About Us


Contact Information


How You Can Make a Difference


Issues


Legislative Action Center


Links


Policy Information Center


Press
Releases


Religious Liberty


Send Me
More Information

 

 

 

2001 Legislative Agenda: Tax Relief
By Dr. Joel P. Rutkowski

Table of Contents

INTRODUCTION
MARGINAL TAX RATE
HOUSE WAYS AND MEANS COMMITTEE
HISTORY PROVES TAX RELIEF WORKS
MARRIAGE TAX
ESTATE TAX
ALTERNATIVE MINIMUM TAX
CAPITAL GAINS
INDIVIDUAL RETIREMENT ACCOUNTS (IRA's)
EDUCATIONAL SAVINGS ACCOUNTS
REFERENCES

To View an Action Alert on Tax Relief, Click Here.

INTRODUCTION

Why does America need tax cuts? The answer is simple. Taxes are just too high. Federal tax revenue as a percentage of the economy reached a historic peak - 20.4 percent of the gross domestic product (GDP) in 1999. (1) Federal income taxes, which increased to 9.9 percent of the GDP in 1999 from 7.8 percent in 1994 comprised a significant portion of the increasing federal revenue. In 1999, the average federal income tax rate on all taxable returns was 15.3 percent - the highest level since the mid-1980s. (This latest statistics on the federal income tax rate was from 1997, the most recent data available.)

American can also benefit from tax cuts because workers are losing their jobs as the economy continues to slow. Factory activity, in particular, has declined to 43.7 percent from 47.7 percent in November according to the National Association of Purchasing Management (NAPM) report on January 2, 2001. This latest statistic marks the lowest level of activity since 1991 when the nation was emerging from a recession. (2) Tragically, a deepening malaise in the manufacturing sector, which has been hardest hit by an economic slowdown in the past six months, was demonstrated by the NAPM report. From increases in interest rates last year, to high energy prices and a slowdown in auto sales manufacturing, which accounts for about 20 percent of U.S. economic activity and jobs, manufacturing has suffered more than other sectors.

Tax cuts will help personal budgets that are strained by an increased cost of living. Since 1999, natural gas prices have almost quadrupled and heating oil prices have increased 29 percent nationwide compared to last year. (3) Two years ago a barrel of oil was between $10 to $20. For the last 11 months, a barrel has sold for $30. To add to the crisis, for the past two years, Congress has spent the surplus created by tax overpayments. According to Stephen Sliviski of the Cato Institute, nondefense, discretionary spending will increase almost 13 percent this fiscal year. (4)

For the United States (US) to remain the number one economy globally, it must keep its tax rates lower than other competitor nations. Savings and investment will be attracted from around the world to those nations that promote pro-growth tax policies. For example, France has been suffering from a general economic malaise, high unemployment and a loss of talented entrepreneurs as a result of its excessive tax burden. On the other hand, nations such as Germany and Japan have growing economies due to reduced tax rates, and others are looking to follow their example. (5)

Compared to two decades ago the global economy has become more competitive. The US has prospered as a result of lower tax rates when compared to its competitor nations. To ensure a strong economy and to provide fiscal discipline in Washington, broad-based tax relief would be a good strategy.

Back to the Top

MARGINAL TAX RATE

According to many economists, targeted tax cuts do little or nothing to energize the economy. (6) On the other hand, a recession can be forestalled or mitigated by reducing the marginal tax rate. (7)

An individual's marginal tax rate is the rate of tax being paid on the highest income of dollars. An increased marginal tax rate can discourage workers from investing more time in labor because their added income will be subject to a higher tax. On the other hand, a lower marginal tax rate may result in increased economic activity for the taxpayer who benefits from a reduced rate of tax.

