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HeatherBousheyWashingtonCenterforEquitableGrowth

TestimonyBeforetheHouseCommitteeonWaysandMeansTaxReformForumSeptember27,2017

Thankyoufortheopportunitytospeaktoyoutodayabouttaxreform.Inmytestimony,Iwillfirstsetthestageforthetaxreformdebatebyreviewingthelonger-termeconomicchallengesfacingAmericanfamilies,includingslowincomegrowthandrisinginequality.Iwillthenturntothesubstanceoftaxreform.Mycommentswillbemotivatedbyasimpleidea:thefocusofreformshouldbethelivingstandardsofAmericanfamilies,particularlymiddle-classfamiliesandfamiliesstrivingtoreachthemiddleclass.Thissimpleidealeadsmetothreekeypoints:

• Taxreformshouldraiserevenueand–atabareminimum–shouldnotloserevenue.Thepurposeofthetaxsystem,aswithpublicpolicyingeneral,istosupportthelivingstandardsofAmericanfamilies.Coretothispurposeisraisingtherevenuesnecessarytofinancetheinvestmentsinchildrenandfamilies,thesocialinsuranceprograms,andthemanyotherbasicgovernmentalfunctionsthatsupportourqualityoflife.Indeed,withanagingpopulation,governmentrevenueswillneedtoincrease.Iftaxreformbecomestaxcuts,Congresswillneedtoreversethosecutsinthefutureortheresultingrevenuelosseswillforcecutstocoreprograms.

o Whentaxcutsarefinancedbyhigherdeficits,theconsequencesfortheprogramsandservicesthatwerelyonareobscuredbecausethecutsarenotimmediate.However,unlessCongressreversesthecuts,inwhichcaseitwouldmakemoresensesimplynottoenacttheminthefirstplace,thebillwilleventuallycomedueintheformofMedicaidcuts,MedicareorSocialSecuritycuts,reductionsindiscretionaryspending,orsomecombinationoftheabove.

o Inaddition,ifthecostoftaxcutsisobscuredbyaddingtothedeficitratherthanidentifyingprogrammaticcutstofinancethem,mosteconomicmodelssuggestthattheywillimposeanadditionalcostontheeconomy:increasinginterestratesandcrowdingoutprivate-sectorinvestment.Notethatthiscostisinadditiontotheeventualneedforspendingcutsortaxincreases;itdoesnoteliminatetheneedforthoseoffsets.

• Giventhedramaticdivergenceofincomegrowthbetweenfamilieswiththehighestincomes

andthosebelowthem,taxreformshouldprovidenonettaxcutforthemostfortunateAmericansandanyeconomicgainsrealizedfromreformshouldbenefitworkingandmiddle-classfamilies,notthewealthy.Well-designed,revenue-neutralandrevenue-raisingtaxreformcangenerateeconomicgainswithwhichtoimprovethestandardoflivingforAmericanfamilies.Congresswilldeterminewhichfamiliesseeanincreaseintheirstandardoflivingandhowlargethatincreaseisbythechoicesmembersmakeindesigningreform.Evaluatingpotentialreformsthusrequiresseriousestimatesoftheimpactofreformonafter-taxincomesacrosstheincomedistributionfromnonpartisananalysts.Itshouldbeaconditionofreformthattheeconomicgainsbenefitworkingandmiddle-classfamilies,notthewealthy.

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• Taxreformshouldpreserveandexpandtheevidence-backedrefundabletaxcreditsthathelpworkingfamilies,whilerealizingthatthesedonoteliminatetheneedfordirectinvestmentinprogramsandservicesthathelpthesefamiliesthrive.TaxreformthathelpsworkingfamilieswillmaintainandexpandinvestmentsintheChildTaxCreditandtheEarnedIncomeTaxCredit,butCongressstillneedstoinvestinotherprogramsandservicesthathelpchildrenthriveandhelpfamiliesstayattachedtothelaborforce.Moreover,asnotedabove,ifincludedinarevenue-losingpackage,taxcutsforworkingandmiddle-classfamiliesmayofferanapparentboost,butthespendingcutsortaxincreasesnecessarytofinancethemwillmostlikelymakethesefamiliesworseoffonnet,particularlyifthepriceofexpandedbenefitsforworkingandmiddle-classfamiliesisadditionalbenefitsforhigher-incomefamilies.

