Four policies to help the middle class, and how to pay for them

Behind the daily headlines of our turbulent political climate is a stark, hard fact: the American middle class is hurting. Household incomes for the middle 60 percent of the distribution are rising, but painfully slowly, and primarily due to more work (including longer hours) rather than better wages. As the economy continues its long climb back after the Great Recession, the middle class are still feeling the squeeze, in terms of both money and time. Whichever party is in power in Congress after the midterms, an immediate priority must be to bolster the quality of life for our middle-class families.

There are plenty of policy ideas floating around, many of them good. But making them a reality requires two political feats: galvanizing congressional support and addressing fears about the fiscal impact of new spending. In the spirit of offering a positive agenda for the middle class, we offer four proposals that ought to find bipartisan appeal, paired with four revenue-raising proposals that could fund each of them. Taken together, the package would be deficit-neutral.

1. A worker tax credit

In her new book, The Forgotten Americans, our colleague Isabel Sawhill reminds us that most Americans want to earn their own living. But middle-class income growth has been tepid for decades, leaving many workers feeling like they are running in place:

Sawhill proposes a worker tax credit similar in design to one described by Elaine Maag. Think of it as an Earned Income Tax Credit (EITC), but with greater support for childless workers and without work disincentives for secondary earners. It would provide a credit equal to 15 percent of individual earnings up to a cap of $1,500 per year and would help all workers earning less than $40,000 a year, for an estimated cost of $868 billion over ten years.

…funded by a carbon tax.

But can we afford it? Aparna Mathur and Adele Morris suggest using a carbon tax to pay for an expanded EITC (which could take the form of a worker tax credit). A carbon tax is a worthy policy goal in its own right, to reduce CO2 emissions, and a wage subsidy for low- and moderate-income workers could more than offset the tax’s regressivity. A carbon tax starting at $27 per metric ton of CO2 and rising at 5 percent per year over inflation is estimated to bring in $1 trillion over 10 years.

2. A tax credit for first-time home buyers

Creating a fairer and more efficient framework for housing policy will mean considerable changes to zoning restrictions and a greater supply of affordable housing, as well as a rebalancing of support between mortgage holders and renters, as our colleague Jenny Schuetz argues.

There is also a strong case for reforms to the current system of federal homeownership subsidies to make these tax expenditures more equitable and effective. In his forthcoming book, Fiscal Therapy, our colleague William Gale recommends replacing the mortgage interest deduction (MID) with a one-time refundable tax credit for first-time home buyers. At an estimated cost of $20 billion per year, a credit of $10,000 for each new homeowner would be less regressive and less costly than the MID, and it would “encourage homeownership, not home indebtedness,” as Gale writes.

…funded by eliminating the mortgage interest deduction.

The mortgage interest deduction does little, if anything, to increase homeownership rates, and it disproportionately benefits high-income households. Only about a quarter of the benefits of the deduction go to the middle class (the middle 60 percent of the income distribution):

The MID will result in a revenue loss of about $34 billion in 2018, according to the Joint Committee on Taxation. This is down from $66 billion in 2017, as a result of an expected decline in the number of filers itemizing their deductions (and a commensurate increase in those who take the standard deduction, which nearly doubled under TCJA).

While TCJA did lower the cap on the mortgage principal eligible for the deduction from $1 million to $750,000, the revenue impact of the new cap will be fairly small. Fewer than 2 percent of households have mortgages above $750,000, according to a recent report by Austin Drukker, Ted Gayer, and Harvey Rosen. Still, it’s a step in the right direction. Gale writes that the MID should be phased out gradually over 10 years to avoid sudden shocks to housing markets. But there is enough money here to comfortably fund his proposed credit.

