makes the tax benefits that investors receive when capital gains taxes are reduced look considerably smaller than they actually are.
Analysts agree that when capital gains tax rates are reduced, as they would be under the House bill, investors sell some assets they otherwise would sell at a later time (or not sell at all) in order to take advantage of the lower tax rate. As a result, investors pay some additional capital gains taxes on the additional profits they take in the years in which they make the additional assets sales. Investors would, of course, choose to follow this course and sell some additional assets only if they found it financially advantageous to do so. The Joint Tax Committee methodology, however, treats the capital gains tax payments that such investors would make, as a result of having elected to sell off some additional assets, as tax increases the government had imposed on them. The Joint Committee subtracts these "tax increases" from the tax cuts investors would secure by paying a lower capital gains tax on the profits from the sales of assets they would have sold anyway.
This methodology makes the net tax reduction that the Joint Committee shows investors receiving from a capital gains tax cut appear artificially small. Since high-income individuals receive the bulk of capital gains income and pay the bulk of capital gains taxes, understating the dimensions of the tax cuts that investors would receive from a capital gains rate reduction, such as that which the House bill contains, makes packages like the House bill appear less tilted toward high-income households than they actually are.
Leading Analysts Reject Joint Tax Methodology
on the Distribution of Capital Gains Tax Benefits
Many of the leading analysts in the field reject the methodology the Joint Tax Committee now uses because of the substantial distortions the methodology produces in estimating the distribution of the benefits of a capital gains tax cut. Among those dismissing the current Joint Tax Committee approach are: Robert Reischauer, former director of the Congressional Budget Office and now a senior fellow at the Brookings Institution; Henry Aaron, also a senior fellow at the Brookings Institution; and Jane Gravelle, the Congressional Research Service's leading tax expert and analyst. In addition, several years ago Gravelle co-authored an article on this matter with Lawrence Lindsey, a noted conservative economist who served for a number of years on the Federal Reserve Board, now advises the presidential campaign of George W. Bush, and has supported capital gains tax cuts. In their article, Lindsey and Gravelle explicitly reject the methodology the Joint Tax Committee employs.
As Henry Aaron has observed, investors who respond to a capital gains tax cut by selling more assets are people who face one set of opportunities under the current capital gains tax rates and find it financially advantageous not to make additional asset sales but face a more generous set of opportunities when capital gains tax rates are reduced and choose to follow a different course. "Since they have the option of doing what they did before (i.e., not selling additional assets), but the new, more favorable tax rates induce them to do something else, they must be better off," Aaron explains. "It is logically absurd to count them as worse off in any way whatsoever" [i.e., to count them as being saddled with a tax increase].
Aaron's view is supported by an article Gravelle and Lindsey co-authored in 1988 before Lindsey joined the Fed. In the article, they wrote:
"... suppose a reduction in the capital gains tax rate led to substantially more capital gains realizations [i.e., more sales of assets] and actually increased the tax revenue paid by upper-income groups....it would be totally inappropriate to say that their tax burden had increased. After all, with a lower tax rate, these upper-income taxpayers are less burdened than they were before, even though they pay more taxes."(2)a
In addition, in a subsequent analysis that examined the current Joint Tax Committee methodology, Gravelle noted that, if anything, the standard methodology that most economists favor (and that the Joint Tax committee used until late 1994) understates the benefits that investors would secure from a capital gains tax cut because it does not reflect the tax benefits they would receive when they voluntarily sell more assets to take advantage of a lower capital gains tax rate. She also observed that economists generally would reject the current Joint Tax Committee methodology.
a This quote is from Jane G. Gravelle and Lawrence B. Lindsey, "Capital Gains," Tax Notes, January 25, 1988, p. 399. Gravelle included this quote in Jane G. Gravelle, "Distributional Effects of Tax Provisions in the Contract with America as reported by the Ways and Means Committee," CRS Report for Congress, April 3, 1995.
