Citizens for Tax Justice, May 1997
President Clinton and congressional Republican leaders have agreed on a balanced-budget plan that, somewhat oddly, includes room for what they call a total of $85 billion in net tax cuts over the next five years (and double that over the succeeding five years). The amount ostensibly budgeted for tax cuts
How do the parties propose to squeeze $93 billion in taxcuts into a $17 billion container? Well, they think it will be easy. All it takes, they feel,is a little creativity and a lot of deceptiveness. Here's thelikely scenario:
1. Money for Nothing
The existing 8% airline ticket tax is technically set to expire at the end of this fiscal year.The budget will take credit for not letting the ticket tax lapse--thereby providing $30billion in "new" revenues over five years to help pay for tax cuts. Why not just call the budget deal a $115 billion five-year tax cut? It could have something to do with the fact that $115 billion is exactly equal to the budget deal's five-year cuts in Medicare.
2. The Incredibly Shrinking Kids Credit
If the government were actually to provide $500 for every one of the 81 milliondependent children in America, the cost would come to $40.5 billion a year. That alone,of course, would be far more than the total revenues available for tax cuts under the budgetagreement. So while Congress and the President have promised a $500 kids credit, they'relikely to take something like the following steps to scale it way back:
1. Deny the credit to families that don't make enough money. About one in four childrenlives in a family that doesn't make enough money to owe federal income tax. Both theClinton and Republican child credit plans would deny the kids credit to such families.
2. Deny the credit to families that make too much money. Both sides have proposed to phaseout the credit above certain income levels,although Clinton's maximum income cutoffs areconsiderably lower.
3. Lower the age limit. Under the current GOPkids credit plan, children must be 17 or youngerto be eligible for the credit. Under Clinton'sproposal, the age cutoff is 12 or younger.
4. Phase in the credit over several years and/ordon't index it for inflation, so that its real valuedeclines over time. Clinton's proposal includes alittle of both of these scale-backs; the GOP plansimply forgoes indexing.
When all these limitations are put together, theGOP's "$500" kids credit proposal actually averages only $250 per child. Clinton's moreaggressive limits cut his proposed credit to only about $110 per kid.
Prediction: Look for the parties to agree on something closer to Clinton's plan, whichprovides a credit to only one in three children and cuts the annual cost of the kids creditdown to less than $9 billion a year (in 1997 dollars). The fact that the final package won'tdeliver anything close to a true $500 per child tax credit to most American families isunlikely to cause Congress or the President to lose any sleep. If you were expecting a $500credit, you'll probably have to settle for a lot less.
3. Ever-Growing Estate Tax Cuts
The GOP proposal to boost the estate tax exemption from the current $600,000 to $1million, along with a few other changes, has an annual price tag of about $8 billion a year(in 1997 dollars). But the short-term cost can probably be reduced to less than $2 billionannually over the next five years, by scaling back the cuts a bit and phasing in the increasedexemption in $50,000 annual increments between now and the year 2006.
Prediction: Most of the true cost of the estate tax cuts will be masked by a slow phase-in. The revenues losses over the second five years (after 2002) will probably be about fourtimes the $10 billion amount likely to be budgeted for the first five years.
4. Exploding IRAs
Both sides want to expand Individual Retirement Account tax breaks for better-off peoplewho already participate in pension plans at work, although the Clinton proposals are far lesscostly because his proposed new tax breaks are phased out for families making more than$100,000. To hide the true cost of these proposals--almost $13 billion a year in 1997dollars under the GOP plan when fully effective--both sides have proposed new "back-loaded" IRAs. Instead of taking a tax deduction when money is put into an account, the"back-loaded" IRAs provide a complete tax exemption when money is taken out afterretirement.
Prediction: Proponents of honesty in budgeting find the "backloaded" IRA idea particularlyobnoxious, because it was intentionally concocted to hide the cost of the new tax breaks byputting it off into the future. But the blatant budget dishonesty of "back-loaded" IRAs hasmade them almost irresistibly attractive to some politicians. Whatever they say this itemcosts, you should probably at least double it.
