July 29, 1999

This paper is substantially the same as the July 28 paper, Is the Roth Proposal a Middle-Class Tax CutThe major difference is that the newer, retitled paper reflects Senate Finance Committee modifications to the Roth proposal IRA provisions.

Is the Senate Finance Committee Bill a Middle-Class Tax Cut?
by Iris J. Lav and Robert Greenstein

Table of Contents

I.  The Income Tax Rate Cut

II.  Increasing the Ceiling for the 14 Percent Bracket

III.  IRA Expansions

IV.  Marriage Penalty Relief

V.   Estate Tax

VI.   Health Insurance Deductions

The tax bill the Senate Finance Committee approved July 21 is sometimes presented as a broad-based middle-class tax-cut proposal. The bill, however, is much less targeted to the middle class than initial reports might suggest. While it does provide some tax reduction for those in the middle of the income spectrum, the bulk of its tax cuts would go to households at higher income levels.

A Treasury Department analysis issued July 27 finds that the ten percent of households with the highest incomes would receive 45 percent of the bill's tax cuts when the tax cuts are in full effect. The top fifth of households would receive 67 percent of the tax cuts — two-thirds of them. By contrast, the 20 percent of households in the middle of the income spectrum would receive only nine percent of the tax cuts, less than one seventh what the top fifth would receive. The bottom 60 percent of the population combined would receive just 12 percent of the tax cuts, about the same amount as the richest one percent by itself would get.

Furthermore, the Treasury analysis estimates that the wealthiest one percent of households would receive an average tax cut of $9,569 a year. The bottom 60 percent of the population would receive a $174 average tax cut.

An analysis conducted by Citizens for Tax Justice finds the bill to be even more tilted toward high-income households than the Treasury analysis does. The CTJ analysis estimates that 76 percent of the tax cuts would go to the top fifth of households, while the bottom 60 percent of households would share just 11 percent of the tax cuts. (The CTJ analysis shows a somewhat larger portion of the tax cuts going to high-income households than the Treasury analysis does partly because the CTJ analysis includes the effects of the bill's corporate tax reductions while the Treasury analysis does not.)

(in billions of dollars)

Provisions Providing Bulk of Their Benefits to Middle-Class or Lower-Income Filers
Reduce 15 percent rate to 14 percent 26.9
EITC marriage penalty relief 1.3
Expand dependent care tax credit 0.7

Provisions Disproportionately Beneficial to Higher-Income Families
Reduce estate and gift taxes 17.2
Raise IRA income and contribution limits 12.8
Raise income limit for 14 percent bracket 20.1
Allow married filers to file as singles 24.5

Source: Joint Committee on Taxation

An examination of the major provisions of the bill shows why it tilts toward those at higher income levels.

But by 2009, when provisions benefitting higher-income taxpayers such as the IRA expansions and estate tax reductions are phased in more fully, the rate reduction accounts for just 17 percent of the total cost of the package.

Should the Distribution of Tax Cuts Mirror the Distribution of Tax Burdens?

Some proponents of the Senate Finance Committee tax bill dismiss data showing the bulk of the bill's tax cuts would go to more affluent households by observing that these households pay the bulk of the taxes and should therefore get the bulk of the tax cuts. This raises the question of what standard to use in assessing how a tax cut is distributed. Should tax cuts be apportioned in accordance with the share of taxes that various income groups pay?

While such a standard may have a superficial appeal, it is, in fact, highly problematic. Use of such a standard implies that the more income disparities widen in the United States and high-income individuals receive the lion's share of the income gains (and thus pay more of the taxes), the more that tax cuts should be directed to the wealthy, making the 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 lion's 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?


The Income Tax Rate Cut

The press release that Senator Roth issued in unveiling his proposal on July 9 stated that as a result of reducing the 15 percent rate to 14 percent, "[a] middle income family of four would receive a tax cut of $450." This figure has been widely reported. The press release and some of the media coverage of it may leave the impression that this rate reduction would provide the same-size tax cut for all taxpayers.

Neither the statement that the rate reduction would provide a $450 tax cut for a typical middle-income family of four nor the impression that all families would get the same-size tax cut is accurate, however. Most middle-class families of four would receive tax cuts considerably smaller than $450.

Even so, the rate reduction would provide a substantial share of its tax-cut benefits to those in the middle parts of the income spectrum. That is not true of the other major proposals in the Senate Finance Committee package.


Increasing the Ceiling for the 14 Percent Tax Bracket

In addition to reducing the 15 percent tax rate to 14 percent, the plan would increase the amount of a taxpayer's income that is taxed at the 14 percent rate rather than the 28 percent rate. This would be accomplished by raising the income levels at which the current 15 percent tax bracket ends and the 28 percent bracket begins.


IRA Expansions

The Senate Finance Committee bill includes three types of IRA expansions. One would remove completely the income limits on the use of Roth IRA tax preferences by individuals with employer-sponsored retirement plans. Another would increase the income limits on the use of conventional, deductible IRAs. These changes would extend the IRA tax breaks to highly paid individuals with incomes above the limits that current tax law sets. A third IRA expansion would more than double the amount that a taxpayer and spouse can contribute each year to either a conventional IRA or a Roth IRA. This, too, would primarily benefit those on the higher rungs of the income scale, since few middle-income families can afford to put this much of their income aside and place it in an IRA each year.

Together, the effect of these three changes would be to give the 20 percent of taxpayers with the highest incomes large new tax breaks. Many of these taxpayers would secure these generous tax breaks by shifting savings from one account to another, rather than by saving more.