"US income tax is a graduated tax, designed so that people pay an increasing percentage rate as their income rises through various tax brackets." (8) Current tax law taxes income at five graduated rates-15 percent, 28 percent, 31 percent, 36 percent and 39.6 percent. A new, lower 10 percent bracket would be created by the President's proposal while the other rates would be reduced. (9) The proposal would establish tax rates of 10 percent, 15 percent, 25 percent and 33 percent when fully phased in by 2006. Tax cuts enacted during the course of this year should be retroactive to January 1, 2001. By subjecting the first portion of taxable income to a rate of 14 percent in 2002 and 13 percent in 2003, declining eventually to 10 percent in 2006 the President envisions gradually creating a new lowest rate bracket. The President's tax relief package would provide $1.6 trillion in tax relief over ten years. The rate cuts would provide more than $810 billion in tax relief while elimination of the estate tax would provide $266 billion in tax relief, the increase in child tax credit would provide $192 billion, and the reduction in the so called marriage penalty would provide another $112 billion in relief.

Back to the Top

HOUSE WAYS AND MEANS COMMITTEE

An accelerated version of President Bush's across-the board reduction in income rates was passed by the Committee on Ways and Means on a party-line vote (Economic Growth and Tax Relief Act of 2001; H.R. 3; To view the markup of H.R. 3, visit http://waysandmeans.house.gov/ tax.htm). (10)

The measure was adopted by a 23 to 15 vote with all Republicans in favor and all the Democrats opposed. It will provide $960 billion over 10 years in tax relief. The Democratic alternative that offered less tax relief was rejected. This year the Republican bill would provide $360 for a couple and $180 for an individual.

Representative Bill Thomas (Republican-California), the chief House tax writer, offered legislation that would accelerate a cut in the lowest tax rate ahead of the President's timetable and made it retroactive to January 1, 2001, just a day after the President outlined his plan before Congress. As early as Thursday, March 8, 2001, a vote is expected by the full House on this bill. The measure would provide $960 billion in tax relief over ten years. Other elements of Bush's $1.6 trillion tax cut would come later said Thomas.

A 12 percent bracket would be created for 2001 and 2002 declining to 11 percent from 2003-2005 and 10 percent in 2006 under the legislation drafted by Representative Thomas. About $65 billion would be added to the President's plan over 10 years in tax relief by including the provision making the lower rate reduction retroactive to January 1, 2001.

For taxpayers with incomes of between $30,000 and $50,000 and three or more children, the measure would include an adjustment in the alternative minimum tax.

Without exceeding the President's overall proposal for $1.6 trillion in reductions, Representative Thomas said Republicans would act later on other elements of the President's legislation.

Back to the Top

HISTORY PROVES TAX RELIEF WORKS

Prior to President John F. Kennedy's initiative to reduce the top marginal rate a full 26 percent points, growth rates averaged only two percent. After the initiative was put into place, growth rates soared into the four percent to six percent range. (11)

When it became clear in 1978 that capital gains tax rates would be reduced from 49 percent to 28 percent, once again investments in venture funds increased tenfold as capital again flowed. (12)

The original Reagan tax program's percentages of 15-28-33 percent were modified to 15-28-31-36-39.6 percent by former President Clinton's tax increase in 1993. Robust economic growth accompanied President's Ronald Reagan's rate reduction, which was phased in from 1981 to 1983. (13) In 1986, President Reagan reduced marginal income tax rates down to an unprecedented 28 percent. In the following years this resulted in Gross Domestic Growth (GDP) averaging four percent.

When the top personal income tax rate was lowered, tax reductions spurred economic growth and accelerated returns on equities-with growth averaging 0.6 percentage points higher during periods since 1926 (excluding the Second World War), (14)

Also, when the top marginal tax rates were lower than in years when rates were higher, the Standard & Poor's 500 posted an average annual total return 4.3 percentage points higher.

