The Deficit Commission and Redistribution

President Obama’s Deficit Commission has proposed a plan to rewrite the social contract, and to make the poor and middle class pay.

By Darwin BondGraham

This is a web-only article from Dollars & Sense: Real World Economics, available at http://www.dollarsandsense.org/archives/2010/1110bondgraham.html


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The Deficit Commission may have styled itself from day one as a bipartisan team bent on cutting the nation’s debt, but upon close inspection some of its core proposals seem less about reducing absolute debt, and more about shifting tax burdens and shrinking government in order to fundamentally rewrite the social contract. While a detailed analysis is yet to be done, some preliminary observations indicate that many features of the recently released Co-Chairs’ Proposal—which upon a first read appears to be a smorgasbord of spending cuts that would hit every sector of society equally—could result in regressive redistribution of income and wealth.

By its very definition redistribution never affects all sectors of society equally: wealth and income are shifted among different classes and racial groups, between men and women, and even different sectors of capital, benefiting some and harming others. On balance the Co-Chairs’ Proposal calls for a restructuring of the U.S. political economy that will likely benefit corporate capital and the wealthy, and force the poor and middle class to pay for an increasing share of whatever emaciated state programs remain. This is in spite of the fact that many ideas released in the Co-Chairs’ Proposal do cut or reduce corporate handouts and government subsidies for the rich, and on face value would appear to make the tax code a hair more progressive.

With respect to taxation, the Deficit Commission presents several alternatives, all of which would produce a general state of austerity, but also shift wealth and income in subtle ways. The Deficit Commission’s eagerness to tackle tax reform would seem within their purview; after all, one way to balance the budget is to raise revenues by implementing new taxes or letting specific tax cuts, such as the Bush administration’s 2001 and 2003 reductions on corporate and wealth taxes, expire. The Commission’s co-chairs might also be commended for even just broaching the subject of serious reforms that would eliminate so-called "tax expenditures," otherwise known as deductions, that currently allow corporations and the wealthy to write off enormous shares of their liability.

However, all three of the tax reform options in the Co-Chairs’ Proposal approach the problem primarily as a means to shrink revenue and the government, not to make the tax code fairer or raise revenues. In their own words, they commit themselves to "Pass[ing] tax reform that dramatically reduces rates, simplifies the code, broadens the base, and reduces the deficit." Note that reducing rates comes first, and reducing the deficit last.

The co-chairs’ first option, the Zero Plan, takes its name from the fact that it would begin with a nearly total elimination of all tax expenditures. Tax expenditures are deductions that taxpayers (real persons and corporations) can make by tallying up special exemptions, credits, and rebates that the Congress uses to promote certain economic and social behaviors such as homeownership or industrial investment. In a nutshell the Zero Plan would reduce the tax code to three individual rates and a single corporate rate. Within these four rates the plethora of tax expenditures would be cut back to virtually zero, saving $1.1 trillion according to the commission. The Congress would then use this cash to reduce the deficit and further reduce marginal tax rates across the board. Last but not least, the Commission says that the government would “add back in any desired tax expenditures, and pay for them by increasing one or all of the rates from their zero-expenditure low."

The Commission’s draft proposal includes a graph to illustrate the main beneficiaries of tax expenditures, implying that their plan is fair to the poor and middle class, because under the current tax code, with its complex and vast array of itemized deductions, it is the wealthy who disproportionately benefit from expenditures (see Figure 1.).

Figure 1: Who Benefits from Tax Expenditures?

Figure 1: Reproduced from the Deficit Commission’s Co-Chairs’ Proposal, p. 25

The bottom half of taxpayers benefit mostly from a handful of major deductions, which include refundable credits such at the Earned Income Tax Credit (EITC), Child Tax Credit, and deductions on mortgage interest. The wealthy and corporations, on the other hand, pay professional accountants to rack up numerous and byzantine deductions on their assets which, to paraphrase Warren Buffett, allow them to pay less in taxes than their secretaries.