Reformthatmeetstheserequirementswouldincreaselivingstandardsforworkingandmiddle-classfamiliesandthusdeliverequitablegrowth.Adequaterevenuestomeetthegovernment’sspendingcommitmentswouldensurethatAmericanscontinuetobenefitfromessentialgovernmentprograms.Eliminatingwastefulloopholesinthetaxsystemandusingtheresultingeconomicgainstobenefitworkingandmiddle-classfamilieswouldprovideamuch-neededlifttothosewhoseincomeshavegrowntheleastinrecentdecades.

TheContextforTaxReform:RisingInequalityandSlowGrowthinIncomes

Thestoryofrecentdecadesisrapidlyincreasingincomesatthetopoftheincomedistribution,slowgrowthinincomesinthemiddle,andverylittlegrowthatthebottom.TheeconomistsThomasPiketty,EmmanuelSaez,andGabrielZucmanestimatethataverageannualpre-taxincomegrowthforthetop0.001percentofthepopulationhasbeen6percentperyearsince1980whileincomeshavefallenoutrightforthebottom20percentofthepopulation.Aftertaxes,averageannualincomegrowthforthetop0.001percentofthepopulationwasstillabout6percent,whileroughlythebottomhalfofthedistributionexperiencedgrowthoflessthan1percentperyear(Figure1).

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Compoundedovertimethesegrowthratescorrespondtoradicallydifferentincomelevels.Since1980,overallincomeshavegrown61percentwhilepre-taxincomesforthetop0.001percenthavegrown636percentandpre-taxincomesforthetop1percent(includingthetop0.001percent)areup204percent.Aftertaxes,growthratesarenearlyashigh.Incomesforthetop0.001percentareup616percentandincomesforthetop1percentareup194percent.Theflipsideofthefaster-than-averagegrowthatthetopisslowgrowthatthebottom(Figure2).Incomesforthebottom50percentofadultsareup1percentbeforetaxandonly21percentaftertax.

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ThesefindingsarebroadlysimilartoestimatesproducedbytheCongressionalBudgetOffice,thoughtheseestimatesdonotprovidethesamelevelofdetailintheextremeuppertail(Figure3).After-taxincomesincreased192percentbetween1979and2013accordingtoCBOwhileincomesforthemiddle-threequintilesofthedistributionincreased41percent.CBOshowssomewhatfastergrowthfortheverybottomthandothePiketty-Saez-Zucmanestimates,at46percent.

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Theseestimateshighlightthesharpincreaseinincomeinequalityinrecentdecades.However,thereislittlereasonforustoacceptthelevelofinequalitythatprevailedaround1980astheideallevel.In1979,theaverageincomeforthetop1percentwas$355,000(in2013dollars)andtheaverageincomeforthemiddlequintileofthepopulationwas$45,000,accordingtotheCBOestimates.Anequalpercentagepointincreaseinincomethatpreservedthelevelofinequalitythatexistedin1979wouldstillhaveimpliedrealincomegrowthforthetop1percentthatexceededthatofthemiddlequintilebyafactorofseven.

In2013,thelastyearavailableintheCBOdata,theaverageincomeforthetop1percentwasover$1millionandtheaverageincomeofthemiddlequintilewas$61,000.Thishighlevelofinequalityisharmfulforoursociety,andweshouldnotacceptit.Taxreformshouldreduceinequality.Thelastthingweshoulddoisincreaseinequalitybygivinglargetaxcutstothefortunatefewwhoseincomeshaveincreasedsomuchinrecentdecades.

Taxreformshouldraiserevenueand–atabareminimum–shouldnotloserevenue.

Thepurposeofthetaxsystem,aswithpublicpolicymorebroadly,istosupportthelivingstandardsofAmericanfamilies.Coretothispurposeisraisingtherevenuesnecessarytofinancethesocialinsuranceprograms,theinvestmentsinchildrenandfamilies,andtheotherspendingcommitmentsthatsupportourqualityoflife.Indeed,withanagingpopulation,governmentrevenueswillneedtoincrease.

