The Center's work on 'Taxes and the Economy' Issues


Obama’s Education Tax Proposals Would Help Middle-Class Families, Not Hurt Them as Opponents Inaccurately Claim

January 22, 2015 at 5:29 pm

Some critics claim that President Obama’s proposal to streamline and better target tax credits for higher education represents an attack on middle-class families, particularly because of the limits it would impose on so-called “529” accounts.  That’s backward:  the plan overall would do more to help both middle-class and lower-income families afford college.

The President’s plan would scale back tax benefits that disproportionately benefit high-income filers and redirect them toward low- and middle-income students — the people who most need help affording college.  By likely enabling more people to attend college, it would help them and the economy as a whole by contributing to a better-educated workforce.

Like many current tax breaks (such as those for retirement saving and mortgage interest), tax benefits for higher education give the biggest benefits to high- and upper-middle-income families since they’re in the highest tax brackets.  This means that the tax subsidies are less effective than they could be in boosting college enrollment because they largely go to people who likely would attend college anyway, while doing too little for many people from low- and middle-income families who simply can’t afford college without help.

Further, the tax subsidies are delivered through a maze of overlapping provisions, so many eligible families aren’t aware of them.

That’s why many education policy groups (see here, here, and here) have called for streamlining and better targeting education tax breaks.  Representatives Danny Davis (D-IL) and Diane Black (R-TN) introduced a bipartisan bill in 2013 based on these principles, and former House Ways and Means Committee Chairman Dave Camp’s tax reform plan included a similar proposal.

The President’s plan also uses this framework.  It would shrink some of the education tax subsidies most heavily focused on high-income families and use the savings to strengthen and make permanent the education tax incentive best targeted on low- and middle-income families:  the American Opportunity Tax Credit (AOTC).

The AOTC is partially refundable, which means families with incomes too low to owe federal income tax can receive a partial credit.  But under current law, the AOTC will expire at the end of 2017 and be replaced by a smaller, non-refundable education tax credit called the Hope Credit.  The President’s proposal would improve the AOTC for both low-income and middle-class families by making it permanent and raising the amount of the AOTC that is refundable.

At the same time, the President’s plan would limit a number of inefficient tax benefits that are heavily tilted toward upper-income families, including those for 529 plans.  Currently, filers don’t owe taxes on the earnings from 529 plans either as they accrue or when those earnings are withdrawn to pay for higher education.

Some 80 percent of the benefits of 529 plans go to households with incomes above $150,000, Survey of Consumer Finances data show; about 70 percent go to households with incomes above $200,000.  That’s because higher-income households can most afford to save substantial amounts for college, and because tax exemptions are worth the most to them, saving them up to 40 cents (for people in the top income tax bracket) per dollar earned in these plans that’s used for higher education expenses.  Since there are no income limits on using the plans, families with multi-million-dollar incomes can amass huge 529 accounts and benefit very handsomely from this tax break.

Under the President’s plan, earnings in 529 accounts would remain tax-free as they accrue, but filers would pay tax on the gains when they withdraw the funds, so filers would still benefit from deferring taxes on those gains. And the proposal would only apply to new deposits in 529 accounts; the billions of dollars already in those accounts would be entirely exempt.

The University of Michigan’s Professor Susan Dynarski, a top expert on education tax policy, has praised the President’s 529 proposal as “smart,” commenting that the current treatment of 529s is “Incredibly expensive, poorly targeted, [and] ineffective.”

Scaling back the 529 tax subsidy for high-income filers and redirecting the funds towards low- and middle-income filers who most need support to afford higher education is sound policy that would make higher education more affordable for more low- and middle-income families.

In fact, overall, the President’s proposal would increase the total amount of resources provided in higher education tax subsidies, benefiting middle- and low-income families, and pay for that increase by reducing inefficient tax subsidies that overwhelmingly benefit people at the top of the income scale.  Since aid for families who don’t have high incomes would increase, opponents’ claims that the plan would increase student debt levels are hard to fathom. The effect is likely to be just the opposite.

Examining the President’s New Tax Proposals

January 20, 2015 at 3:09 pm

We’ve issued two pieces on the President’s new proposals, which he’ll discuss in tonight’s State of the Union address, to reduce the tax code’s tilt toward capital gains and use the new revenues to support work and help working families build skills and savings.

  • Robert Greenstein’s statement:

    In recent decades, economic growth has powerfully benefitted Wall Street, while leaving much of Main Street behind.  The plan that President Obama unveiled today would take large, important steps to help redress part of the imbalance and make prosperity more broadly shared.  The President’s new tax proposals will surely elicit howls of protest from various special interests and on ideological grounds; adversaries will make predictable claims that the proposals would harm the economy and jobs.  Yet while the proposals do present a major challenge to the status quo, they should benefit economic growth, not hinder it, while substantially helping tens of millions of middle- and lower-income working families and individuals. . . .

    Click here for the full statement.
  • Our analysis of the capital gains proposals:

    The tax code strongly favors income from capital gains — increases in the value of assets, such as stocks — over income from wages and salaries. These preferences are economically inefficient:  they promote tax schemes that convert ordinary income into capital gains and encourage people to hold assets just to escape tax, even if they have better investment opportunities.  They are also highly regressive, since capital gains are heavily concentrated at the top of the income scale.  The President has proposed to make the tax code more efficient and equitable by reducing one of the biggest subsidies for capital gains (a preferential rate compared to wage and salary income) and largely eliminating another (the ability to avoid capital gains tax completely by holding on to an asset until death).

    These changes would allow investments to flow to where they are most productive and reduce investment in creating tax avoidance schemes instead of in real economic activity, among other economic benefits.  And, because the benefits of the current preferences for capital gains flow overwhelmingly to the top, fully 99 percent of the revenue from the President’s capital gains proposals would come from the top 1 percent of filers, the Treasury Department estimates [see graph]. . . .

