The President’s Tax Proposal: Second Thoughts

On January 7, 2003, President Bush proposed a new
package of tax cuts, consisting primarily of a new tax
cut for dividends and capital gains on corporate stock
and an acceleration of most but not all of the provisions
of the 2001 tax cut that were scheduled to take effect
in future years. In the last two weeks, this column
provided initial reactions to the package and a more
focused examination of the proposal to cut taxes on
dividends and capital gains. This week, we build on
these findings and focus on four broad aspects of the
plan:

Budget effects
The new package will cost at least $925 billion (including
debt service) through 2013. The long-term cost
exceeds one-quarter of the 75-year actuarial deficit in
Social Security. The new proposal, in combination with
AMT reform and making the 2001 tax cut permanent,
would reduce revenues by between two and three
times the size of the actuarial deficit in Social Security
over the next 75 years.

Distributional effects
The proposed tax cuts would make the federal tax
system more regressive. The percentage increase in
after-tax income is higher for those with higher incomes.
The share of the tax cut received by households
in the top 1 percent significantly exceeds the share of
federal taxes they are slated to pay under current law
in 2003. By 2010, the share of the tax cut going to the
top 1 percent is almost double the share of all federal
taxes they would pay under current law. The tax cut
becomes more regressive over time because the main
permanent feature of the tax cut —the change in taxation
of dividends and capital gains—is regressive.
Most of the other items are temporary. In 2003, the
package would provide a tax cut of $100 or less to
almost one-half of tax filers, while providing an
average tax break of $90,222 to those with more than
$1 million in income.

Economic effects
According to the administration’s own analysis, the
proposals would have a negligible effect on economic
activity during 2003. In the short term, the plan would
have only a modest impact because it is not targeted
at boosting demand for goods and services; in the long
term, any positive effects on corporate activity would
be offset substantially or completely by the expansion
in the budget deficit and associated reduction in national
saving, and reductions in noncorporate activity.

Corporate tax reform
The dividend exclusion proposal would fail to
achieve the goal of taxing all corporate income once
and only once. It would not address the portion of
corporate income that is received by nontaxable shareholders.
It would also undermine the political viability
of true corporate tax reform and create costly new
loopholes in the tax code.