Tax Cut Proposals; Chapter and Verse of a Prudent Compromise

How much and where to cut taxes was hotly debated during the 2000 presidential campaign. This debate is likely to continue as the 107th Congress considers the president’s across-the-board tax-cut proposal and alternatives to it.

We suggest a tax proposal that builds on the president’s plan to double the child tax credit from $500 to $1,000 per child. But, in deference to Democratic concerns about fairness, it allows those with limited incomes—and thus limited tax liabilities against which to claim the credits—to receive some benefits as well.

The cost of our proposal is $400 billion over 10 years, leaving room for other tax measures to be added to the package or for some part of projected surpluses to be used for debt reduction.

During the campaign, President Bush promised that, if elected, he would place an ambitious tax-cut package at the top of his list. Among the most important facets of the Bush tax plan are a reduction in marginal income tax rates, an expansion of the child tax credit, a repeal of the estate tax and the partial alleviation of marriage penalties in the tax code. The Bush plan would cost about $1.6 trillion over 10 years, by some estimates, with more than 70 percent of the tax cuts going to the wealthiest 20 percent of taxpayers and more than 40 percent of the cuts going to the wealthiest 1 percent.

Many Democrats have a different agenda in mind: one focused on providing more help to low- and moderate-income families. Three of the most important proposals are expansions in the Earned Income Tax Credit and the Dependent Care Tax Credit and a $1 increase in the minimum wage. We estimate that a hypothetical Democratic package of Earned Income Tax Credit and the Dependent Care Tax Credit expansions would cost the government about $6 billion a year. Twenty-four percent of benefits would go to the bottom 20 percent of families, whereas only 8.5 percent would go to those in the top 20 percent.

George W. Bush’s campaign promise to “end the bitterness in Washington” will be quickly put to the test as he begins to forge relationships with a narrowly divided Congress. True bipartisanship will require not only that President Bush reach out to those on the other side of the aisle but that he and his administration develop an agenda that will appeal to Democrats as well as Republicans. Likewise, Democrats must, in the same spirit, seek out common ground with Republicans.

Our tax-cut proposal might be at least one part of a compromise tax package. It provides tax relief to almost all working families with children. Its benefits are broadly distributed, but most of them go to the middle class. It rewards work and marriage. And it is fiscally disciplined, adding only about $14 billion per year to the cost of the president’s original child tax credit proposal.

The core of the plan is a more generous child tax credit similar to the one that President Bush has proposed, but it extends these benefits to lower-middle-income families by making the credit partly refundable; that is, even families that pay no taxes would receive a cash benefit. It also includes an extension of the Earned Income Tax Credit that is designed to encourage work and marriage among lower-income families with children.

Our plan would provide substantial benefits to lower-middle-income and middle-class families. More than 70 percent of the benefits would go to families in the middle three-fifths of the income distribution, those with annual incomes between $14,000 and $65,000. A considerable proportion—almost 27 percent—would also flow to families in the top 20 percent. Only about 1 percent of benefits would go to the wealthiest 1 percent of the population.

In addition to providing most of its benefits to the middle class rather than to the wealthy, our initiative would lift almost 2 million families out of poverty. The biggest benefits would go to the lower-middle class. A two-parent family with two children making $24,000 a year would receive an extra $3,517 relative to both current law and the Bush plan. But, under our plan, almost everyone gains. Even families with $100,000 of income would be better off than they are now.

We estimate that this proposal would cost $35 billion per year. Most of the cost of this plan—about $21 billion—reflects the cost of President Bush’s original proposal to double the Child Tax Credit. Making the credit partly refundable would add $7 billion a year. And reducing the disincentives to work and marry associated with the Earned Income Tax Credit adds $7 billion annually.

In addition to providing a substantial amount of assistance to low-income families, our proposal has a number of other attractive features. First, it would encourage work by linking benefits to earnings. Second, it would encourage people to move up the economic ladder through work or marriage by reducing marginal tax rates for those who now pay a steep toll to enter the middle class. And third, it would further encourage marriage by explicitly reducing the very large marriage penalties that currently exist in the Earned Income Tax Credit.

This proposal is just one of many that could become part of an overall plan that a majority in the Congress as well as the White House could support in the current political environment. We suggest it as one example of the kind of ideas that should be considered before any legislation is enacted. We believe that a modest tax cut is preferable to either legislative gridlock or a bidding war between the parties that throws fiscal caution to the winds.