A Tax Cut for All

With the 2001 tax cuts beginning to expire in a few years, perhaps it is time to revisit them. Those tax cuts, along with a subsequent tax cut in 2003, cost roughly $150 billion per year in lost tax revenue. Tax rates were cut across the board, with a drop from 15 percent to 10 percent in the lowest tax bracket, and a drop from 39 percent to 36 percent in the highest bracket. A myriad of other tax breaks including a cut in taxes on dividends and capital gains combined to make one of the largest tax reductions in years. Now, with the tax cuts set to expire in 2010, Democrats argue that they be allowed to expire to reduce the deficit while Republicans argue that they should be made permanent. A recent Congressional vote over a minimum-wage increase succumbed to this battle, as Republicans attempted to tie the repeal of the estate tax to a minimum wage hike.

There is room for compromise on this issue, where all Americans can enjoy a tax cut without increasing current structural deficits. A reduction in the lowest federal tax bracket (for income below $10,000) from 10% to 0% would provide $1000 in tax relief for every full-time American worker, from the richest to the poorest. The elimination of the lowest tax bracket would lift more Americans out of poverty than a hike in the minimum wage, since it wouldn’t have the adverse affects on employment that a wage floor can have. If developing nations like China and India can do without an income tax for the poorest in society, can’t America? One caveat: giving $1000 in taxes back to all 145 million American workers would cost $145 billion annually.

How can America pay for a tax cut even larger than the last round? For starters, since the lowest tax bracket would be eliminated, the Earned Income Tax Credit could be largely eliminated as well. The EITC rebates $40 billion per year to the poorest families in America, but adds a large regulatory burden for both families and the IRS by requiring taxpayers to claim the credit, with the IRS auditing them to ensure eligibility. Eliminating the EITC could help pay for a large chunk of lowest-bracket elimination while lightening the tax filing burden for a significant percentage of the population. Next, allow the upper tax bracket and estate tax reductions to expire in 2010, adding roughly $100 billion to government revenue. Finally, make permanent the 15% tax rate on dividends and capital gains, providing investment tax relief for the middle class and wealthy. The 15% rate on dividends and capital gains costs $5 billion to government coffers, but provides an incentive to the investing class to support the overall tax package.

All this leaves a neat compromise in which all Americans get a $1000 tax cut, and upper-middle class and wealthy Americans get to keep low investment tax rates in return for pitching in on broader tax relief. The elimination of the lowest tax bracket and the EITC would also simplify tax filing for millions of Americans, from poor working class families to the elderly and part-time workers as well. US mid-term elections take place tomorrow; if the Democrats take the House, this sort of tax cut would be a welcome new idea for their platform. If the Republicans narrowly maintain control, a broad-based compromise tax cut for all might be just the kind of legislation they need to break the legislative logjam. Any takers?

3 thoughts on “A Tax Cut for All

  1. Gale’s articles are well researched, but don’t provide very concrete policy proposals. He mentions a long laundry list of changes that “could” be made, but doesn’t fit them together into a coherent policy.

    In the end, tax reform will probably end up being incremental, not a wholesale rework like the national sales tax. In that vein, trade-offs that simply eliminate loopholes while preserving some benefits will probably be the only way to move forward. For instance, the wealthy might get to keep the dividend and capital gains tax cuts, but lose the fight to repeal the estate tax. And so on.

  2. Interesting proposal.

    One of the more far-reaching but politically feasible set of tax reform proposals I have seen are by Bill Gale at Brookings. He suggests integrating the payroll and the income tax to eliminate one of the more regressive taxes. He also suggests coordinating the corporate and individual income tax so that corporate income is taxed only once. Actually, the whole paper is worth reading:


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