Thedistributionoffederalspendingishighlyprogressive.Thoughdated,aCongressionalBudgetOfficeanalysisoffederalspendingin2006concludedthatnonelderlyfamiliesinthebottomincomequintilebenefittedfromfederalspendingequaltoeither130or200percentofincomedependingonthemethodologyusedwhilefamiliesinthetopquintilebenefittedfromspendingequaltoeither5or12percentofincome(Figure4).CBOdidnotconductananalysisofelderlyhouseholdsacrosstheincomedistribution.However,whilespendingontheelderlyislikelytobelessprogressivethanspendingonthenonelderlyitwouldalmostcertainlybeprogressiveoverall.

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Deficit-financedtaxcutsobscuretheirtruecostbyavoidinganexplicitstatementofwhatthespendingcutsortaxincreasesrequiredtopayforthemwillbe.However,iftaxreformbecomestaxcuts,Congresswillneedtoreversethosecutsinthefutureortheresultingrevenuelosseswillforcecutstocoreprograms.Giventhestronglyprogressivenatureoffederalspending,spendingcutswilldisproportionatelyharmworkingandmiddle-classfamilies.

Toillustratethehiddenharmsofdeficit-financedtaxcuts,considertheestimatesfromtheTaxPolicyCentershowingpossibilitiesforhowthedeficitsresultingfromtheAprilversionoftheTrumpadministration’staxplancouldbeoffset.Iftaxcutsarepaidforbyimposinganequalcost,indollars,onallhouseholds,familiesinthebottomquintilewouldseetheirincomesdecreasebymorethan15percent,familiesinthemiddle-quintilewouldseetheirincomesdecreaseby3percent,andfamiliesinthetopquintilewouldseetheirincomesgoupby4percent(Figure5).Theimpactcouldbeevenmoreregressiveif,forexample,taxcutsarepaidforbythekindsofsevereMedicaidcutsreflectedineachversionofRepublicanhealthcarelegislationconsideredthisyear.

Evenifweassumethattheultimatecostsoftaxcutswillfallonfamiliesinproportiontotheirincomes,theultimateimpactofthetaxcutwillbetoreduceincomesonaverageineachofthebottomfourquintilesandtoincreaseincomesinthetopquintile.

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Inaddition,ifthecostoftaxcutsisobscuredbyaddingtothedeficitratherthanidentifyingprogrammaticcutstofinancethem,mosteconomicmodelssuggestthattheywillimposeanadditionalcostontheeconomy:increasinginterestratesandcrowdingoutprivate-sectorinvestment.Thisisarealissuethatshouldbeincludedinthedynamicanalysisofdeficit-financedtaxcuts.However,thecentralrolethisissuehastakenonreflectsamisguidedemphasisresultingfromtheincreaseduseofdynamicscoring.Bywayofanalogy,itislikeborrowing$1millionfromthebankandworryingnotaboutwhetheryoucanpaybackthe$1million,norwhetheryoucanpaybacktheinterestonthe$1million,butwhetheryourloanwillcausethebanktoincreasetheinterestrateitchargesonotherloans.

CongressshouldensurethatthereisnonettaxcutforthemostfortunateAmericansandthattheeconomicgainsfromtaxreformarerealizedbyworkingandmiddle-classfamilies.

Well-designedtaxreformcangenerateimprovementsinthestandardoflivingforAmericanfamilies.Congresswilldeterminewhichfamiliesseeanincreaseintheirstandardoflivingandhowlargethatincreaseisbythechoicesmembersmakeindesigningreform.Evaluatingpotentialreformsthusrequiresseriousestimatesoftheimpactofreformonafter-taxincomesacrosstheincomedistributionfromnonpartisananalysts.

ThecriterionbywhichtaxreformshouldbejudgedisthatthereisnonettaxcutforthemostfortunateAmericansandthatanyefficiencygainsfromtaxreformareusedtobenefitworkingandmiddle-classfamilies.Todeterminewhetherreformmeetsthiscriterionwillrequiredistributiontablesthatshowtheimpactofpotentialreformsonafter-taxincomes.Thesetablesmustbefreeoftheimpactofgimmicksandexcludegainsattributabletoincreasedfederalborrowing.