However if we read closely into the Zero Plan its redistributionary potential in favor of the wealthy becomes apparent. First there’s the matter of the "simplification" of marginal tax rates to three personal brackets and one corporate bracket. While this means cutting taxes relies on eliminating tax expenditures, and therefore will not affect social welfare programs financed through legislation, at the zero baseline level it does eliminate very important tax reductions for low-income and middle-class families. These tax reductions are relied upon for survival—to provide income to pay rent, tuition, for child care, and groceries—and therefore are fundamentally different from tax expenditures available to the wealthy and corporations. Equally eliminating reductions that allow poor people to pay their rent, own their homes, or purchase food and clothing is not at all equal to the elimination of a deduction that allows a millionaire to pocket tens of thousands of dollars because of their second and third homes in Malibu and Santa Fe. In treating every taxpayer equally, the Co-Chairs’ Proposal does disproportional harm to those at the bottom.

While the reduction in marginal tax rates appears to be fair and even across the board, we have to remember that we’re cutting rates across a drastically different set of absolute incomes. This means that while millions of taxpayers in the lowest tax bracket would see a seven-point drop, the money they keep will only be a tiny fraction of what a taxpayer in the uppermost brackets will save under the plan.

For example, a single person with an income of $34,000 is scheduled to pay at a rate of 15% in 2011, totaling about $5,130. Under the Zero Plan their tax bracket would fall to 8%, reducing their tax burden to $2,740. They save about $2,390, and while this is a serious chunk of change, it’s also not a serious bit of assistance considering the levels of debt Americans are now dealing with, as well as the rising costs of everything from college to gas, due in part to the privatization of previously public goods like education as well as creeping inflation (a subject we’ll return to below). If you’re among the working poor, a few thousand dollars is welcome, but not life changing.

However if we look at a taxpayer in the upper brackets the savings under the Co-Chairs’ Proposal are immense. An individual with an income of 375,000 is scheduled to be taxed at a rate of 33% in 2011. Under the Zero Plan their burden is reduced by ten points to 23%. Their savings under the Zero Plan increases by $37,570—more than the pre-taxed income of the hypothetical individual discussed above! At the uppermost levels, in the realm of millionaires and billionaires, tax rates are set to reach 39%, but under the Zero Plan would all drop to 23%, allowing the nation’s wealthiest individuals and families to keep an immense share of wealth that would otherwise fund important federal programs that benefit the majority of Americans and pay down the national debt.

The impression of equality that the across-the-board tax-cuts gives under the Deficit Commission’s draft proposal may therefore prove illusory. Low-income and middle-class families will end up saving relatively small amounts of their income that will hardly make a difference in paying for housing, health care, transportation, and other major expenses, while simultaneously losing key tax credits and deductions they already rely upon for survival. The wealthy, on the other hand, lose the myriad of deductions they already use to save immense amounts of money from the taxman, but they save some of these dollars anyhow with the huge proportional drop in their tax rates.

The Zero Plan includes three baseline options that do not initially ax the Child Tax Credit, EITC, and Current Mortgage, Health, and Retirement Benefits. But even when it keeps these important tax expenditures, the Zero Plan may do harm to the poor and middle class by redistributing the tax burden on them.

This could partly be accomplished by protecting corporate capital from any rate increases. Under the Zero Plan the corporate tax rate drops from 35% to 26%, and then, under each scenario which considers keeping some or all of these important tax reductions for working- and middle-class families, the corporate rate does not rise if (under scenario B) the Child Tax Credit and EITC are kept, and only rises one point at a time under the next two scenarios including further tax expenditures (C and D). Table 1 illustrates this virtual corporate exemption from incremental rate increases. This two-point absolute rise contrasts starkly with the five- to seven-point hikes for individual taxpayers, with the middle class taking on the burden of rate increases to pay for retained expenditures.