Back to the Top

MARRIAGE TAX

Since working married couples have their income added together for tax purposes, they often face a penalty in the tax code. If, for example, one earner makes $38,000, his income falls under the upper limit of the 15 percent bracket ($42,350). His spouse earns $23,000. Instead of both incomes being place into the 15 percent tax bracket, the $23,000 income is divided into two parts. The first part ($4,350) is added to the other income to reach the 15 percent bracket limit. The remaining amount ($18,750) is taxed in the next tax bracket at a higher 28 percent marginal tax rate. Simply because two-income couples are married, about 25 million pay more income tax when compared with singles at the same income level. (15) This results in an average additional income tax of $1,400 annually.

The "Marriage Tax Penalty Relief Reconciliation Act of 2000," (H.R. 4810; To view the bill visit: http://thomas.loc.gov/cgi-bin/bdquery/z?d106:H.R.4810:) was a measure that would have reduced taxes for married couples by approximately $89.9 billion over five years. Both the House (To see how your representative voted see: http://143.231.123.93/cgi-bin/vote.exe?year=2000& rollnumber=392 ) and Senate (To see how your senators voted see: http://www.senate.gov/ legislative/vote1062/vote_00215.html) in 2000 passed the bill by less than a two-third majority required to override a Presidential veto. On August 5, 2000, former President Clinton vetoed the Republican-sponsored tax relief for married couples. (16) On September 13, 2000, the veto override was rejected 270-158 (To see how your representative voted see: http:// 143.231.123.93/cgi-bin/vote.exe?year= 2000&rollnumber=466) (17) This measure would have gradually expanded the bottom 15 percent income tax bracket for married couples to twice the current corresponding bracket for single taxpayers. The standard deduction for married couples who do not itemize would have been increased to equal that of two single people. For low-income families, the earned-income tax credit limit would have been increased annually by $2,000. For married couples who claim personal credits, such as the $500 per-child tax credit, a current exemption from the alternative minimum tax would have been extended through 2004.

For almost all married couples, particularly the 25 million with two incomes who pay more than they would if single, the marriage penalty bill would have provided tax relief. Such tax relief must be enacted during the 107th Congress.

Back to the Top

ESTATE TAX

The Death Tax Elimination Act (H.R. 8: To view bill see http://thomas.loc.gov/cgi-bin/bdquery/z?d106:h.r.00008:), a bill that would amend the Internal Revenue Code of 1986 to reduce and ultimately repeal the estate and gift tax by 2010, was passed in the House (To see how your representative voted see: http:// 143.231.123.93/cgi-bin/vote.exe?year=2000& rollnumber=254) in June 2000, with enough votes to override a veto. The measure passed 59-39 in July 2000, in the Senate (To see how your senators voted see http://www.senate.gov/ legislative/vote1062/vote_00197.html) but was far short of the 67 votes required to overcome a veto. (18) On August 31, the former President vetoed the bill. President Clinton's veto override was rejected on September 7, by a vote of 274-157. (To see how your representative voted see http://143.231.123.93/cgi-bin/vote.exe?year=2000&rollnumber=458)

Currently, after a taxpayer's dies, the Internal Revenue Service can take up to 60 percent of his possessions and investments in taxes. This has proven to be a tremendous loss to families of these individuals that had spent a lifetime working and investing in a small business to provide a good economic foundation for their offspring. (19)

Since the estate tax revenue yield is negligible, its only purpose is to redistribute income. Most often, death taxes burden the very people they are intended to help such as women and minorities, farmers, workers, and low-income people. Furthermore, death taxes undermine savings and investments, are the most expensive taxes to pay, and are costly for the government to collect. (20) According to National Bureau of Economic Research economists Steven Venti and David Wise, the estate tax punishes people for their virtues. (21) It propagates the philosophy, "Spend it before you die if you have it because if you do not, the government will get it." Simply fools whose heirs will suffer are wealthy individuals who are inclined to be frugal and invest in profitable businesses. The majority of the burden of the estate tax falls not on those who have been lucky throughout their lives but instead on those who have been frugal.

The 107th Congress should eliminate the death tax as they tried to do last year.

