Off the Charts Blog | Center on Budget and Policy Priorities

Here are the analyses and blog posts we’ve issued in the past few days on tax issues.

• Top 10 Federal Tax Charts
• Federal Income Taxes on Middle-Income Families Remain Near Historic Lows
• Where Do Federal Tax Revenues Come From?
• Where Do Our Federal Tax Dollars Go?
• Top Five State Tax Charts
• Where Do Our State Tax Dollars Go?
• Earned Income Tax Credit Promotes Work, Encourages Children’s Success at School, Research Finds
• Tax Foundation Figures Do Not Represent Typical Households’ Tax Burdens

In recognition of Tax Day, we’ve collected our top ten charts related to federal taxes.  Together, they provide useful context for ongoing debates about how to reduce deficits and reform the tax code.

Our first chart, below, reminds us what taxes pay for.  National defense, Social Security, and major health programs like Medicare and Medicaid account for roughly three-fifths of federal spending.  Safety net programs and interest on the debt account for 12 percent and 6 percent of federal spending, respectively, while the remaining 20 percent goes to other areas such as roads, education, and health and science research.

Our second chart, below, shows where federal revenues come from.  Individual income taxes make up a little under half of all federal revenues — and have for more than half a century.

Payroll taxes make up a much larger share of federal revenues than in earlier decades, while corporate income taxes make up a much smaller share.  In fact, corporate tax revenues are near record lows when measured as a share of the economy, even though corporate profits are at historic highs.

Many business leaders have called for cutting the top U.S. statutory corporate tax rate of 35 percent, which is high by international standards.  But the average tax rate — that is, the share of their profits that companies actually pay in U.S. taxes — is much lower because of the many deductions, credits, and other write-offs that corporations can take.  Many corporations pay very little tax.

As for taxes on individuals, the country’s overall tax system — counting state and local taxes as well as federal taxes — is modestly progressive, as our third chart, below, shows.  Low-and moderate-income Americans pay significant shares of their income in taxes.

Policymakers considering changes in tax policy must keep in mind the economic context, including the dramatic increase in inequality in recent decades.  Congressional Budget Office data show that incomes grew at much faster rates for high-income people than for everyone else between 1979 and 2009 (the most recent year available).

One way to look at the impact of this unequal growth is to compare the average 2009 income for households in different income groups to what it would have been if the income of every group had grown at the same rate since 1979.

Our fourth chart, below, and the accompanying table give the results.  They show, for example, that the average middle-income family had $8,700 less after-tax income in 2009, and an average household in the top 1 percent had $349,000 more, than if incomes of all groups had grown at the same rate since 1979.

The sharp growth in income inequality suggests that higher-income taxpayers can and should contribute more in taxes to help reduce deficits.

The fifth chart, below, shows that both parties have recognized the need to raise more revenue to help reduce deficits.  During the December 2012 budget negotiations between President Obama and House Speaker John Boehner, both sides called for much larger tax increases than those in the January 2013 “fiscal cliff” deal, the American Taxpayer Relief Act (ATRA), as the fifth chart, below, shows.

Moreover, the bulk of the deficit savings enacted to date — including ATRA and earlier legislation, most notably the 2011 Budget Control Act (BCA) — have come from spending cuts rather than revenues.

An obvious place to turn for more revenue is reforming tax expenditures.  As a group, they cost more than Social Security or Medicare and Medicaid combined, as our sixth chart, below, shows.

Both parties have recognized the need for tax expenditure reform.  For example, Speaker Boehner’s December 3 offer called for raising $800 billion in revenues entirely through tax expenditure reforms.  And Harvard economist Martin Feldstein, former chair of President Reagan’s Council of Economic Advisers, has said that “cutting tax expenditures is really the best way to reduce government spending.”

Tax expenditures are not only costly; many share a design flaw that makes them both economically inefficient and inequitable.  Because their value is based on a person’s tax rate, it rises as income rises, so the biggest subsidies go to higher-income people — even though they least need a subsidy to do what the subsidy is supposed to encourage, like buy a house or donate to charity.

The mortgage interest deduction is a good example, as our seventh chart shows.

The design of the mortgage interest deduction is “upside down.”  For example, an investment banker making $675,000 pays about 65 cents per dollar of mortgage interest, and the taxpayers pick up the remaining 35 cents.   By contrast, a schoolteacher making $45,000 pays 85 cents of every dollar of mortgage interest and taxpayers pick up 15 cents.  Thus the banker’s subsidy represents a greater share of the banker’s mortgage interest expenses than is the case for the schoolteacher.  In addition, the high-income banker is likely to have a more expensive house and thus a larger mortgage than the schoolteacher, further increasing the disparity in the subsidy each receives.

