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Center on Budget and Policy Priorities

Revised May 11, 2006

TAX RECONCILIATION AGREEMENT DISTORTED BY OBSESSION WITH CAPITAL GAINS AND DIVIDEND TAX CUTS:

Middle-Income Households to Receive Tax Cuts Averaging Only $20

By Joel Friedman and Aviva Aron-Dine

Summary

House and Senate negotiators announced an agreement yesterday on a tax-cut reconciliation bill that would reduce revenues by $70 billion between 2006 and 2010, according to Joint Committee on Taxation estimates. Although nearly half of this cost reflects a one-year extension of relief from the Alternative Minimum Tax, it is the two-year extension of the capital gains and dividend tax cuts that fundamentally shaped the final agreement. Even though the capital gains and dividend tax cuts are not slated to expire until the end of 2008, the Administration and Congressional leaders went to great lengths to ensure that a two-year extension through 2010 is part of the final package.

The end result is a conference agreement that:

  • circumvents the reconciliation cost limits by leaving out popular tax-cut provisions with the full intention of enacting them in a subsequent bill, thereby increasing the total budgetary cost and the amount by which the deficit will be increased;
  • relies in large part on budget gimmicks and timing shifts to create the appearance that it is complying with a key Senate budget rule that bars the reconciliation bill from increasing the deficit in any year after 2010; and
  • provides an overwhelming share of its tax-cut benefits to those at very high income levels.

Tax Cuts Left Out. The conference agreement omits more than a dozen other tax-cut provisions that were in both the House- and Senate-passed reconciliation bills, such as the extension of the research and experimentation tax credit and the higher-education tuition deduction. A one-year extension of these provisions costs about $20 billion.

Unlike the capital gains and dividend tax cuts, these provisions all have already expired or will expire at the end of 2006, meaning that failure to extend them this year would have immediate consequences. Congressional leaders could not include these expiring “extenders,” however, and also pack a two-year extension of the capital gains and dividend tax cuts within the $70 billion cost limit for the tax reconciliation bill. They concluded that they needed the protections against a filibuster that a reconciliation bill provides in order to pass the capital gains and dividend tax cut extension, but do not need these protections to pass the continuation of the other expiring tax provisions. Accordingly, their plan is to move these other tax cuts in coming weeks or months in one or more other tax bills outside of the reconciliation process, thereby adding still more to budget deficits.

Most troubling, the bill includes a substantial tax cut for affluent households disguised as an offset — that is, it attempts to use one tax cut to pay for another tax cut. This provision, which will allow high-income individuals to convert regular IRAs to Roth IRAs, will raise revenue initially but lose significantly larger amounts of revenue in later years, according to analyses by the Joint Tax Committee, the Congressional Research Service, and the Urban Institute-Brookings Institution Tax Policy Center. The conferees have used this temporary increase in revenue to help “offset” the cost of the capital gains and dividend tax cut in 2011-2013, but the eventual revenue losses, which will start in 2014, will continue to grow in the years after 2015, when the official cost estimate ends. After a few years, these revenue losses will begin to outstrip the revenue gains from the other offsets contained in the conference agreement (which are modest). As a result, the agreement will increase long-term deficits, violating the Senate rule designed to prevent such an outcome.

Benefits Skewed to the Well-Off. The final package offers virtually no benefits to low- and moderate-income households while showering high-income households with munificent tax cuts. Preliminary estimates by the Tax Policy Center of the major provisions in the conference agreement show that middle-income households will receive an average tax cut of just $20 (about enough to purchase six gallons of gasoline), while households with incomes over $1 million will see tax cuts averaging $43,000. For the top 0.1 percent of households, whose incomes exceed $1.6 million, the tax cuts will average $84,000.

Overall, 55 percent of the tax-cut benefits will flow to the 3 percent of households with incomes above $200,000, and 22 percent of the benefits will go to the 0.2 percent of households with income over $1 million. In contrast, the 20 percent of households with incomes in the middle of the income spectrum will receive less than one percent of the benefits

Finally, it is worth remembering that the tax reconciliation bill is the second of two reconciliation bills authorized under last year’s budget resolution. The first reconciliation bill, enacted in February 2006, cut entitlement programs by $39 billion over five years, including reductions in programs such as Medicaid that directly affect low-income families and children and low-income people who are elderly or have serious disabilities. The first reconciliation bill was promoted as reducing the deficit, but it is clear now that it will not do so. Instead, it will simply offset a little more than half of the cost of the tax cuts in the tax reconciliation bill.

The combined effect of the policies in the two reconciliation bills — benefit reductions for lower-income families to help pay for tax cuts primarily for high-income individuals — will be to increase deficits and further distort the nation’s budget priorities, while also further widening disparities between the most well-off households and Americans of modest means

Capital Gains and Dividend Tax Cuts Did Not Significantly Boost the Economy

Overall, despite at least one major tax cut every year for four years, the current economic recovery has been weak in comparison to other post-World War II recoveries. Notably, investment growth in this recovery has been weaker than in the average previous post-World War II recovery, even though several recent tax cuts — including the capital gains and dividend tax cuts — were promoted with the promise that they would lead to stronger investment growth. In fact, investment growth has also been weaker than during the 1990s recovery, when taxes were increased.

Proponents of the capital gains and dividend tax cuts stress that the economy, though weak in the first two years of the current recovery, has improved since these tax cuts were enacted. Even if one focuses only on the few years since the tax cuts took effect, however, the economy’s performance has failed to vindicate the claims made by tax-cut enthusiasts. For example, employment at the end of 2005 was more than six million jobs short of the level the Administration predicted would result if the 2003 tax legislation that included these tax cuts was enacted.

The very large tax breaks that the reconciliation agreement provides to households with the highest incomes largely reflect the impact of the capital gains and dividend tax cuts. Nearly half (45 percent) of the benefit of extending these tax cuts would flow to households with incomes of more than $1 million, according to Tax Policy Center estimates. Although supporters of these tax cuts like to claim the benefits of these tax cuts are widespread, they usually fail to acknowledge that for less well-off households, the tax cut amounts to only a few dollars, reflecting the modest amount of taxable assets those taxpayers hold preliminary estimates by the Tax Policy Center show the distribution of the overall package to be extremely skewed to those at the top of the income spectrum:

  • About 87 percent of the benefits of the tax cuts in the final package would flow to households with incomes above $100,000, and 55 percent would flow to those with incomes above $200,000. Households earning more than $1 million a year would receive 22 percent of the benefits of these tax cuts.
  • In contrast, the three-quarters of households with incomes below $75,000 would receive 5 percent of the benefits. The 60 percent of households with incomes below $50,000 would receive less than 2 percent of the benefits.
  • The differential treatment of various income groups is even more striking when one looks at the dollar amounts involved. The average tax cut for the 20 percent of households in the middle of the income spectrum would be just $20. The average tax cut for those in the top one percent of the income spectrum would be $14,100. And for those with incomes above $1 million, the average tax cut would be $43,000.

The conference agreement’s relief from the Alternative Minimum Tax also would flow primarily to households with incomes above $100,000. Unlike the investment tax cuts and the Roth IRA proposal — which direct large shares of their benefits to people with incomes over $500,000 — the benefits of AMT relief are concentrated on households with incomes between $100,000 and $500,000. Those households would receive about 80 percent of the AMT relief, according to the Tax Policy Center. (Households at higher income levels are less affected by the AMT, so they receive fewer benefits from AMT relief.)

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