Back to the Top

ALTERNATIVE MINIMUM TAX

The Alternative Minimum Tax (AMT) was developed by the government to reduce the ability of individuals to escape payment of tax on income by using tax preferences (e.g., items excluded from income subject to tax) available under the regular tax system. Following congressional testimony by the Secretary of the Treasury reporting that 155 high-income individuals paid no federal income tax in 1966, Congress enacted an add-on minimum tax that served as the predecessor to the current AMT in 1969. The minimum tax, since 1969 has been amended a number of times, most notably in 1976, 1978, 1982, 1986, 1990, and 1993. The minimum tax was changed from essentially a surcharge on certain tax preference items (i.e., items excluded from taxable income under the regular tax but taxable under the minimum tax) to a separate tax system, paralleling the regular income tax. With its own definition of income subject to tax and its own tax rates through these amendments, AMT has affected relatively few, mostly higher-income taxpayers, and has generated a relatively small amount of tax liability in addition to the regular income tax according to recent research at the Joint Committee on Taxation (JCT) (22). AMT, for example, is expected to affect about 1.3 million-about 1.3 percent of all taxable returns-and generate a projected $5.8 billion in additional tax liability in 2000 according to the research at Treasury.

However, the number of taxpayers affected by AMT and the corresponding tax liability generated are expected to increase substantially over the next 10 years, according to the research at JCT and Treasury. Unfortunately, the AMT now affects far more Americans than Congress envisioned or intended as a result of inflation and real income growth. For example, the number of taxpayers affected financially by AMT is expected to increase from about 1.3 million in 2000 to 17 million in 2010-almost 16 percent of all taxable returns-and the additional tax liability generated by AMT is projected to grow from $5.8 billion to $38.2 billion during the same period according to the research at Treasury. (23)

Significantly adding to the overall compliance burden on taxpayers and the administrative burden on the Internal Revenue Service (IRS) is the projected increase in AMT coverage and the complexity of the system. Among individuals, AMT's projected increase would also affect the distribution of taxes. Between 2000 and 2010, AMT is projected to shift from affecting mostly higher-income individuals to more middle-income taxpayers. Also, certain economic incentives created by the regular tax system may be affected.

Since 1993, many of the credits Congress enacted to help middle-class families resulted in new AMT liabilities, particularly the child tax credit. Many deductions and exemptions are not allowed under the AMT. Under both the normal tax system and the AMT, taxpayers subject to the ATM must calculate their tax liability. They are liable for whatever yields a higher amount. In 1999, legislation was passed to repeal the ATM by Congress. However, it was vetoed by former President Clinton. (24) The ATM was never meant to impact middle-income families.

The Taxpayer Relief Act of 1997, was the last major round of tax legislation, that reduced tax rates on long-term capital gains, provided some death tax relief, and created the Roth Individual Retirement Account (Roth IRA). The 107th Congress should expand on these three initiatives and repeal the AMT and exempt the family credits immediately.

Back to the Top

CAPITAL GAINS

US capital gains tax rates are higher than average among industrial nations. Compared to the US only the United Kingdom and Australia have higher rates but unlike the US, they both index their rates for inflation.

A reduction in the capital gains tax rate would have strong political appeal because more than one-third of American adults who own stocks earn less than $30,000 annually. It is projected that the 1997 law which would reduce the rate for long-term capital gains from 28 percent to 20 percent would increase US household incomes by an average of $309 (in 1999 dollars-annually) starting in 2005. And the average worker's wage would increase by $250 annually according to a study undertaken for the American Council for Capital Formation. (25)

For capital gains, two tax rates were established by the Taxpayer Relief Act of 1997. Taxpayers in the 15 percent marginal tax bracket would pay the 10 percent tax rate and all other taxpayers would pay at a tax rate of 20 percent on capital gains.

