CRS Reports on Tax Proposals of Presidential Candidates

                       CRS REPORT FOR CONGRESS

[1] The views of presidential candidates on tax issues are of general interest. At this early stage of the debate, many proposal lack detail. This report discusses the candidates' proposals and will be updated as more information becomes available. It also briefly describes issues which often arise in public policy debates about taxes.

[2] The presidential candidates differ in their focus on tax revisions. Democratic candidates Bill Bradley and Albert Gore have not indicated support for major tax cuts or major revision of the tax system at this time, although Gore has supported some smaller targeted tax reductions and Bradley has proposed measures to limit special tax benefits to raise revenue ($124 billion over ten years) to finance his health care and other spending initiatives. Republican candidates all propose major tax revisions, although the nature and degree of detail varies. George Bush and John McCain have proposed significant income tax cuts. Orrin Hatch has proposed some shorter term income tax cuts to be followed by a reconsideration of the tax system overall; he has indicated some interest in a sales tax or a flat tax. Both Gary Bauer and Steve Forbes have proposed a flat tax, allowing for personal exemptions or credits. Alan Keyes proposes to abolish the income tax and rely on tariffs and excise taxes. One of the reform party candidates, Pat Buchanan, has proposed a flat tax; Donald Trump has not proposed a major tax revision but has suggested a one time tax on net worth. Libertarian candidate Harry Browne proposes to eliminate the income tax by reducing the size of government.

[3] The remainder of this report summarizes six proposals for major revisions of the income tax in more detail, considering first the income tax proposals of George Bush, Orrin Hatch, and John McCain and then the flat tax proposals of Gary Bauer, Pat Buchanan, and Steve Forbes. The final section summarizes the issues often associated with tax revision proposals.

[4] Many of the tax issues discussed are addressed in more detail in various CRS studies. See the CRS electronic briefing book on taxation for an overview and guide to tax issues, at [http://www.congress.gov/brbk/html/ebtxrl.html]. Information on candidates' positions can be found at [http://issues 2000.org] and at [http://taxpolicyresearch.umich.edu] as well as candidates' websites.

PROPOSALS TO REVISE THE INCOME TAX

[5] In some cases the specifics of candidates' proposals are not clear. For example, a proposal to "eliminate the marriage penalty," could accomplish this goal in different ways, with some approaches simply cutting taxes for all couples and others only for those with marriage penalties (many couples have tax bonuses as a result of marriage). Indeed, the "marriage penalty" itself is not precisely defined since it depends on one's assumptions of how financial and family affairs (such as custody of children) would be arranged in the absence of marriage. ¹

[6] Before describing these proposals, some brief highlights of the current system are provided. First, the current individual income tax system allows personal exemptions and a standard deduction, along with $500 child tax credits that currently exempt the equivalent of $25,000 from income tax for a married couple with two children. (Individuals may also itemize deductions for mortgage interest, most state and local taxes, charitable contributions and some other items). Wages and salaries, interest, dividends, capital gains, rents and profits from businesses are taxed. There are separate rate schedules for singles, married couples (joint returns) and heads of households and one result of a progressive tax rate structure applied to families is that individuals can experience tax penalties or bonuses from marriage. Tax rates apply at 15, 28, 31, 26 and 39.6 percent. About seventy percent of taxpayers pay at the 15 percent rate. Capital gains rates are lower than ordinary rates. There are a variety of special tax benefits such as deductions or exemptions for individual retirement accounts and credits for child care and college tuition. An important benefit for lower income individuals is a refundable earned income tax credit (which raises the exempt level for a family of four to about $28,000). There is a tax on corporations and on estates and gifts, with large exemptions from the latter. Both individuals and corporations are subject to an alternative minimum tax (AMT). Many tax benefits are phased out as income rises.

[7] George Bush's plan is estimated to cost $483 billion over the first five years and $1.2 billion over ten years. He proposes to replace the current structure of taxes with a 10, 15, 25 and 33 percent rate structure. The child tax credit will be doubled to $1000 and the phase-out of the credit will be increased from $110,000 to $200,000 for married couples and from $75,000 to $200,000 for single parents. The marriage penalty will be reduced by allowing a ten percent deduction for the second earner (up to $3000). In addition, the proposal will eliminate estate and gift taxes, make the R&D tax credit permanent, extend the deduction for charitable contributions to non-itemizers, raise the cap on corporate charitable donations, and increase the annual limit on education savings accounts from $500 to $5,000. His plan would also eliminate the Social Security earnings test, which acts in the nature of a tax.