3. Provide paid family leave

Despite widespread support for paid family leave, the U.S. remains the only advanced economy without a paid leave policy at the national level. Several states and private employers have implemented or plan to implement their own paid leave policies. But only about 16 percent of workers receive a defined paid family leave benefit from their employers, and access to leave is uneven across the wage distribution:

Almost one-fifth of middle-income workers report that there was a time in the past two years when they needed or wanted to take time off from work for parental, family, or medical reasons but were not able to, according to a Pew Research Center survey. (Here, middle-income refers to those with household incomes between $30,000 and $75,000.)

The bipartisan AEI-Brookings Working Group on Paid Family Leave (of which Reeves is a member) proposes a federal policy providing mothers and fathers with eight weeks of paid parental leave, at a wage replacement rate of 70 percent up to a cap of $600 per week. This could cost up to $13 billion dollars annually, according to the working group’s cost model.

…with a payroll tax.

States with existing paid leave policies tend to package them as social insurance programs, with universal benefits funded through employee payroll taxes. This reduces the burden on employers and thus avoids incentivizing firms to discriminate against women, who are more likely to take leave. The AEI-Brookings proposal also takes this approach, though some members of the working group recommended reducing tax expenditures in other areas. The scheme could be fully funded with a payroll tax of 0.15 percent.

Alternatively, policymakers could fund paid leave by targeting one of many regressive elements of the tax code. For instance, Congress could further lower (or at least keep intact) the $10,000 cap that the Tax Cuts and Jobs Act imposed on the deduction for state and local taxes (SALT). The cap is set to expire in 2025, and is already under attack by blue states. Lifting the cap would reduce federal tax revenues by $620 billion over 10 years, and the top 20 percent of households would reap 96 percent of the rewards.

4. Child savings accounts for college

The cost of college, and of the debt often needed to fund it, is a growing concern for middle-class families. Reform proposals range from free tuition to a federal-state match to reforming the student loan repayment system. William Elliott and Melinda Lewis approach the problem from a different perspective, urging a move to an asset-based rather than debt-based funding system. Specifically, they propose a national system of long-term Children’s Savings Accounts (CSAs) to help children build assets to fund postsecondary education in adulthood.

Asset-building programs are gaining popularity in policy circles. Darrick Hamilton and William Darity have long argued for the potential of “baby bonds” to close racial wealth gaps. Hamilton presented on the idea at a conference of the American Economic Association earlier this year. And Sen. Cory Booker (D-NJ) is introducing a bill to provide low-income children with “opportunity accounts” that could grow to almost $50,000 by the time they enter adulthood.

Under the Elliott and Lewis proposal, initial seed funding from the government would start at $10,500 for low-wealth children. Higher-wealth families would have smaller initial deposits and larger expected contributions from the parents. They estimate that their proposal would allow all children to turn 18 with approximately $40,000 in dedicated educational assets. The cost to government would be $42 billion per year. For context, in 2017 the federal government spent about $60 billion (not counting student loans) supporting college students. CSAs would reduce reliance on student loans and could replace some other federal educational expenditures.

…paid for by taxing large inheritances.

In the spirit of narrowing wealth gaps, one option is to use the estate tax to fund education for asset-poor children, ensuring that wealth is transferred more equitably from one generation to the next. Fewer and fewer estates have been subject to the tax since the exemption level started increasing (and the rate started declining) in the 1970s. Revenue from the estate and gift tax now constitutes less than one percent of federal receipts:

The Tax Cuts and Jobs Act doubled the exemption on the estate and gift tax until 2025, so that only the portion of an inheritance that exceeds $11.2 million (or $22.4 million for couples) is subject to taxation. The Tax Policy Center estimates that if we returned to the 2000 tax law, with an exemption of $1 million for individuals and a top statutory rate of 55 percent, estate tax liabilities for 2019 would total $66 billion, compared to just $15.6 billion under the current law: more than enough to fund the college savings accounts.

A plea to the new Congress

To be clear: there are hundreds of policies and “pay-fors” being proposed and debated in policy circles, many of which may have advantages over the examples we have outlined here.

Our main message is that policymakers are not helpless in the face of the challenges facing the middle class. But some bold action will be required. Congress, there is work to be done.