Investors take the opportunity to sell their less productive investments in order to acquire new ones with higher rates of return when tax rates for the appreciated value on long-term assets go down. Unexpected revenues are yielded for the federal government by these unlocked transactions. In the long-term this improves productivity and wages. Two tax rates for capital gains were established by the Taxpayer Relief Act of 1997. Taxpayers in the 15 percent marginal tax bracket would pay the 10 percent tax rate and all others would pay 20 percent. However, these lower rates will not take effect until 2005. The 107th Congress should make these rates effective on January 1, 2002 and reduce these two tax rates to 18 percent from 20 percent and from ten percent to eight percent. They should also simplify the law relating to long-term gains.

Back to the Top

INDIVIDUAL RETIREMENT ACCOUNTS (IRAs)

Popular with a growing number of taxpayers concerned about their future retirement income are tax-preferred savings plans.

Often forgotten by many is that IRAs are tax deferred, not tax free. Qualified employees can deduct the full amount from their taxable income when they make deposits to IRAs. This results in an immediate tax saving of $560 for an individual in the 28 percent tax bracket. (26)

When contributions are withdrawn, what the government can lose up front from IRA deductions, it makes up at the back-end. Therefore, while IRAs reduce federal revenues by $16 billion, the long term cost (in present term value) is only $6 billion demonstrates the Treasury Department's tax expenditures budget. (27)

However, according to a study by economists Brianna Dussealt and Jonathan Skinner of Dartmouth University, published in Tax Notes that IRAs do not reduce revenues at all in the long-term and actually increase revenue for the government. This is because generally investors earn a higher return on their IRAs than the government pays on its bonds. Thus they are withdrawing a much larger amount than they put in when they withdraw their funds and pay taxes. To compensate the government for the lost revenue plus interest, taxes on the withdrawals are more than enough.

Between 1982 and 1997, the federal government made at least $14 billion in net revenue on all IRA contributions and perhaps as much as $54 billion. Also, by assuming that IRAs did not increase the rate of saving or capital formation, these are conservative estimates.

The House passed its version of the Comprehensive Retirement Security and Pension Reform Act (H.R. 1102; To view the bill visit http://thomas.loc.gov/cgi-bin/bdquery/z?d106:h.r.01102:) [To see how your representative voted visit http://143.231.123.93/cgi-bin/vote.exe?year=2000& rollnumber=412) in the summer of 2000 that would have increased contribution limits for IRA and 401(k) retirement plans. (28) The annual contribution cap would have increased from $10,500 to $15,000 for 401(k)'s, in which an estimated 36 million people now participate. For people over 50, particularly women whose retirement savings lags behind since they left the work force temporarily to raise children, both bills contain special IRA "catch-up" caps of $7,500 in annual contributions. Also, with the creation of a Roth 401 (k), similar to a Roth IRA, in which contributions are made with after-tax dollars, withdrawals are tax-free. Tax credits encourage businesses to offer pensions, accelerated pension vesting for employees and rules making it easier for workers to carry assets from job to job.

The annual IRA contribution limit would have been increased to $5,000 by the legislation approved by the house.

Since 1981, the annual 2,000 contribution limit for traditional individual retirement accounts has not changed.

The 107th Congress should pass legislation similar to H.R. 1102. It should increase the yearly contribution to IRAs for qualified taxpayers from $2,000 to $5,000 annually. In order to build up their retirement savings more rapidly, taxpayers age 50 or above should be allowed to contribute slightly more annually to an IRA than a younger taxpayer. Also, for determining the income limits for converting traditional IRAs to Roth IRAs and the income limits for determining whether a taxpayer may purchase a Roth IRA (created with after-tax dollars; account withdrawals are not subjected to taxation) increase both the income limits.