Table 1: Option One: The Zero Plan Scenario

Table 1: Tax rates under different scenarios in the Zero Plan

The result, it would appear, is that even if important tax breaks for the majority of Americans whose income places them in the bottom two brackets are kept, they disproportionately shoulder the burden of keeping these tax breaks under the new plan, thereby canceling out these same breaks that previously served to distribute wealth more evenly. The bottom line is that corporations would retain more capital and pay fewer taxes, and any increase in the marginal rate for the wealthy would be relatively small.

The Tax Policy Center has conducted a preliminary analysis of the Zero Plan, demonstrating that some scenarios will in fact result in concrete redistributive gains for the wealthy and losses for the poor and middle class. According to their modeling, "when compared with current law, the [Co-Chairs’ Proposal] reduces after-tax income in the bottom four quintiles of the income distribution and raises after-tax income in the top quintile, making the tax system on average less progressive." Figure 2 illustrates gains and losses in after-tax income under this variant of the Zero Plan. "Current law" in this scenario will mean allowing the Bush tax cuts to expire in 2011, making the tax code more progressive. Compared to the pre-Bush tax regime that is supposed to return next year, the Co-Chair’s Proposal is regressive.

Figure 2: Percentage Change in After-Tax Income

Figure 2: Author’s analysis based on data from the Tax Policy Center.

When compared against the scenario which assumes extension of the Bush tax cuts, the Co-Chairs’ Proposal takes on a progressive flavor, but only because the Bush tax cuts were so incredibly favorable to corporations and the wealthy. If Congress seriously considers the Zero Plan when it debates taxes this coming year, the options would be between extending the Bush tax cuts (a very regressive option that the Obama administration is reportedly considering as part of a deal), implementing the co-chairs’ Zero Plan (a relatively less regressive option that still favors corporations and the wealthy over the poor and middle class), or allowing the Bush tax cuts to expire while keeping the tax code otherwise unchanged (the true baseline option, and most progressive possibility at this point).

The co-chairs’ second proposed tax option is Wyden-Gregg style tax reform, named after the senators who introduced an identical bill in the Congress this year called the Bipartisan Tax Fairness and Simplification Act. While it would represent a major simplification of the tax code, it would seem on first glance, like the Zero Plan, hardly a fair restructuring.

Cutting taxes and specifically lowering taxes on capital are at the center of Wyden-Gregg reform. Like the Zero Plan, it would reduce the corporate tax rate to 26%. It would simultaneously eliminate tax breaks for corporations that currently cancel out the nation’s nominal 35% corporate tax rate. In other words, Wyden-Gregg reform would at best have a net neutral impact on corporate tax rates. It would assuredly reduce the absolute amount of corporate taxes collected by the government, requiring cuts in discretionary spending.

By establishing three individual rates at 15%, 25%, and 35%, revenues would increasingly be collected from personal income taxes. Individuals across all brackets would have few or no targeted deductions for dependents, housing, and education available to them, even though the standard deduction would be increased. The general picture would be austere, as revenues would plummet.

The co-chairs’ final proposal, the Tax Reform Trigger, proposes a "haircut" solution. The haircut however, is more like a massive draining of blood. Under the plan the Congress would commit itself to some kind of unspecified tax reform by 2012 (probably meaning either the Zero Plan or Wyden-Gregg), and if this reform agenda were not achieved, an across-the-board elimination of 15% would be implemented for all deductions. This haircut would increase over time, taking tax expenditures away in the same "equal" fashion that the other plans propose, likely resulting in the same unequal impacts on low-income and middle-class taxpayers until Congress fulfilled its promise to reform the tax code.

The final miscellaneous proposal from co-chairs Bowles and Simpson is perhaps most revealing of all. To raise revenues from non-corporate sources, especially from the poor, they advise a gradual increase of the gas tax to finance transportation projects, and secondly call for making a "technical correction" to adopt a chained consumer price index. Both of these illustrate the regressive and redistributionary agenda at the core of the Deficit Commission’s tax plan.