[8] Orrin Hatch proposes in the long run to adopt a major tax reform and abolish the Internal Revenue Service. In the short run, he proposes to repeal the 1993 tax increases (which introduced the 36 and 39.6 percent tax rates on higher income individuals), double the personal exemption, allow a deduction for payroll taxes, exempt $5,000 of interest and dividends from tax, eliminate the capital gains tax, eliminate the marriage penalty, eliminate estate and gift taxes, and eliminate the alternative minimum tax.

[9] John McCain proposes a $237 billion tax cut offset by $150 billion raised from eliminating corporate tax benefits (both amounts are for five years). His tax cut would expand the 15 percent bracket to $35,000 for singles and to $70,000 for individuals, eliminate the marriage penalty for most families by increasing the standard deduction for joint returns, double the child credit, allow a $400 exclusion ($200 for single returns) for interest and dividends, allow increased contributions to deferred savings accounts, provide relief for the AMT and increase the estate and gift tax exemption to $5 million (phased in over ten years). His plan would also eliminate the social security earnings test.

FLAT TAX PROPOSALS

[10] Three of the candidates have proposed specific plans for a flat tax rate with a broad base. Flat tax systems can be designed in a variety of ways. The base of the flat tax can be either consumption or income. Flat rate taxes can achieve a degree of progression when exemptions are allowed. Most of the tax plans proposed thus far are not detailed enough to assess either revenue consequences or the precise nature of the tax base.

[11] Gary Bauer proposes a flat rate of 16 percent which would also apply to capital gains; most deductions would be eliminated but those for mortgage interest and charitable deductions would remain. Social security payroll taxes and benefits would be cut by 20 percent. The estate and gift tax would be abolished. There would be a personal tax credit of $1400 per person (which is equivalent to a deduction of $8,750 at a 16 percent rate). He has proposed to retain the earned income tax credit.

[12] Pat Buchanan's proposal is similar to Bauer's in several ways. It also proposes a 16 percent tax rate which would exempt the first $35,000 of income, while retaining charitable and mortgage interest deductions. It also proposes a per-child tax credit, and abolishing estate and gift taxes on estates up to $5 million. Revenue from tariffs on foreign imports would be used to offset some of that lost by tax relief.

[13] Steve Forbes proposes a 17 percent flat tax that appears to be similar to the Hall Rabushka tax proposal and therefore falls on consumption rather than income. The tax would apply to wages and salaries of individuals and to business income (and thus not to capital gains, dividends, or interest income). There would be a $36,000 exemption for a family of four. The estate and gift tax would be repealed.

ISSUES

[14] One underlying issue is whether or not we should cut taxes. Those who oppose a tax cut have argued that any surpluses that develop should be used to increase the financial viability of Social Security and Medicare. They have also suggested that the surpluses, particularly the on-budget surpluses which exclude social security trust fund flows, may not materialize. The economic performance that gave rise to this surplus could falter, or it could be difficult to maintain the built-in spending caps. Those in favor of a tax cut are concerned that the surplus will be too easily spent on government programs and cite the high level of current income taxes as a reason to cut these taxes.

[15] There are also disagreements about the nature of any tax cut or tax substitution that takes place. These issues generally involve efficiency (or economic growth), distribution and fairness, and simplicity. Often these objectives conflict. For example, flattening the tax rate structure is likely to contribute to economic efficiency and greater output, but it also tends to redistribute the tax burden from high income individuals to lower income individuals, an outcome that is viewed as undesirable by some. Efficiency may or may not conflict with simplicity. Many special provisions that may lead to non-neutral taxes also complicate the tax system; in other cases, however, the more precisely income is measured for tax purposes the more complicated is compliance. And some special provisions are designed to achieve desirable social objectives, but nevertheless complicate tax compliance. Provisions that are designed to relieve the tax burden for certain groups of people (such as those with large medical expenses) may complicate the tax code and also lead to economic efficiency (by encouraging certain types of behaviors).

EFFICIENCY AND ECONOMIC GROWTH

[16] One of the principal arguments for cutting tax rates, devising a flatter rate system, or shifting to a consumption tax base is to reduce the distortions in the tax system. All of the tax proposals appear to flatten the tax rate structure and some (such as the Forbes flat tax) shift the base to consumption. All of these changes should increase savings and labor supply, with the greatest effects probably arising from the three flat tax proposals. However, empirical evidence suggests that these responses may not be very large.