Back to the Top

EDUCATIONAL SAVINGS ACCOUNTS

To enhance the taxpayer's ability to save for educational expenses, the Affordable Education Act of 2000 (S. 1134; To view the bill visit: http://thomas.loc.gov/cgi-bin/bdquery/z?d106:s.01134:) would have made a number of tax law modifications. S. 1134 was a measure that would have allowed families to deposit up to $2,000 per child annually into tax-free Educational Saving Accounts (ESA) for elementary, secondary and higher education in private or public schools. The accounts' annual limit would have increased from $500 to $2,000. Full contributions to accounts would be allowed for married couples with combined income of up to $190,000. Also, the measure would have made permanent a tax exemption for employer-provided higher education expenses, and would extend the exemption to graduate courses. On March 2, 200, the bill passed 61-37 (To see how your senators voted see: http:// www.senate.gov/legislative/ vote1062/vote_00033.html) which was short of the two-thirds margin required to override former President Clinton's threatened veto.

The 107th Congress should enact ESA legislation to provide tax relief for taxpayers with educational expenses.

Back to the Top

REFERENCES

(1) Editorial, "The Bush Tax Cut," The Wall Street Journal, December 19, 2000.

(2) Marjorie Olster, "Manufacturing Slump Deepened in December," Reuters, January 2, 2001; David Leonhardt, "Factory Index Fell Sharply Last Month," The New York Times, January 3, 2001.

(3) Brian Melley, "Energy Sows Internal Turmoil, The Associated Press, December 21, 2000.

(4) Editorial, "The Bush Tax Cut," The Wall Street Journal, December 19, 2000.

(5) Joel Baglote, Marc Champion and David Woodruff, "Tax Cuts Loom Globally as Economies Grow, The Wall Street Journal, May 18, 2001.

(6) Editorial, "Tax Cuts for Growth," The Wall Street Journal, October 16, 1998.

(7) Ibid.

(8) "Your Marginal Tax Rate" Quicken.com, 2001.

(9) David Espo, "House GOP To Expand Bush Tax cuts, The Associated Press, February 28, 2001.

(10) John Godfrey, "House panel Oks tax-rate reductions," The Washington Times, March 2, 2001.

(11) Joint Economic Committee, "The Mellon and Kennedy Tax Cuts: A Review and Analysis," June 18, 1962.

(12) Editorial," Tax Cuts for Growth," The Wall Street Journal , October 16, 1998.

(13) Editorial," Tax Cuts for Growth," The Wall Street Journal , October 16, 1998.

(14) George Melloan, "What About Those Sound Economic Fundamentals?," The Wall Street Journal, April 18, 2000.

(15) Curt Anderson, "Bill would Ease Marriage Penalty Tax," The Associated Press, March 28, 2000.

(16) Anne Gearan, "Clinton Vetoes GOP Marriage Tax Cut, The Associated Press, August 5, 2000.

(17) Curt Anderson, "House Upholds Marriage Tax Cut Veto, The Associated Press, September 13, 2000.

(18) John Godfrey, "Switched votes help Clinton with veto," The Washington Times, September 8, 2000.

(19) Bruce Bartlett, "Estate Tax History Versus Myth," National Center For Policy Analysis, July 19, 2000.

(20) William W. Beach, "Time To Eliminate The Costly Death Tax, The Heritage Foundation Executive Memorandum No. 679, June 8, 2000.

(21) Steven Venti and David Wise, "Choice, Chance, and Wealth Dispersion at Retirement," National Bureau of Economic Research Working Paper No. 7521, February 2000.

(22) United States General Accounting Office, Report to the Chairman, Committee on Finance, US Senate, Alternative Minimum Tax, An Overview of Its Rationale and Impact on Individual Taxpayers, GAO/GGD-00-180, August 2000.

(23) Ibid.

(24) Bruce Bartlett, "Repeal the Alternative Minimum Tax," National Center for Policy Analysis, January 31, 2000.

(25) Editorial, "The People's Tax Cut," Investor's Business Daily, July 2, 1999.

(26) Bruce Bartlett, "Tax Deferred IRAs May Raise Federal Revenues," National Center for Policy Analysis, March 20, 2000.

(27) Ibid.

(28) Curt Anderson, "IRA, 401(k) Bills Gains Momentum, The Associated Press, September 11, 2000) In September the Senate Finance Committee unanimously approved a somewhat different package.

 

Back to the Top