President Bush sent his $1.6 trillion tax cut proposal to Congress in January for consideration. Congress estimates tax cuts over ten years. Thus, the $1.6 figure is the estimated cut over a ten-year period, starting next year and extending through 2011.

Probably the most controversial (and most expensive) feature of the Bush tax proposal is the change in income tax rates. Bush has called for a reduction and simplification in the income tax rates by 2006. Current rates are 15%, 28%, 31%, 36%, and 39.6%. Bush has proposed that the rates be 10%, 15%, 25%, and 33%.

The Bush tax plan also consists of some other important features. One is the change in the child tax credit, which will gradually increase from the current $500 credit to $1,000 by 2006. Another is the proposal to end the current "Marriage Penalty," where married couples pay more in taxes than two single people would. To end the "penalty," Bush plans to restore the deduction for two-income families, allowing a 10% deduction for the first $30,000 of the lower-earning spouse's income. A third feature of the proposal involves gradually repealing the estate tax over eight years. Many farmers and small business owners complained that they could not pass down their businesses to their children because of the high inheritance taxes. This attempts to resolve their problem. Other features involve tax credits for business research and development and deductions for charitable contributions for those who do not itemize.

What is the cost of this tax overhaul? The Congressional Joint Committee on Taxation estimates that the total cost would be $1.3 trillion over 10 years. The largest loss of tax revenue--$727 billion-- would come from cutting the income tax rates. The next most expensive cut comes from the elimination of the estate tax–the loss in revenue from it is estimated to be $236 billion. The cost of ending the Marriage Penalty is about $162 billion. The other cuts make up the difference.

The whole issue of a tax cut arose once the federal government began having sustained budget surpluses. The central question became whether to pay off the national debt (over $5 trillion) with the excess funds or whether to give it back to the people through tax cuts. When the economy began to show signs of a slowdown, a tax cut began to gain more popularity. When taxes are cut, people are able to keep more of what they have earned. They have more money to spend, so spending rises, output rises, and the economy prospers. Although the original plan called for most of the cuts to be phased in over the next five to eight years, recent concerns about an economic slowdown have prompted the administration to consider speeding up the process.

One concern with passing such a large tax cut is that the government might deplete funds allocated for Social Security recipients. In particular, many Baby Boomers questioned whether there would be enough funds available once they begin to retire. However, Republican Senator Phil Gramm calmed their fears by stressing that both parties have agreed not to use the part of the budget surplus generated from Social Security taxes for tax cuts or new spending. Current predictions are for about $2.9 trillion in surpluses to come from outside the Social Security program over the next decade.

Although both parties agree that taxes should be cut, the Republicans are arguing for an even larger cut, while the Democrats are insisting that the cut be reduced. And the Democrats are insisting that the tax cuts be smaller, with cuts directed toward the low- and middle-income households. We will have to wait and see what happens in the end.

Discussion Questions

1. Is the federal income tax on households a progressive, regressive, or flat tax?
2. Is the federal income tax an average tax rate or a marginal one? Discuss.
3. Discuss how the design of the Bush tax proposal offers incentives for certain kinds of behavior. Give examples.
4. Discuss the pros and cons of using the budget surplus to pay off the debt versus cutting taxes.
5. By attempting to simplify the individual income tax, has Bush made the tax system more efficient or more equitable? Discuss.

Key Words

Taxes, budget surplus, tax credit, income taxes, estate taxes, Marriage Penalty, national debt, Social Security, economic slowdown, tax efficiency, tax equity, deadweight losses, progressive taxes, regressive taxes.

Sources

Stevenson, Richard W., "Bush’s Proposal to Cut Taxes Is Swiftly Introduced in Senate," New York Times, January 23, 2001, page A15.

Answers to Discussion Questions

1. The federal income tax on households is progressive. Those making higher incomes pay a larger percent of their incomes in taxes than those with lower incomes.
2. The federal income tax is a marginal one. For example, if Sarah makes $60,000, she will (currently) pay about 15% on her first $26,000 earned plus 28% on the rest. Thus, (.15 x $26,000) + (.28 x $34,000) = 13,420. (If it was an average tax, then the rate would be $60,000 divided by 13420) = 22%)
3. Look at where the increases are. Those with more children can reduce their taxes. This encourages couples to have more children. Married couples will no longer suffer. This encourages couples to marry. The deduction on charitable contributions will encourage more people to donate to charity. The tax credit on research and development will encourage businesses to spend more on this. And those hard-working farmers and small businesses will have an increased incentive to sacrifice and build their businesses because they know that they can pass it down to their children intact.
4. The large US public debt requires the US government to borrow money by issuing US government securities. The government must pay interest to the holders of these securities. In 1999 alone, the net interest paid by the US government was $227 billion. Once the debt is paid off, the government will no longer owe interest. With spending less, taxes could fall for our children.

But there is also an argument for the other side. Suppose the money can be put to a better use so that today’s children will benefit even more. Current tax burdens are so high that deadweight losses are high. Many people are worse off and many transactions do not take place. Incentives are distorted (think of the Marriage Penalty, which offers a disincentive for couples to marry). By lowering the taxes and removing most of the distortions, resources will be better allocated to reflect the true costs and benefits of the goods and services. In addition, a tax cut can be used to stimulate the economy in the short-term. A tax cut can result in more jobs, more output, higher incomes.

5. A tax system is more efficient when it raises the same amount of revenue at a smaller cost to taxpayers. An efficient tax system is one that imposes small deadweight losses and small administrative burdens. An equitable tax system is one that is fair. "Fair" can mean that those who receive more benefits should pay more taxes, or "fair" can allude to an ability-to-pay principle, where those who are better able to pay taxes, pay more. The Bush plan attempts to simplify the tax system, lower the tax burden, and end some of the more flagrant distortions. The simplification should lower the administrative burden, while the reduced rates should lower the deadweight losses. This should make it more efficient. The household income tax proposed is still progressive in nature, so it incorporates the ability-to-pay principle–an equity issue.