Because it could prove politically difficult to reform tax expenditures on a case-by-case basis, several recent proposals would impose an across-the-board limit on tax expenditures for high-income people.

The soundest of these proposals is President Obama’s proposal to cap the value of certain tax expenditures at 28 percent.  The eighth chart, below, shows that this proposal would raise more than half a trillion dollars over the coming decade.

At the same time, policymakers should close loopholes that allow wealthy people to avoid substantial tax.

One example is the tax break that allows investment fund managers to pay taxes on a large part of their income — their “carried interest,” or the right to a share of the fund’s profits — at the 20 percent capital gains tax rate rather than at normal income tax rates of up to 39.6 percent.

As a result of this tax break, a hedge fund manager earning $10 million or more can pay a smaller share of his income in federal income taxes than a middle-income schoolteacher or policeman.

The House-passed Ryan budget also calls for tax expenditure reforms.  But, whereas the President’s proposal would use the resulting savings to reduce the deficit, the Ryan budget would use them to pay for a new round of tax cuts.

The Ryan budget lays out tax-cut goals that would reduce revenues by $5.7 trillion over ten years, according to the Urban-Brookings Tax Policy Center.  It implies that these tax cuts would be fully offset by tax expenditure savings but doesn’t specify any actual changes in tax expenditures to accomplish this.  And, as our ninth chart, below, shows, the $5.7 trillion revenue hole that the budget’s tax-cut goals would create is even larger than the budget’s $5.2 trillion in program cuts.

In addition to being extremely costly, the Ryan budget’s tax-cut goals are heavily tilted towards people with the highest incomes, as our tenth chart, below, shows.

We estimate that the individual income tax cuts specified in the budget (assuming they met their goals, including a top rate of 25 percent) would raise after-tax incomes by 15.4 percent among households with annual incomes above $1 million but by just 1.8 percent for households with incomes between $50,000 and $75,000.

In dollar terms, the tax cuts would be worth an average of $330,000 apiece to those millionaire households, compared to $1,700 for the middle-class households.

The revenue levels in the Ryan budget imply that the cost of its tax-cut goals will be offset by scaling back tax expenditures.  But Tax Policy Center analyses indicate that if policymakers coupled the Ryan tax-cut goals with sweeping (and likely politically implausible) cuts in tax expenditures for households with incomes above $200,000, these households would still receive a large net tax cut.

As a result, to fully finance the net tax cuts for people with incomes over $200,000, taxes on people below $200,000 would very likely have to rise.  Alternatively, if those with incomes under $200,000 were protected from tax increases, then the Ryan tax changes would add mightily to the deficit.

Some Congressional critics of Senate Budget Committee Chairwoman Patty Murray’s budget, which her committee approved last week, claim it double-counts spending cuts and boosts spending rather than reducing it.  An examination of these issues suggests, however, these charges are politically driven and don’t stand up well under scrutiny.

The main charge is that Senator Murray cannot legitimately say that spending cuts that help replace sequestration contribute to deficit reduction.  Sequestration is current law, the critics argue, so repealing it represents a spending increase — and replacing it with a combination of spending cuts and revenue increases results in higher, not lower, spending.

This charge may seem plausible at first blush, but it’s a classic example of moving the goalposts to secure political advantage.  For many years, both parties, every bipartisan budget commission, and virtually every budget watchdog group has agreed that deficit-reduction plans should not be measured from a “current-law” baseline — because such a baseline assumes highly unrealistic budget cuts or tax increases that are very unlikely to occur — and should instead be measured from a more realistic “current-policy” baseline.  Indeed, recognizing the shortcomings of its “current-law” baseline, the Congressional Budget Office has routinely provided a number of adjustments for policymakers so they can construct more realistic projections (and it did so again with its most recent budget outlook report in February).

For these reasons, the bipartisan budget negotiations that Vice President Biden headed in early 2011, the Obama-Boehner negotiations of both July 2011 and December 2012, the congressional “supercommittee” deliberations, the Simpson-Bowles and Rivlin-Domenici budget commissions, the Committee for a Responsible Federal Budget, the Concord Coalition, and the Center on Budget and Policy Priorities all have used a current-policy baseline, not a current-law baseline.

Until recently, Republican Congressional leaders themselves insisted on using a current-policy baseline.  They argued that the current-law baseline, under which President Bush’s tax cuts all would have expired on schedule, was unacceptable.