[17] Tax reductions alone, even without changing the progressivity of the tax system, would also increase labor supply and savings. However, if these tax reductions are financed by reducing government savings, the overall effect could be negative as government borrowing claims more of funds available for investment.

DISTRIBUTIONAL ISSUES

[18] Distributional issues relate to both the distribution of taxes across income groups (vertical equity) and differential taxation of individuals with the same incomes. Assessing the effects on horizontal equity is difficult, although broadening the tax base tends to increase this type of equity. The distribution across income classes is more straightforward and is discussed here.

[19] Without detailed information, it is difficult to compare proposals. The Bush proposal has been presented with detailed distributional tables. It includes benefits for lower and moderate income taxpayers through the lower 10 percent rate bracket and the increase in the child credit. According to the Bush documents, larger percentage cuts in income taxes would occur at lower income levels. However, percentage reductions in income tax liability may not be very informative about the distributional effects since these taxes are very small at low income levels. This point is discussed in "Dubya's Tax Plan: Realistic, Yes, Progressive, No," in Tax Notes, December 20, 1999 and an article by Al Davis in "Candidate Bush's Tax Cut Plan," Tax Notes, January 10. Davis also states that most of the tax cut still goes to higher income individuals: 29 percent goes to those over $200,000 and 51 percent goes to those over $100,000. Also, many taxpayers will receive limited or no tax cuts because they have no regular income tax liability or would be shifted to the AMT.

[20] On an absolute basis, most income tax cuts will tend to favor higher income individuals who pay most of these taxes. Another way to examine the distributional effects of tax cuts is to calculate the percentage increase in disposable income. Some rough calculations suggest that the Bush plan would increase disposable income of higher income individuals more than that of lower income individuals.

[21] According to an analysis by Citizens for Tax Justice ([http://www.ctj.org]), the McCain proposal would provide a smaller share of its benefits to the bottom 60 percent of taxpayers than the Bush proposal (6 percent versus 11 percent). It would also, however, provide a considerably smaller share to the top one percent (2 percent versus 37 percent).

[22] In general, the other tax proposals appear to be somewhat more favorable to higher income individuals than the Bush or McCain proposals, although these proposals are not as specific and detailed. Most elements of the Hatch proposal, including the rolling back of higher rates, the elimination of the capital gains taxes and AMT, and the $5000 exclusion for interest and dividend income would favor high income individuals, although the increased personal exemption would benefit lower income taxpayers. Any flat tax proposal is likely to particularly benefit higher income individuals who tend to pay currently higher income taxes, relative to the middle and lower income classes. Proposals that do not retain the earned income tax credit will cause the loss of these benefits for lower income individuals. Thus, overall flat tax proposals are thought to lead to a less even distribution of after-tax income than rate cuts in a progressive income tax system. These effects could be moderated by retention of the earned income tax credit, but a higher rate or lower exemption would be required.

SIMPLIFICATION

[23] A flat tax, especially one that eliminated tax on capital income, as in the case of the Forbes proposal, would be a substantial simplification for taxpayers who receive only wages and salaries. Other flat tax proposals would also be simpler than current law because the number of deductions and exemptions would presumably be reduced. However, there are many ways to simplify the current income tax, without making major changes, by broadening the base.

[24] Many of the income tax cuts would also simplify taxes in some ways, although most current proposals do not provide very much detail. Eliminating the AMT, as in the Hatch plan, would simplify compliance for higher income individuals and those more moderate income individuals who will be increasingly affected by this provision. Eliminating or exempting interest, dividends and/or capital gains from the tax base would also be a simplification, as would eliminating the estate and gift tax or increasing the exemption from the estate tax. The higher phase-outs of the child credit in the Bush plan would subject fewer taxpayers to this phase-out and the higher personal exemptions in the Hatch plan and standard deductions in the McCain plan would raise the level at which the income tax does not apply. However, some of the changes would further complicate the tax law, including the deduction of charitable contributions for non- itemizers and the second earner deduction in the Bush plan and the payroll tax deduction in the Hatch plan. Some ways of addressing the marriage penalty can also complicate the law. Cutting tax rates without fundamentally altering the AMT, as appears to be the case in the Bush and McCain plans, will subject more taxpayers to the complications of the AMT.

CONCLUSION

[25] Tax proposals have received particular attention from Republican and Reform candidates. So far, neither of the Democrat candidates have proposed major tax revisions. The tax proposals differ in the degree to which they trade off distributional effects for lower marginal tax rates -- the flatter the rate structure and the more oriented to a consumption base, the more likely the proposal is to shift the tax burden away from higher income individuals.