President Obama’s FY 2012 Budget: An Analysis of Tax Policies
The president’s budget proposes roughly $1.1 trillion worth of deficit-reduction measures over a decade, excluding war savings and an expiration of the 2001 and 2003 tax cuts for high-income earners. Tax reforms and new revenue sources account for roughly one-third of this sum, which is consistent with the proposals of the National Commission on Fiscal Responsibility and Reform, but falls shy of a balanced approach to deficit reduction. Scored against a current policy baseline, which would assume all the Bush tax cuts are extended, the president’s 2012 budget looks more fiscally responsible and more balanced.
But, by relegating the onus of deficit reduction to spending cuts rather than tax increases, the proposal risks severe cuts to investments and a costly, counterproductive expansion of tax expenditures. Successful and balanced deficit reduction requires revenue-positive tax reform and new progressive revenue sources to fund national priorities, address widening income inequality, and ease pressures elsewhere in the budget.
Spending for priority areas is paired with new revenue sources
President Obama’s tax policy as reflected in his budget request for fiscal year 2012 is broadly similar to last year. The proposal contains many policies that were included in last year’s budget but that were passed only temporarily or not at all.
Overall, revenue would increase slightly from the current fiscal year to 16.6% percent of gross domestic product (GDP) in 2012 as a result of the recovering economy. As the economy further recovers, revenue would quickly rebound to 19.1% of GDP in 2015, and then rise gradually to 20.0% in 2021 (although the budget includes an unfunded “patch” to the alternative minimum tax in these out-years).
The budget’s spending priorities—including investments in infrastructure, innovation, and competitiveness—are generally paired with new revenues or dedicated funding sources. For example, a $554 billion surface transportation reauthorization proposal (which includes $50 billion in upfront investment) is contingent on finding bipartisan agreement on $328 billion in financing over a decade. Expansion of broadband access is funded through additional spectrum auctions.
Upper-income tax cuts and tax deal
The president’s budget requests have consistently adhered to one campaign pledge: Allow the Bush-era tax cuts for the wealthiest 2% of Americans to expire. Like last year’s budget, this budget proposes to permanently extend middle-class tax relief for individuals earning less than $200,000 and joint-filers earning less than $250,000. This proposal implicitly means allowing the top 33% and 35% marginal tax rates to revert to 36% and 39.6%, respectively, for individuals earning above $200,000 and joint-filers making more than $250,000. The budget also assumes that the personal exemption phase-out and the limitation on itemized deductions are reinstated for these top earners. Finally, the preferential rate on capital gains and dividends would increase from 15% to 20% for upper-income tax filers (prior to the Bush-era tax cuts, qualified dividends had been taxed as ordinary income under progressive tax rates). Last December’s tax deal had extended these upper-income tax cuts through the end of 2012 as the price for securing middle-class tax relief and continuing emergency unemployment insurance.
December’s tax deal also included a two-year estate tax cut (benefiting only the wealthiest 0.25% of Americans) instead of reinstating the estate tax at 2009 levels, as the president’s 2011 budget had proposed. This year’s budget proposes extending the estate and gift tax rates at 2009 parameters (after the December tax deal expires), adding an estimated $271 billion to deficits over a decade, relative to current law. In contrast, extending the upper-income tax cuts and the estate tax levels in the tax deal would add $953 billion to deficits over the next decade, relative to the president’s proposals, offsetting almost all of the deficit reduction measures in the president’s budget request.
Budgeting for alternative minimum tax relief
As part of the middle-class tax relief package, the president proposes budgeting for the annual patch of the alternative minimum tax (instead of extending the AMT without specifying how to pay for it). The patch is a routine upward adjustment of the AMT exemption threshold that would prevent more than 24 million additional taxpayers from becoming subject to the AMT. December’s tax deal patched the AMT through the end of 2011. The president’s budget pays for extending this patch through 2014 by capping the benefit on itemized deductions at 28% (the value of the benefit increases with the marginal tax rate of a tax filer itemizing deductions, making itemized deductions regressive and costly). This proposal, also drawn from last year’s budget request, will produce $321.3 billion (over 10 years) in savings that is specifically designated as an offset for middle class AMT relief in this year’s budget. Last year’s budget included the limitation on itemized deductions and separately built indexing the AMT to inflation from 2009 levels into baseline budget projections. This year’s budget alters only the framing of these proposals; their impact on the bottom line is unchanged. Beyond 2014, the unfunded cost of AMT relief adds $1.2 trillion to deficits through 2021.