5. Education Tax Breaks
The idea that taxpayers will have to file their children's report cards with their tax returnshas caused even some lawmakers who are usually gung-ho about any kind of tax break tolook a bit askance. Likewise, colleges have been less than enthusiastic about thePresident's proposed tax credits and deductions for college, even though they'd probablybenefit from the tax breaks by being able to raise tuition.
Prediction: President Clinton has been insistent that his education tax subsidies be part ofthe budget package, and the $35 billion over five years that's budgeted for them should(unfortunately) allow them to be included with only minor tinkering.
6. The Big Enchilada: Capital Gains Tax Cut Flimflammery
This is the Holy Grail for congressional Republicans, and they made it a central goal in thebudget negotiations. President Clinton made it clear early that he has "never beenphilosophically opposed as some of my fellow Democrats are," although he has alsoinsisted that he strongly objects to "a big tax cut for people who don't need it."
The GOP capital gains tax cut plan now pending in Congress includes a 50% exclusionfor gains from selling stocks and other assets, plus indexing for inflation--which togetherwould make about 61% of capital gains tax-exempt.
Such a capital gains tax cut is indeed a very big deal--the GOP plan would reduce taxes,mainly for the wealthy, by about $26 billion a year and could revitalize the tax-shelterindustry. But by the time the official numbers crunchers get done cooking the books, thisenormous tax cut for a very small portion of the population is likely to look like it's hardlyworth worrying about. That, of course, will be a false impression.
Prediction: The most likely scenario starts with a proposal floated by the Clintonadministration during the abortive 1995 budget negotiations, when presidential adviser DickMorris was urging the President to reach a deal with congressional Republicans at any cost.The "Morris plan" would cut the top capital gains tax rate to 19.6% from the current28% maximum, with a 10.5% top rate for taxpayers in the regular 15% bracket.
At first blush, the Morris plan looks a lot like the 50% exclusion proposed bycongressional Republicans. Specifically, if one foolishly ignores indexing, the GOP planwould seem to set the top capital gains tax rate at 19.8%--half the 39.6% regular tax rate.But because the Morris plan (1) doesn't include indexing, (2) lowers capital gains taxes by30%, rather than by 50% for taxpayers now in the regular 28% and 15% tax brackets, and(3) unlike an exclusion, doesn't affect various income tax provisions keyed to adjusted grossincome (such as the itemized deduction disallowance at high income levels), it actuallywould reduce capital gains taxes by less than half the amount that the GOP capital gainstax cut plan entails.
Even if Congress accepts the Morris plan, however, the numbers crunchers will still havesome serious creative work to do to fit its cost into the budget. They'll assume a huge andunprecedented stock market sell-off in response to the lower capital gains tax rate. Andthey may engage in a few more tricks to cut the apparent cost, at least in the short term.
When all the dust clears, the official estimate of the Morris capital gains tax cut is likelyto average only a couple of billion dollars a year over the next five years--only a fractionof its true cost. Indeed, in the first few years, it will probably be claimed that the capitalgains tax cuts actually lead to increased revenues for the government. Even the officialestimates will likely have to admit, however, that the cost in the second five years will betwo or three times the cost in the first five years.
The official estimate not only will almost certainly far understate the real cost of the capitalgains tax cut plan that Congress approves, the estimators may even go so far as to claim,preposterously, that wealthy people will be worse off as a result of the tax cuts! But thesekinds of rank deceptions probably won't stop our lawmakers, since the goal is not actuallyto balance the budget in 2002, but rather to appear to do so. After all, by 2002 Bill Clintonwill be long gone and Newt Gingrich has promised he'll be about to retire.
If a GOP- or Morris-style capital gains tax cut is adopted, it will haunt tax and budgetpolicy for a long, long time. If there's any tax provision in the budget worth fighting over,this is it.
Additional Tables:
Comparison of Various Capital Gains Tax Proposals
Comparison of Clinton & GOP Tax Proposals
Tax Cuts Proposed Compared to Revenue Available in Budget Agreement
Outlines of Tax Proposals:
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