The Center's work on 'Estate Tax' Issues

Greenstein on President Obama’s New Budget

March 4, 2014 at 1:47 pm

CBPP President Robert Greenstein has issued a statement on the President’s fiscal year 2015 budget:

President Obama’s new budget is a solid blueprint that would reduce deficits, alleviate poverty, and boost investment in areas needed for future economic growth, such as infrastructure, education, and research.

On the deficit front, the budget confounds the recent predictions of some pundits by including, rather than eschewing, deficit reduction.  While offsetting the costs of its new investment initiatives by cutting spending and scaling back tax breaks, the budget goes further by reducing deficits enough to put federal debt as a share of gross domestic product (GDP) on a declining path.  With about $1.7 trillion in deficit reduction over the next ten years (excluding the savings from winding down operations in Afghanistan), the budget would reduce the debt-to-GDP ratio to 69 percent in 2024.

As previously announced, the budget doesn’t include the proposal in the President’s budget last year to switch to the “chained Consumer Price Index” in calculating annual cost-of-living adjustments in Social Security and other programs.  It does, however, retain the $400 billion in Medicare savings in last year’s budget, including about $60 billion in Medicare beneficiary reductions (through increases in premiums for affluent beneficiaries, increases in some co-payments, and changes affecting Medigap coverage).

On the poverty-fighting front, the budget features an important proposal to boost the Earned Income Tax Credit (EITC) for low-income workers who are not living with minor children — a measure many analysts across the political spectrum believe holds considerable promise for reducing poverty and also increasing labor-force participation, including among young minority men.  Single low-wage men and women are the one group of Americans whom the federal tax code literally taxes into — or deeper into — poverty.  The Obama proposal, which builds on a long bipartisan tradition of support for the EITC, would substantially address that problem.

No one should declare this budget “dead on arrival,” for two reasons.  First, under the Murray-Ryan agreement of last year, both parties have agreed on the total amount available for appropriated programs this year, and the Obama budget includes program-by-program requests that hit that total.  Consequently, the budget’s appropriations requests will likely play an important role as the Appropriations Committees craft the annual funding bills this year.

Second, with no big budget showdowns or deadlines looming this year, 2014 likely won’t be a year of significant budgetary action beyond the appropriations bills.  But 2015 may well be.  Policymakers likely will seek to negotiate another budget deal to ease the scheduled sequestration budget cuts for 2016 and beyond and also may consider tax reform and other measures.  Both the new Obama budget and the budget proposal that House Budget Committee Chair Paul Ryan will unveil in a few weeks will offer dueling frameworks for a year-long debate on where fiscal and program policy should go, in advance of larger decisions next year.

The vision reflected in the Obama budget will provide a much sounder course than the one we’ll likely see in the Ryan budget.  That’s because the Obama budget curbs lower-priority spending and unproductive special-interest tax breaks in order to make investments that the nation needs for future prosperity, reduce poverty and better reward low-paid work, and give many young children a better chance of success, while reducing mid-term and long-term deficits at the same time.

“Blank Slate” Approach to Tax Reform Leaves Biggest Question Unanswered

June 28, 2013 at 11:54 am

Yesterday’s call from Senate Finance Committee Chairman Max Baucus and ranking Republican Orrin Hatch to initiate tax reform with a “blank slate” that doesn’t include any of the deductions, credits, exclusions, and other tax breaks collectively known as “tax expenditures” leaves a critical question unresolved:  what will policymakers do with the proceeds from narrowing or eliminating tax expenditures?

Will they use a substantial share of the savings to help put together an alternative to sequestration or otherwise devote such savings (presumably in conjunction with spending reductions) to the long-term deficit reduction that the nation needs?  Or will the savings go entirely to cutting tax rates?

Using some of the savings as part of a responsible, balanced alternative to sequestration —thereby averting harsh cuts in areas ranging from national security to education, medical research, and Head Start — and to help put the nation on a firmer long-term fiscal footing ought to be a higher priority than the pursuit of ever-lower tax rates.