Making Work Pay, the payroll tax cut, and tax stimulus
Last year the president proposed extending the Making Work Pay (MWP) refundable tax credit —the largest tax provision of the American Recovery and Reinvestment Act. The MWP refunded 6.2% of earned income up to a maximum credit of $400 for individuals ($800 for joint-filers). The MWP credit was replaced with a more expensive, but also more regressive and less targeted, flat 2% payroll tax cut in last December’s tax deal. The payroll tax cut reduced employee contributions to Social Security from 6.2% to 4.2%, and while the revenue loss to the Social Security trust fund was patched from general revenue, the cut sparked concerns that Social Security’s dedicated, off-balance sheet funding source would be threatened. Relative to extending the Making Work Pay credit, the payroll tax cut also reduced the after-tax earnings of lower-income workers making less than $20,000 a year while raising after-tax earnings on all higher-earning workers. Although it is encouraging that the president’s budget does not extend the payroll tax cut, the president missed an opportunity to support economic recovery and working class families while protecting the finances of Social Security by replacing the payroll tax cut with the more targeted Making Work Pay credit.
To complement a domestic agenda heavy on education investments, the president’s budget again proposes making permanent the American Opportunity Tax Credit, a partially refundable tuition credit. The 2012 budget also proposes extending the earned income tax credit (EITC) for families with three or more qualifying children (one of the targeted tax cuts temporarily extended in December’s tax deal). The administration’s budget baseline again assumes that two Recovery Act measures also extended in the tax deal—the expanded EITC phase-out for joint-filers (i.e. EITC marriage penalty relief) and the lower earnings threshold for the refundable portion of the child tax credit—are included in the extension of the middle-class tax cuts enacted in 2001 and 2003.
Tax expenditures and tax reform
Individual and corporate income t
ax expenditures are projected to cost the Treasury Department up to $1.1 trillion in 2012—roughly the size of the entire base discretionary budget (excluding supplemental funding for overseas contingency operations). The president’s budget has proposed extending many existing tax expenditures and incentives, such as the American Opportunity Tax Credit and the Research and Experimentation (R&E) credit, that would advance his competitiveness and innovation agenda. The budget also calls for limits to the value of tax expenditures for upper-income taxpayers.
The use of the tax code to pursue policies (subsidizing many individuals or firms for economic choices they would have made anyway) may be less efficient than direct spending, but the nonsecurity discretionary spending freeze constrained options for public investment.
Like last year’s budget, targeted tax expenditure reform was largely limited to eliminating a handful of wasteful fossil fuel production incentives and taxing carried interest (partnership profits treated as investment income) as ordinary income instead of preferentially taxing hedge fund managers at a lower rate than many working Americans. The president’s 2012 budget proposes redirecting $46.2 billion (over 10 years) from the elimination of fossil fuel tax preferences to funding the following investments: putting a million electric cars on the road by 2015, reducing buildings’ energy use by 20% by 2020, and doubling the share of electricity from renewable energy sources by 2035.
Corporate tax reform
The president’s budget also alludes to, but does not detail, revenue-neutral corporate tax reform to lower corporate tax rates.
The budget weakens last year’s proposal of a financial crisis responsibility fee, which was meant to recoup some of the cost of to the economy incurred by Wall Street’s reckless gambling. Last year’s proposal would have raised $90 billion over 10 years. In this year’s budget, however, the financial crisis responsibility fee has been watered down to raise only $30 billion over a decade. While estimates of the cost of bailing out the financial system have dropped significantly (the Congressional Budget Office recently estimated a net taxpayer subsidy of only $25 billion), the cost of recession-induced job losses and increased deficits dwarfs the cost of the Troubled Asset Relief Program.
Adding it all up
The president’s budget puts the nation on a more fiscally responsible and more balanced path than current policies.
It is worth noting the last December’s tax deal cost $858 billion—nearly the amount of deficit reduction spread over a decade—and, with the exception of $57 billion for an extension of unemployment insurance, this sum resulted from revenue loss. Tax policies have been responsible for much of the accumulation of debt over the last decade, and will continue to add to the deficit over the next 10 years under current policy.
The president’s budget signals that the onus of deficit reduction will be relegated to spending cuts rather than tax increases. Such an approach risks severe cuts to investments and a costly, counterproductive expansion of tax expenditures. Successful and balanced deficit reduction necessitates revenue-positive tax reform and new progressive revenue sources to fund national priorities, address widening income inequality, and ease pressures elsewhere in the budget.