Update 361 — 2020 Pres. Candidates Propose Bevy of Tax Credits, But Are They Progressive?
The 2020 Democratic presidential candidates are advancing a smorgasbord of tax credit proposals, mainly focused on augmenting existing tax credit programs, such as the earned income tax credit (EITC) and the child tax credit (CTC). Tomorrow, House Ways & Means will mark up a bill to expand EITC and make CTC and Dependent Care Assistance Credits fully refundable through 2020.
Do these tax credits achieve their policy goals? Are tax expenditures the most progressive and efficient way to achieve them? With such expenditures comprising nearly a third of all federal domestic spending, it is worth considering the economic, distributive, and fiscal impact of the tax credits candidates are increasingly relying on.
The leading proposals, among the many floated by the 2020 Democratic candidates in the early stages, use the tax code for economic and social goals, including:
• Affordable Housing
Sens. Kamala Harris and Cory Booker, as well as Sec. Julian Castro, have introduced tax programs to address the affordable housing crisis in the country. Castro’s plan, Harris’s Rent Relief Act, and Booker’s HOME (Housing, Opportunity, Mobility, and Equity) Act are targeted at low-income renters. All three proposals offer refundable tax credits to renters who spend more than 30 percent of their income on housing, the value of which would be based on the size of family, income, and cost of living.
Sens. Bennet and Gillibrand, Rep. Seth Moulton, and others support either a new child care tax credit (CDCTC), or an expanded CTC. Currently, families can receive a credit of between 20 and 35 percent of up to $3,000 of childcare expenses ($6,000 if there are at least two children in the household). The credit is nonrefundable; it can only offset taxes owed. Many progressives hope to increase the allowable expenses and make the program fully refundable to benefit low-income families.
• Poverty Reduction
Forty-seven Democratic Senators, including presidential candidates Bennet, Booker, Gillibrand, Harris, Klobuchar, Sanders, and Warren, have co-sponsored the Working Families Tax Relief Act, legislation to increase the value and progressivity of the EITC and CTC. Sen. Harris’ LIFT Act would also boost the EITC, with tax credits of up to $3,000 available to singles without children earning under $50,000 and single parents who earn under $80,000. Joint filers earning under $100,000 would get tax credits up to $6,000.
The Rise of Tax Expenditures
Tax expenditures — tax credits, exemptions, deferrals, etc. — have grown in scope and size since their inception in the 1960s and are now a well-established tool to advance social policy goals and aid redistribution. Reducing federal tax revenue by around $1.5 trillion, total tax expenditures cost more than flagship government spending programs, such as Medicare & Medicaid. Unlike spending programs, tax expenditures are not subject to PAYGO requirements.
Source: Center on Budget and Policy Priorities
Tax expenditures as a percentage of revenue loss have remained relatively stable, but high, since the 1980s. New tax credits and changes to the tax Code by the Clinton administration grew the percentage of tax expenditures in terms of GDP from 5.9 percent in 1990 to 7.4 in 2016. When the Trump Administration pushed through its tax bill in December 2017, many expenditures were tweaked, some were expanded, but nearly all remained in the Code.
Who Benefits Currently?
The largest tax expenditures and their beneficiaries are as follows:
• Employer-sponsored insurance exclusion ($172.8 billion in FY 2019)
Employer-paid premiums for health insurance are exempt from federal income and payroll taxes. Moreover, premiums paid by the individual are typically excluded from taxable income. Because this program reduces taxable income — as opposed to a credit that could be used to pay down tax burden — it is worth more to taxpayers in higher tax brackets than it is to their lower-earning counterparts. Higher-income individuals also tend to have more expensive coverage, further exacerbating the distributional inequalities.
• Preferential treatment on long-term capital gains ($127 billion in FY 2019)
Long term capital gains are taxed at lower rates than ordinary income. Although rates increase with income, this policy is still regressive since relatively few Americans earn income from capital gains. Additionally, capital gains income is exempt from taxation if assets are passed on to heirs or charity, and gains are taxed only upon the sale of an asset, meaning a taxpayer can defer paying taxes for years.
• Employer-sponsored retirement plans ($121.5 billion Defined Contribution, $90.7 billion Defined Benefit plans in FY 2019)
Because savings rates increase with income, tax benefits for retirement plans mainly benefit wealthier Americans. If younger and/or low-income households do save, they primarily do not save for retirement, and thus cannot enjoy tax breaks. When participating in employer-sponsored retirement plans, low-income workers tend to assign a much lower value to retirement contributions than high-income workers for obvious reasons. While the government should be incentivizing retirement savings, it should do so in a way that benefits all Americans.
• Earned Income Tax Credit ($72.6 billion in FY 2019) and Child Tax Credit ($120 billion in FY 2018)
Because the EITC is a fully-refundable tax credit, it stands as one of the few progressive tax expenditures. The value of the EITC phases out with income, guaranteeing that the program targets only those earning less than around $60,000. However, therein lies a problem: the EITC also phases in with work, so individuals without an income get nothing. This group includes the recently unemployed, students, and caregivers. Additionally, the EITC for workers not raising children in the home remains small, meaning that those workers are the only group taxed into or deeper into poverty by federal taxes.
The CTC is a maximum of $2,000, but its refundability is limited. The refundable portion of the credit is worth 15 percent of a family’s earnings above $2,500; this is capped at $1,400 per child. The CTC also begins to phase out at much higher income levels ($400,000 for joint filers).
Tax Credits, Inequality, and Inefficiency
Expenditures meant to encourage behavior — like saving for retirement, homeownership, charitable giving, or participating in employer sponsored healthcare — are provided by the government as itemized deductions, only helping the roughly 30 percent of taxpayers who do not take the standard deduction when paying their income tax. And because they are deductions and not credits, even those who do choose to itemize earn minimal benefits.
Source: Center on Budget and Policy Priorities
Democrats who pursue the tax expenditure route need to reckon with the regressivity built into existing structures. The argument against tax expenditures as opposed to social spending is clear: most of the tax Code’s biggest expenditures purport to cater to middle-class Americans, but end up benefiting the wealthy a good deal more.
Why, then, do putatively progressive candidates champion tax expenditures? And what is the alternative?
One reason the expenditure tools are so frequently used is such provisions are not subject to the oversight, regulation, and administration costs which can degrade the efficiency of conventional spending programs. And removing tax breaks for employer-sponsored healthcare and retirement would probably require a policy replacement, a steep political hurdle.
A la Carte Solution for Candidates
It would be impractical to reverse course and abandon all tax expenditures in favor of regular order or other direct spending entirely, or even to try to do so eventually. It is best to remember that not all tax credits are created equal. Tax breaks such as the reduced capital gains rate and retirement savings incentives do not benefit low-income households in the same way as refundable credits such as the EITC and CTC.
That said, tax credits requiring a paycheck for eligibility are less equitable and less fiscally accountable ways of making social policy, than the available alternative, regular order federal spending. Since tax credits’ unintended consequences — allocating benefits by income bracket and penalizing children, seniors, and others not earning a salary — make them inherently and conspicuously regressive, candidates promising them should consider whether direct spending is a better solution in a case-by-case basis.