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This blog post is part of a series dedicated to analyzing the impact of the Tax Cuts and Jobs Act. Click here to see all of the blogs in the #TCJANowWhat series.
The Tax Cuts and Jobs Act (TCJA) cut federal tax revenues by nearly $2 trillion over its first decade, with almost all of that largesse aimed at higher-income households and corporations. But, that’s not surprising. The bill passed without a single Democratic vote, and in the current environment, inequality is perceived as a partisan issue.
But that is a misperception. The political viability of pro-growth policies depends on sharing economic gains broadly — something that does not happen automatically. A tax system designed to share the gains from economic growth could generate support for and enable pro-growth tax reforms and other policies. A system that allows middle-class people to fall further behind will fuel populist, anti-growth policies that could leave all income groups worse off. A far better approach would be a tax reform that guarantees that people who work hard can fully share in the gains from economic growth.
The TCJA didn’t do much for low-income households. It raised the standard deduction and cut marginal tax rates, but those revisions are worth little or nothing to people who do not owe much income tax. The TCJA doubled the child tax credit from $1,000 to $2,000, but only $400 of that increase was made refundable (available to filers who do not owe income tax). In 2018, the tax cuts amounted to less than 1 percent of income to households in the bottom quintile compared with 3 percent or more for households with the highest incomes, as shown in Figure 1. After 2025, almost all the individual income tax provisions expire, but the slower indexation of tax parameters will persist, raising taxes for all taxpayers, but especially for low-income people.
The Tax Reform Act of 1986 (TRA86) took a different approach. It was designed to be distribution and revenue neutral. President Reagan touted its benefits for low-income families when he signed it, calling it “the best antipoverty bill, the best profamily measure, and the best job-creation program ever to come out of the Congress of the United States.” TRA86 substantially increased the earned income tax credit (EITC) and, for the first time, set income tax filing thresholds above the federal poverty threshold based on the principle that poor people shouldn’t owe income tax.
TRA86 was a bipartisan effort from the start. Initiated by President Reagan, it would have failed but for the active participation of Democrats in Congress.
But horse trading shouldn’t be required to pay attention to lower-income households. The 2016 elections and the primary debate in the run-up to the 2020 elections shows that pro-growth policies are not necessarily self-sustaining because they create winners and losers — and the people who feel like they are losing are not happy. President Trump’s promises of trade barriers and immigration restrictions were aimed at easing middle- and-working-class anxiety. Sen. Bernie Sanders in 2016 and several Democratic primary candidates now are proposing more regulation of businesses and explicitly punitive taxes on wealthy individuals. Before he exited the race, Mayor Bill de Blasio proposed a robot tax designed to suppress the advance of technology thought to cost jobs. These policies might reduce overall inequality, but they could also entail large economic costs.
The right policy response depends on a diagnosis of the problem. One 2020 Democratic candidate, Andrew Yang, proposes a $1,000 per month universal basic income (UBI) financed by a value-added tax (VAT) as a cure for inequality. The package would be progressive, and a UBI has a long and distinguished conservative pedigree — dating back to Milton Friedman, who called it a negative income tax. If the problem is that middle-class people don’t have sufficient income to pay for health care, education, and so forth, directly raising income is more efficient than a menu of government-provided goods and services. However, if the main problem is that the market is not adequately rewarding work, a better approach may be to subsidize wages so people who work hard can get ahead.
I laid out an alternative: a universal earned income tax credit (UEITC) — a one-for-one match on the first $10,000 of earnings delivered through a refundable tax credit. It’s like the existing EITC, but it is bigger, doesn’t phase out, and is available to every worker regardless of family composition or household income. Workers could have the credit added to their paychecks or collect it as a lump sum when they file their tax returns. Like other earnings, the UEITC would be subject to income tax. My proposal would also increase the child tax credit from $2,000 to $2,500 and make it fully refundable. The UEITC would be funded by a broad-based 11 percent VAT.
Importantly, the maximum UEITC would be indexed to changes in gross domestic product. So, if the economy grew by 5 percent, the maximum credit would increase to $10,500. For the first time since the 1970s, working-class families would fully share in the gains from economic growth. This change could bolster support for pro-growth economic policies such as freer trade and more open immigration.
These aren’t the only or necessarily the best options to address rising inequality. Certainly, training and education are also important. But people who care about economic growth need to think harder about how to share the gains from growth more equitably. Otherwise, they will be ceding the policy agenda to those who are ignorant or indifferent (or even hostile) to the benefits of growth.
The expiration of most TCJA individual income tax provisions after 2025 guarantees that tax reform will come up again. Tax reform 2.0 can improve on the original and ultimately be more conducive to economic growth if it addresses the challenges facing middle-income working people.
Leonard Burman is an institute fellow at the Urban Institute, the Paul Volcker Professor and a Professor of Public Administration and International Affairs at the Maxwell School of Syracuse University, and senior research associate at Syracuse University’s Center for Policy Research.
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Additional tax reform can improve on the TCJA and ultimately be more conducive to economic growth if it addresses the challenges facing middle-income working people.
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