When, just a few weeks ago, Erskine Bowles and Alan Simpson released their new budget plan, they continued to use a current-policy baseline.  Most independent budget analysts, such as the Committee for a Responsible Federal Budget and ourselves, continue to use such a baseline as well.  That’s because the current-law baseline still reflects an unrealistic scenario.  First, it assumes massive cuts in Medicare payments to physicians that no one believes policymakers will allow to occur.  Second, it assumes that the federal government will continue spending at current levels for Iraq, Afghanistan, and Hurricane Sandy in every year for the next ten years, with no drawdowns in operations or reductions in costs; none of that’s going to happen so, in these cases, the current-law baseline overstates likely spending.

The current-law baseline also assumes that sequestration will occur in every year through 2021.  While sequestration may remain in effect for fiscal year 2013, I know of virtually no one in Washington who believes it’s likely to remain in effect for the nine scheduled years.  The history of past sequestrations is that, unless they’re quite modest in size, policymakers either don’t let them take effect or don’t let them remain in effect.  Most observers expect the current sequestration eventually to follow the same course.

From 1992 through 2012, no sequestration occurred, even when Congress violated budget targets and triggered sequestration.  While the current polarized political atmosphere may make it harder than normal for policymakers to reach agreement on turning off the current sequestration, history doesn’t support the notion that sequestration will stand — especially through 2021 — or that a realistic budget baseline should include it.

The Murray budget appropriately uses a current-policy baseline that assumes sequestration will not remain in effect.  Bowles and Simpson received no criticism when they did the same thing for their new budget plan of a few weeks ago.  Nor did the Committee for a Responsible Federal Budget when it published such a baseline earlier this year.  That highlights the political nature of the current attacks on Chairwoman Murray’s baseline.

Finally, House Budget Committee Chairman Paul Ryan’s budget plan does not use a pure current-law baseline, either.  Instead, it removes the unrealistic spending that’s built into the current-law baseline regarding future spending for Iraq, Afghanistan, and Hurricane Sandy.

The Ryan budget is selective in its adjustments.  In fact, Chairman Ryan essentially built a baseline with the smallest possible starting deficits.  For example, it retains the deep sequestration cuts and also assumes that Medicare reimbursements to physicians will be slashed nearly 30 percent on December 31.  That eased his task in producing a budget he describes as reaching balance in ten years.

Some Members of Congress want to use a baseline that builds in the sequestration savings for an obvious reason — it locks in these spending cuts.  In doing so, it also makes it nearly impossible to restore policy balance to the overall deficit-reduction effort.  Policymakers have already achieved about $1.6 trillion in spending cuts and $700 billion in revenue increases since Simpson and Bowles issued their original plan in late 2010 (even without counting any of the resulting interest savings as a spending cut).  When the effects of sequestration are also included, the ratio of spending cuts to revenue increases achieved to date stands at almost 4 to 1 (and almost 5 to 1 if the interest savings are counted as a spending cut, as Simpson and Bowles, among others, do).

These Members not only insist that we use a baseline that starts from the post-sequestration level, but they also argue that no one should view any policy as a budget cut unless it cuts spending below that level.  Such an approach would be virtually certain to produce an overall budget package under which total deficit reduction is highly unbalanced — and highly regressive.

Maybe that’s the point. 

With the “fiscal cliff” budget deal behind us, congressional Republicans leaders say they’re done raising revenues.  They likely will push this year for “revenue-neutral” tax reform, meaning it would raise the same amount of revenue as the current tax code.

That, however, would be highly ill-advised; in inhibiting the further deficit reduction we need the negative effects of such a course would substantially outweigh any positive economic benefits from cutting tax rates and broadening the tax base.

Here’s why:

In the current political environment (which remains inhospitable to a new tax such as a carbon or a value-added tax), policymakers really have two opportunities to secure substantial revenue to help address deficits in a balanced way:  letting President Bush’s tax cuts for high-income taxpayers expire and curbing tax expenditures (deductions, exclusions, credits, preferential rates, and the like) — probably through tax reform.

The fiscal cliff deal secured about $600 billion from the upper-income Bush tax cuts.  That leaves tax expenditures.

Tax reform will likely exhaust the achievable savings in tax expenditures.  As a result, after tax reform, opportunities for significant revenue-raising will likely be gone for many years.  If tax reform is revenue-neutral, the total revenue raised for deficit reduction would be only about $600 billion.