The 15-cent increase of the gas tax the co-chairs propose is a consumption tax. Like nearly all consumption taxes the burden would fall overwhelmingly on consumers who spend higher proportions of their incomes on gas than the wealthy and corporations. It would punish those who spend and cannot save, and it would treat capital as sacrosanct. Thus the middle class and poor would increasingly finance the nation’s transportation infrastructure.

Chaining the consumer price index would also result in shifting taxation onto the poor and middle class. Currently many items for deduction in the tax code are calculated using the consumer price index. These include some of the same popular deductions discussed above, like the Child Tax Credit and Earned Income Tax Credit. Indexing these deductions ensures that inflation does not undermine the constant dollar value of taxpayer’s exemptions and that each deduction is worth the same amount year after year, even as the value of the dollar drops. An accurate consumer price index that truly reflects the increasingly volatile cost of living many Americans are experiencing is extremely important for ensuring that lower-income taxpayers benefit from deductions.

The chained consumer price index is a method of calculating inflation that reduces the estimated rate. It reaches this lower estimate by making a questionable assumption about consumer behavior; if the price of one good increases but the price of a similar good does not, consumers will supposedly shift their purchasing patterns and substitute the second for the first. If the CPI is lowered, then everything from the standard deduction to Child Tax Credits will be de-valued. Billions of dollars will effectively be taken back from low-income and middle-class taxpayers.

These two miscellaneous revenue proposals are meant to complement the three tax reform proposals in that they generate revenues paid for mostly by the poor and middle class for an otherwise gutted federal treasury that has fewer sources of wealth and corporate capital to draw on. Taken as a set, and placed in historic context, the character of the entire tax reform suite presented in the Co-Chair’s Proposal seems to shift the burden of funding government further upon the shoulders of the poor and middle class.

After World War II the tax rate for large corporations stood at 53%. Ronald Reagan slashed rates for both corporations and the wealthy to post-war lows. George H.W. Bush and Bill Clinton mostly stewarded this social contract through the late 1980s and 1990s, but rates for the wealthiest were allowed to rise back up to 39% by the end of the Clinton years. The George W. Bush administration grabbed the Reagan hatchet, further cutting taxes for the wealthy and corporations and dropping the rate for wealthy individuals to 33%. Bush implemented a number of targeted tax breaks for capital while pursing further revenue sources from consumption. The trend all along was toward a regressive tax code relying increasingly on ways of taxing the consumption of the middle class and poor to raise revenues, and taking a hands-off approach to wealth and corporate capital. As the Treasury Department’s own unofficial history explains it:

Another feature of the 2001 tax cut that is particularly noteworthy is that it put the estate, gift, and generation-skipping taxes on course for eventual repeal, which is also another step toward a consumption tax. One novel feature of the 2001 tax cut compared to most large tax bills is that it was almost devoid of business tax provisions.

Prioritization of tax reform in the Co-Chairs’ Proposal, specifically large tax cuts across the board, and insulation of corporate tax rates from future hikes, coupled with proposals to increase the variety of consumption taxes which will disproportionately affect bottom-bracket taxpayers, would amount to a very dramatic reconfiguration of the social contract leading to general austerity and a significant redistribution of income and wealth.

Darwin BondGraham is a sociologist and staff member of the Los Alamos Study Group.

Sources: National Commission on Fiscal Responsibility and Reform, "Co-Chairs’ Proposal," November, 2010 (www.fiscalcommission.gov/news/cochairs-proposal); U.S. Department of the Treasury, "History of the U.S. Tax System," (www.ustreas.gov); Congressional Budget Office, "Budget Options: V. 2, August 2009"; Daniel Baneman and Eric Toder "Distributional Estimates for Bowles-Simpson ‘Chairmen’s Mark’" Tax Policy Center (www.taxpolicycenter.org); Tax Policy Center "2011 tax rate schedule" (www.taxpolicycenter.org); Tom Bawden "Buffett blasts system that lets him pay less tax than secretary," The Times, June 28, 2007 (www.timesonline.co.uk).

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