Consider the example of a wealthy investor who plans to sell assets for a profit of $100,000. The House bill would lower the capital gains tax rate on these profits from 20 percent to 15 percent, providing the investor a $5,000 tax cut. Now suppose the investor decides to sell additional assets to take advantage of the lower capital gains tax rate and realizes an additional $20,000 in profits now rather than in a future year. The investor would pay $3,000 in capital gains tax on these profits (15 percent of $20,000). This would represent a savings of $1,000 over the $4,000 in taxes the investor would have paid had the 20 percent capital gains rate remained in effect. But instead of placing the total tax cut for this investor at either $5,000 (ignoring the additional $1,000 in tax savings) or $6,000 (including these savings), the Joint Tax Committee methodology places it at only $2,000. The Committee counts the $3,000 in taxes paid on the profits from the sale of the additional assets the investor chose to sell as a tax increase, and subtracts this "tax increase" from the $5,000 tax cut the investor received on profits from the sale of the assets he or she would have sold anyway.
The Joint Tax Committee's peculiar methodology in this area is rejected by leading economists and analysts. Experts such as former CBO director and Brookings senior fellow Robert Reischauer, Jane Gravelle of the Congressional Research Service, and Lawrence Lindsey, a conservative economist who served for a number of years as a governor of the Federal Reserve and is now a leading adviser to presidential candidate George W. Bush, have in the past sharply criticized the methodology the Joint Tax Committee now uses and pronounced it as invalid. (See box above.) A Joint Tax Committee report published in 1993 also rejected this approach.(3)
The much more widely accepted methodology for examining the effects of a capital gains rate cut on different income groups is to consider the tax cuts that investors would receive as a result of paying less in capital gains tax on profits from the sales of assets they would have sold in the same years anyway, while disregarding the taxes that investors would pay on profits from additional assets sales they elect to make to take advantage of a lower capital gains tax rate.(4) This is the approach both the Treasury and Citizens for Tax Justice use. It also is the approach the Joint Tax Committee itself used until late 1994.
Fuller Estimates Show House Bill Heavily Skewed Toward High-Income Taxpayers
The Treasury Department and Citizens for Tax Justice have analyzed the distributional effects of the principal provisions of the House bill. Their approaches provide fuller and more accurate assessments than the Joint Tax Committee's distributional tables because Treasury and CTJ include the effects of the estate tax changes, examine the tax provisions when fully in effect, and use the traditional method to assess the benefits of a capital gains tax reduction rather than dubious Joint Tax Committee method. The provisions of the House bill that the Treasury analysis covers are: the 10 percent cut in personal income taxes; the individual capital gains tax cut; the elimination of estate taxes; the repeal of the individual Alternative Minimum Tax; the new interest and dividends exclusion; and the increase in the standard deduction for married filers. The CTJ analysis includes all of these provisions plus the provisions of the bill that would increase pension limits for upper-income tax filers, create a deduction for health insurance premiums costs incurred by those who pay at least half of such costs, and reduce corporate taxes. As noted earlier, the Treasury and CTJ assessments of the House tax bill both find its benefits to be heavily concentrated among high-income taxpayers.
1. This figure does not include the tax cuts in the bill that are connected to investments in renewal communities.
2. This quote is from Jane G. Gravelle and Lawrence B. Lindsey, "Capital Gains," Tax Notes, January 25, 1988, p. 399. Gravelle included this quote in Jane G. Gravelle, "Distributional Effects of Tax Provisions in the Contract with America as reported by the Ways and Means Committee," CRS Report for Congress, April 3, 1995.
3. Joint Committee on Taxation, Methodology and Issues in Measuring Changes in the Distribution of Tax Burdens, June 14, 1993, pp. 46-7.
4. Going back to the example in the last paragraph on page 4, the tax cut of the investor in question would be estimated as $5,000 (ignoring the $1,000 in tax savings on the taxes the investor would pay on the additional assets he or she would sell).