More tax cuts, higher deficits

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Snapshot for December 7, 2005.

More tax cuts, higher deficits
In spite of the current projections of unsustainable deficits, the House Republicans are moving ahead with additional tax cuts.  The magnitude of these cuts—$112 billion over the next 10 years—far exceeds possible spending decreases that are being touted erroneously as deficit reduction.

The composition of the tax cuts also reflects debatable priorities (Figure A).  The bulk of resources in the tax bill passed by the Committee on Ways and Means are devoted to tax cuts on dividend income, capital gains, and business firms.  Bringing up the rear are breaks for college tuition, the state sales tax, Individual Retirement Accounts (IRAs), and a reduction in the Alternative Minimum Tax (AMT).

The AMT is a provision of the individual income tax aimed at ensuring that high-income taxpayers do not escape tax liability.  Since it is not indexed to inflation, it is expected to cover many more taxpayers over the next 10 years.  The very limited AMT fix in the House bill—about $2.8 billion—actually neglects the bulk of the AMT problem.  Preventing millions of upper-income taxpayers from falling under the AMT will cost another $30 billion.  The extra $30 billion is being voted on separately and is not shown in the chart.1

Both AMT fixes are temporary.  As such, they obscure the huge long-run cost of restraining AMT revenue growth.  Congress continues to duck its responsibility for settling the AMT problem once and for all.  Consequently, frequent tax changes will continue to be necessary, heightening uncertainty about tax policy and economic decisions in general.

The tuition and sales tax provisions are also temporary and will terminate after 2007.  Besides hiding the true cost of these tax provisions, their treatment also reflects the low priority that policy makers attach to provisions not aimed at the wealthy.  A tax break that automatically phases out is easier to eliminate than one that is made permanent.  In contrast, priority is granted to dividends and capital gains tax cuts, which would be made permanent by legislation now pending.

Notes
1. The $2.8 billion is for preservation of some tax credits that the taxpayer would ordinarily lose under the AMT.  The $30 billion being considered separately in the House is to increase the standard deduction under the AMT.  Failure to index the deduction to inflation is the reason no action by Congress would result in many more taxpayers falling under the AMT and losing the benefits of the Bush tax cuts.

This week's Snapshot was written by EPI economist Max B. Sawicky.