Tax Reform and Tax Cuts for the Middle Class

January 15, 2018

With tax reform on the horizon, much is heard about tax cuts for the middle class and higher taxes for the wealthy.  As with most political debates, one can find compelling arguments for opposing positions.  The Tax Policy Institute estimates that under the Republican tax blueprint, the median family would see a reduction in taxes of $420, while the top quintile would see a reduction of about $10,610.  Quite appalling when no other facts are considered.  Here are some other facts to consider.  According to a report on 2013 income tax burdens (the latest year for which such information is available) put out by the Congressional Budget Office (CBO), the highest-earning 20% of taxpayers paid 88% of all federal income taxes, or about $1.2 trillion.  The next 20% paid $175 billion, while the bottom 60% collectively paid $0.  This does not include employment taxes, which arguably impact lower income earners more than higher income earners.  When all federal taxes are considered, the top 20% carries 69% of the burden, while the middle quintile pays about 8.9% of the burden.  Another interesting statistic is that the top 1% pays 38% of all income taxes, while only earning 15% of all pre-tax income.
 
Tax reform is generally about income taxation.  It is very difficult to show that any tax reform is meant to favor the middle class when the top 20% pays such a large share of the federal income tax burden.  The bottom three quintiles carry such a low proportion of the tax burden, zero percent in many cases and a refund due to the Earned Income Tax Credit in many others, that mathematically, any proportional cut will impact the top 20% more than the middle class.  The aggregate tax savings will generally align with the aggregate tax burden.  It would be easy to argue for a reduction in taxes that cover Social Security and Medicaid, because reductions here would have a true positive impact on the bottom three quintiles.  But these programs are heavily relied on by this group of people in later years.  For an interesting editorial on the topic of tax reform, see Reidl, Yes, U.S. Tax Cuts Will Mainly Benefit Those Who … Pay the Most Taxes, New York Post, October 6, 2017.
 
Staying on the topic of tax reform, it is a hard task indeed.  Want to simplify the Code?  Eliminate deductions and lower the tax rate.  But some of the deductions that theoretically could be eliminated are very popular.  Eliminating them could be political suicide.  Look at SALT, for example – the state and local tax deduction.  Along with the mortgage interest deduction and charitable contributions, this is one of the largest deductions offered to individuals.  The Tax Policy Center estimates that the deduction will cost the federal government $96 billion in 2017.  This is a deduction that favors wealthier families and individuals.  30% of all Americans took this deduction, with about half going to those with annual incomes over $200,000.  Who specifically would the elimination of SALT impact?  The tristate area and California have some of the highest property taxes in the country.  You would see more of an impact in those states than in most others.  Other ideas that have been floated – elimination of the current income exclusion for 401(k)s and the making employer-provided health insurance taxable.  Perennial favorites where a major change in tax policy could impact entire industries.  Another one?  Tax more of the Social Security benefits people receive.  The fact that the FICA tax is paid with after-tax dollars seems not to matter.  Stay tuned – Congress is gearing up for quite the fight.
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