Tax reform that curbs unproductive tax expenditures surely has merit.  Yet revenue-neutral tax reform would be highly problematic, as it would likely take revenues off the table for deficit reduction for years to come by using up virtually all politically achievable reductions in tax expenditures.  That, in turn, would likely take mandatory programs off the table for deficit reduction as well, because many policymakers would justifiably reject large mandatory cuts in the absence of new revenues.

In addition, policymakers face an immediate need to replace the harmful sequestration budget cuts, which are affecting defense and non-defense programs alike, with a mix of savings from tax expenditures and mandatory programs.  But revenue-neutral tax reform could foreclose that option by using up all of the politically achievable tax expenditure savings to pay for tax-rate reductions.

An essential ingredient of tax reform — and the one target for policymakers to specify in advance — is therefore a revenue target: one that contributes to a balanced deficit-reduction package that includes replacing sequestration.  Revenues raised through tax reform — including through a “blank slate” approach — should go to lower rates only after this target has been met, as most budget agreements under discussion over the past few years would have done.

This means that while policymakers may have useful exploratory discussions on tax reform now, they should defer actual legislative action until there is a larger fiscal policy agreement that includes a revenue target under which tax reform will contribute meaningfully to deficit reduction.

Rep. Brady’s Stunning Mischaracterization of the Estate Tax

June 25, 2013 at 11:48 am

Proponents of permanently repealing the estate tax often propagate various myths about it, but Rep. Kevin Brady (R-TX), who chairs the Joint Economic Committee and is a senior member of the House Ways and Means Committee, went a step further last week.  In introducing legislation to repeal the estate tax, Brady stated, “What kind of government swoops in upon your death and takes nearly half of the nest egg you’ve spent your entire life building?”

Well, not the U.S. government — not even close.  Rep. Brady’s characterization of the tax, highlighted in a news release he issued June 19 with Senate Finance Committee member John Thune (R-SD), the bill’s Senate sponsor, is not only flatly wrong.  It’s also highly irresponsible, in that it comes from such a senior member of two relevant congressional committees who should know the basic facts about the tax he’s proposing to abolish, at considerable cost to the Treasury.

The truth is this:  only a tiny sliver of estates pay any tax at all, and the very wealthy ones that do so pay at a rate that’s far less than half.  Repealing the estate tax would amount to a massive windfall for the inheritances of the wealthiest Americans.

  • Only the richest 0.14 percent of estates pays any estate tax at all. Only the estates of the wealthiest 0.14 percent of Americans — fewer than 2 out of every 1,000 people who die — now owe any estate tax whatsoever, according to the Urban-Brookings Tax Policy Center (TPC), because the tax is levied only on the portion of an estate’s value that exceeds $5.25 million per person (effectively $10.5 million per married couple).
  • Those paying the estate tax generally pay less than one-sixth of the value of the estate in tax, a far cry from Brady’s claim that nearly half of estates are taxed away. As noted, 99.86 percent of estates owe no estate tax at all.  TPC reports that among the 3,780 estates that owe any tax this year, the “effective” tax rate — that is, the percentage of the estate’s value that is paid in tax — is 16.6 percent, on average.  The 16.6 percent rate is far below the top statutory tax rate of 40 percent because taxes are due only on the portion of an estate’s value that exceeds the $5.25 million per-person exemption level and because heirs can often shield a large portion of an estate’s remaining value from taxation through various deductions.
  • Large estates consist of a large amount of “unrealized” capital gains that have never been taxed. The estate tax serves in part as a “backstop” to the capital gains tax.  Usually, capital gains are taxed when an asset is sold or disposed of and the gain is “realized.”  But if a person holds an asset that mounts in value until his or her death, this “unrealized” capital gain is exempt from the capital gains tax.  Research shows over half of the assets in large estates — those that contain more than $10 million in assets — has never been taxed.  Without the estate tax, those unrealized gains would escape taxation entirely.

Tax Day Roundup

April 15, 2013 at 10:40 am

Top 10 Federal Tax Charts

April 15, 2013 at 5:00 am

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.