    Click here for the full analysis.

We’ll be live-tweeting the State of the Union this evening.  Follow along with @centeronbudget and at #cbppsotu.

Case for Repealing Medical Device Tax Is as Weak as Ever

January 16, 2015 at 12:41 pm

As the New York Times’ Robert Pear explained this week, health reform’s 2.3-percent excise tax on medical devices “has become a prime target for Republicans, some Democrats and a small army of lobbyists for the industry.  But a new report from the Congressional Research Service [CRS] challenges economic arguments that are being made to justify repealing the tax.”

The CRS report reaffirms what we’ve said repeatedly:  the tax, which will raise $26 billion over the next decade to help pay for health reform, has only a very limited economic impact, contrary to industry lobbyists’ dire predictions.

  • “The effect on the price of health care,” CRS says, “will most likely be negligible because of the small size of the tax and small share of health care spending attributable to medical devices.”
  • “The drop in U.S. output and jobs for medical device producers due to the tax is relatively small, probably no more than 0.2%.”
  • “[I]t is unlikely that there will be significant consequences for innovation and for small and mid-sized firms.”
  • “The tax should have no effect on production location decisions, since both domestically manufactured and imported medical devices are subject to the excise tax.”

In short, the scare talk about the medical device tax doesn’t square with reality.  Moreover, proponents of repeal need to explain how they would replace the billions in lost revenue.

New House Rule Could Ease Passage of Deficit-Increasing Tax Cuts

January 5, 2015 at 11:02 am

Our new paper analyzes a House Republican plan to amend House rules this week to require the Congressional Budget Office (CBO) and Joint Committee on Taxation (JCT) to use “dynamic scoring” for official cost estimates of tax reform and other major legislation.   Under dynamic scoring, the official cost estimates would incorporate estimates of how legislation would affect the size of the U. S. economy and, in turn, federal revenues and spending.

Incoming Ways and Means Committee Chairman Paul Ryan has said this change is designed simply to generate more information on the impact of proposed policies.  In reality, however, the House would be asking CBO and JCT for less information, not more, and the new rule could facilitate congressional passage of tax cuts that are revenue-neutral only on paper.

As our paper explains:

CBO and JCT already provide macroeconomic analyses of some proposed bills as a supplement to the official cost estimates they produce.  These analyses typically present a range of estimates of the legislation’s impact on the economy.

The new House rule, in contrast, asks for an official cost estimate that only reflects a single estimate of the bill’s supposed impact on the economy and the resulting revenue impact.  By incorporating additional revenue in the official cost estimate (as a result of an estimate of economic growth), this would enable lawmakers to write bills with deeper tax-rate cuts, or smaller offsetting curbs on tax breaks, than they otherwise could do.

The economic impact of even a well-designed tax reform plan is likely to be modest relative to the size of the U.S. economy.  But the estimates of revenue gains from the plan’s estimated dynamic effects could be large in the context of current fiscal debates.  Those estimates could also be highly dubious, depending on the models and assumptions used.

For example, JCT estimated that the tax reform plan that former Ways and Means Chairman Dave Camp produced last year could generate between $50 billion and $700 billion of additional revenue over the decade through faster economic growth (see chart), with the $700 billion estimate reflecting a series of very rosy assumptions — including the assumption that a future Congress will stabilize the debt as a share of gross domestic product (GDP) by approving large spending cuts that aren’t part of the Camp bill.  If highly optimistic economic and fiscal assumptions like these are included in official cost estimates but then fail to materialize, the result will be higher deficits and debt.  And as CBO, JCT, and other analysts have warned, tax cuts that ultimately expand deficits can slow economic growth, rather than increase it, because the higher deficits can create a drag on saving and investment.

Click here for the full paper.

Let Ineffective “Bonus Depreciation” Die Next Year

December 18, 2014 at 3:06 pm

We strongly agree with today’s Washington Post editorial that calls on policymakers to let the “bonus depreciation” tax break, which they extended for a year in the recent “tax extenders” package, expire next year.

Bonus depreciation lets businesses take bigger upfront deductions for certain purchases such as machinery and equipment.  As our report explains, Congress enacted it on a temporary basis in 2008 to bolster the economy during the Great Recession, not to make it a permanent part of the tax code or extend it year after year.

The House, however, voted earlier this year to expand bonus depreciation and extend it permanently at a cost of $276 billion over ten years — enough to wipe out one-third of the revenue raised by the high-income revenue provisions of the 2012 “fiscal cliff” legislation.  (See graph.)

Permanent bonus depreciation wouldn’t just be fiscally irresponsible.  It would also be economically unjustified.  As the Post points out:

[S]everal economic studies have shown that, in practice, bonus depreciation is “not very effective” as a boost to economic growth, in the words of a recent Congressional Research Service report — and probably less effective than other tax cuts or spending increases that have since expired.  Tax break or no, many firms won’t invest at times of weak demand for their products; in any case, bonus depreciation affects only one incentive in what, for many companies, may be a highly complex tax-planning scenario.

Whatever stimulative effect bonus depreciation has, though, depends on its being both temporary and timely — i.e., that companies understand it will be available during recessions and only then.  Extending the measure now amounts to a gratuitous handout; indeed, it’s been decreasingly necessary ever since the “Great Recession” officially ended in June 2009. Since the proposed one-year extension, which would cost $5 billion, is retroactive, it actually amounts to a windfall benefit for investment decisions corporations have already made.

In short, bonus depreciation provides only modest benefit as a temporary stimulus measure and none at all as a de facto permanent part of the code. . . .