There is, in addition to these three IRA provisions, one other upper-income IRA tax break in the Senate Finance Committee bill. Under current law, taxpayers with incomes below $100,000 may choose to convert conventional IRAs they hold to Roth IRAs. The Senate Finance package would lift the income limit for such conversions from $100,000 to $1 million beginning in 2003. Anyone with gross income of up to $1 million would be able to roll over his or her conventional IRAs into Roth IRAs.


Marriage Penalty Relief

The Senate Finance Committee bill claims to "eliminate" marriage penalties by allowing taxpayers the option of filing as though they were single taxpayers on a combined form, with income from jointly-owned assets split evenly. Unlike marriage penalty reduction options that target relief on middle-class taxpayers, such as proposals to increase the standard deduction for married couples, allowing married taxpayers the option of filing as though they were single taxpayers provides a disproportionate share of the tax-cut benefits to higher-income couples.


Estate Tax

The Senate Finance Committee bill also contains a large cut in the estate tax. It would increase the estate tax exemption by 50 percent, raising the amount of an estate that is exempt from tax from the first $1 million to the first $1.5 million. That change would take place in 2007. Several other reductions in the estate tax also are included in the plan.

These changes have a large cost. The Joint Tax Committee estimates they would lose $16.3 billion in 2009.

The large tax reductions that these changes in the estate tax would generate would be concentrated on the estates of the nation's wealthiest decedents. Joint Tax Committee estimates show that under current law, only two percent of all deaths result in estate tax liability. The Committee's estimates show that only 1.96 percent of decedents in 1999 will have estates large enough to require payment of any estate tax.(3)

Moreover, the bulk of the estate tax is paid by rather large estates. An IRS analysis of the 32,000 taxable estates filing in 1995 showed that the one-sixth of taxable estates with gross value exceeding $2.5 million paid nearly 70 percent of total estate taxes.(4)

The estate tax cut in the Senate Finance Committee bill thus would benefit the estates of those on the top rungs of the income scale. Claims that family farms and small businesses would be among the principal beneficiaries of this tax cut are inaccurate. Farms and small, family-owned businesses make up only a very small proportion of taxable estates. The IRS analysis of estates that filed in 1995 found that all farm property, regardless of size, accounted for less than one-half of one percent of all assets included in taxable estates. Family-owned business assets such as closely-held stocks, limited partnerships, and non-corporate businesses, accounted for less than four percent of the value of all taxable estates of less than $5 million.


Health Insurance Deductions

The Senate Finance Committee bill also includes a new tax deduction for the purchase of health insurance by taxpayers who pay at least 50 percent of the cost of the premium. As first glance, this may sound like an attractive idea. The proposed deduction, however, would provide little help to most of the uninsured and would not reduce the ranks of the uninsured significantly.

At least 93 percent of the uninsured individuals either pay no income tax or are in the 15 percent income tax bracket. For them, the deduction would do little or nothing to make insurance more affordable, because it would reduce the cost of insurance by no more than 15 percent. As a result, those who would benefit most from such a tax deduction are, by and large, individuals in higher tax brackets who already purchase individual insurance.

Few families that have forgone health coverage because they cannot afford to spend 19 percent of income on it would be able to afford coverage because a deduction lowered its cost to 17 percent of income. Insurance would generally remain unaffordable for them. (It is worth noting that to address affordability problems, the child health block grant established in 1997 limits premiums and co-payments to five percent of income for families with incomes above 150 percent of the poverty line and to lesser amounts for poorer families.)

That might help some families afford insurance, but the number of such families would likely be small. Moreover, the deduction could induce some employers that currently pay more than 50 percent of premium costs to scale back their contribution to 50 percent (or possibly less).

End Notes:

1. Under current law, married taxpayers who participate in an employer-sponsored pension plan may deduct contributions to a conventional IRA if they have income below $61,000 in 1999; the income limits rise to $100,000 by 2007. Married taxpayers participating in an employer-sponsored plan may contribute to a Roth IRA if they have income below $160,000. (For single individuals, the income limit for deductible contributions to a conventional IRA is $41,000 in 1999, rising to $60,000 in 2005. The income limit for making a contribution to a Roth IRA is $110,000 for single taxpayers participating in an employer-sponsored plan.)

2. Statement of Donald C. Lubick, Assistant Secretary of the Treasury for Tax Policy, before the Subcommittee on Oversight, House Committee on Ways and Means, March 23, 1999.

3. Joint Committee on Taxation, Present Law and Background on Federal Tax Provisions Relating to Retirement Savings Incentives, Health and Long-Term Care, and Estate and Gift Taxes (JCX-29-99), June 15, 1999.

4. Internal Revenue Service, SOI Bulletin, Winter 1996-97.

5. Government Accounting Office, Letter to The Honorable Daniel Patrick Moynihan, June 10, 1998, GAO/HEHS-98-190R, Enclosure II. The analysis is based on the 1996 Current Population Survey.

6. A Government Accounting Office study found that in 1996 the middle of the range of premium costs was $5,700 for a family-coverage policy that included a $1,000 deductible. The proposed tax deduction would provide a subsidy of $840 (15 percent of $5,700 equals $840). This means the family would have to pay the remaining $4,860, or 14 percent of its income, to purchase the health insurance policy. Since this premium is for a policy with a $1,000 deductible, another three percent of income would have to be expended before any benefits would be available. The family's net expenditure for health coverage — the premium plus the deductible — would total $5,860, or 17 percent of the family's income. Without the proposed tax deduction, the full cost of the policy plus the $1,000 deductible is equal to 19 percent of the family's income.

7. Leighton Ku, Teresa Coughlin, The Use of Sliding Scale Premiums in Subsidized Insurance Programs, Urban Institute, March 1997.