And, having locked in permanent tax rates and secured the achievable tax-expenditure savings (and used them to fund other tax cuts), policymakers will have squandered the opportunity to raise significant additional revenue for deficit reduction.  Virtually all other deficit reduction would have to come from spending.

To be sure, the 1986 Tax Reform Act was revenue-neutral, but the story is very different now.  Given our long-term deficits, tax reform’s single most important goal should be to raise substantial revenue, in a progressive manner, as part of a balanced deficit reduction policy that also includes savings on the spending side.  Tax reform will be a large step backward unless it raises significant revenue.

Many assume that tax reform that lowers rates and broadens the base will yield substantial economic benefits.  But the literature in the field indicates that the economic benefits of revenue-neutral tax reform are likely much more modest.

Indeed, economic studies show that deficit reduction is substantially more important for long-term economic growth than tax reform.  And revenue-neutral tax reform would undercut efforts to achieve substantial further deficit reduction, not only because revenue-raising opportunities would be gone but also because reductions in spending would almost certainly be smaller.  The President and congressional Democrats will (with good reason) resist more sizeable spending cuts in the absence of additional revenue.

Thus, by squandering the opportunity to shrink deficits (by raising revenue and encouraging complementary spending cuts), revenue-neutral tax reform likely would yield adverse economic effects that substantially outweigh the more modest economic benefits of tax reform itself.

We’d like to see tax reform that both cleans up the tax code and raises substantial revenue.  But policymakers should not undertake tax reform that does the former without the latter.  At this juncture, no tax reform at all would be a sounder and more prudent policy than tax reform that is revenue-neutral.

The new budget deal delays the across-the-board spending cuts (or “sequestration”) for two months — and covers half of the resulting $24 billion cost through spending cuts and half through tax increases.  This 50-50 balance between spending cuts and revenue increases marks an important principle that policymakers should follow in producing the additional long-term deficit reduction that the nation needs.  Unfortunately, while the spending cuts in question are real, the tax increase isn’t.  It’s fake.

Actually, it’s worse than fake — it’s a new tax cut, primarily for affluent households, that’s being portrayed as a tax increase.  It uses a timing gimmick to raise $12 billion in revenue over the next ten years.  But every dollar of that $12 billion is revenue that the federal Treasury would have collected in subsequent decades.  And, the resulting revenue loss in later decades will be substantially greater than $12 billion — probably several times that amount.

That also suggests that the White House’s crucial call for a dollar in revenues for each dollar in spending cuts in a budget package later this winter that would presumably replace sequestration and raise the debt limit — an essential condition for a balanced package — is not off to a promising start.  To get a Joint Tax Committee “score” of $12 billion in new revenue over the next ten years, Republican negotiators crafted a new tax break that slightly worsens long-term fiscal imbalances and ultimately reduces revenue rather than increasing it.

Here’s the issue.  Under current law, amounts deposited in employer-sponsored retirement accounts like 401(k)s and 403(b)s are exempt from income tax when the deposits are made, while the withdrawals in retirement are taxable.  Some employers offer plans that include not only a 401(k) or similar type of account but also accounts, known as “Roth” accounts, in which contributions are taxed up front while the withdrawals in retirement are tax free.  Currently, taxpayers can shift money from the 401(k)-like parts of their plan into a Roth account only in very limited circumstances — generally, only with money that they’ve paid out of their 401(k) because they have reached the age of 59½ or have left the employer.

The new provision would let these individuals decide, at any time, to shift large sums (even their entire balances) from 401(k)s, 403(b)s and the like to a Roth account.  They would have to pay tax on the amounts that they shifted, but all subsequent earnings on the Roth accounts — and all withdrawals in later years — would be tax free.  People who calculated that this would maximize their tax break and minimize their tax payments over time would make the shift.  People who didn’t think they would get a bigger tax cut wouldn’t.

This maneuver raises money for the Treasury in the early years, because people making the shift would pay income tax on the amounts that they moved to the Roth accounts, while the corresponding revenue losses would largely occur beyond the 10-year “budget window.”  But people would do so only if they would pay less tax over time.  The long-run effect would be a significant revenue loss.

As the Wall Street Journal put it yesterday, “In effect, the move provides more up-front revenue to the Treasury, but potentially at the cost of revenue over the long term — as taxes paid when individuals make withdrawals from their 401(k) plans would likely be far greater.”

So, here’s the bottom line: this isn’t a tax increase to offset half of the cost of delaying the sequestration.  It’s another tax cut masquerading as one.