Unfortunately,notaxreformplanputforwardbyHouseRepublicansortheTrumpadministrationtothispointwouldmeetthistest.Everyplanhasprovidedlargegainstothemostfortunate,littleor

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nothingtoworkingandmiddle-classfamilies,andreliedonhigherdeficitstogenerateeventhesemodestgains.

TheblueprintfortaxreformreleasedbyHouseRepublicansin2016,forexample,wouldhaveboostedincomesforthetop1percentby13percentintheyearafterenactmentwhileincreasingincomesforthebottom95percentoffamiliesbylessthanhalfofonepercent(Figure6).Insubsequentyears,high-incomefamilieswouldbenefitsomewhatless,butmanyfamiliesoutsidethetop5percentwouldbemadeworseoff.Moreover,asnotedabove,mostfamilieswouldbeworseoffinallyearsafteraccountingforspendingcutsoroffsettingtaxincreasestoeliminatethedeficits.

TheseestimatesoftheimpactoftheHouseblueprintreportthepercentchangeinafter-taxincome.However,anequalpercentchangeinafter-taxincomeacrosstheincomedistributionwouldmeanthatthegainsforthetop1percentoffamiliesaremorethan20timesthegainsformiddle-classfamilies.Indeed,expressedindollarsthedisparityinthebenefitsoftheHouseblueprintisevenmorestriking(Table1).Familiesinthetop1percentwouldseetheirafter-taxincomesincreasebymorethan$200,000whilefamiliesinthemiddlequintileoftheincomedistributionwouldseethemincreaseby$260.

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Thebenchmarkfortaxreformshouldnotbethatafamilywithafter-taxincomeof$6millionreceivesabenefitof$60,000forevery$600receivedbyafamilywithincomeof$60,000.Instead,Congressshouldenactreformthatdirectsalloftheefficiencygainsrealizedtothebenefitofworkingandmiddle-classfamiliesthusreducinginequalityandfulfillingthepromisesmadebyofficeholdersacrosstheideologicalspectrumthatthefocusoftheireffortswhileinofficewillbetheeconomicfortunesoftheAmericanmiddle-class.

Itisworthcomparingthisfocusonafter-taxincomeswithafocusoneconomicgrowthorGDP,whichisalsofrequentlyused.Asaneconomicmatter,measuresoftotaleconomicoutputandtotalincomeshouldbeequal.Thus,usinganoutput-basedmeasureofeconomicgrowthasthemeasureofreformratherthanincomesisnotprimarilyaboutthedifferencebetweenoutputandincome.

Themostimportantimpactoffocusingoneconomicgrowthratherthanthechangeinincomesacrossthedistributionisthatitimplicitlyadoptstheperspectivethatapolicythatincreasestheincomeofahouseholdmaking$1millionby$11,000ismorevaluablethanonethatdoublestheincomeofahouseholdmaking$10,000.Itdoesthisnotbydirectlyassertingthisvaluejudgment,butbyadoptingasummarymetricthatusesthisweighting.

Infact,ameasureofthelevelanddistributionofafter-taxincomesacrossthedistributionprovidesfarmoreinformationthanknowledgeofthelevelofoutput.Focusingonoutputgrowthisthusakintoputtingonblindersthatobscurethebroaderpicture.Whenincomeshavegrownbyabout600percentinthelastthree-plusdecadesattheverytopofthedistributionbutbyonly21percentinthebottomhalf,thereisnoreasontochooseanobjectivethatdoesnotfocusonincreasingthelivingstandardsofworkingandmiddle-classfamilies.

ThereisnothingcontroversialabouttheeconomicclaimsIammaking.Whiletherearenumerousdisagreementsabouttherightwaytomeasurethedistributionoftaxesandaboutwhatkindsoftax

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reformwillboostgrowthandhowlargeanygrowtheffectswillbe,thereisnodisagreementthatthedistributionofthebenefitsfromtaxreformwillbedeterminedbythestructureofthetaxreform,andthatifCongresschoosestoenactreformthatdirectsthebenefitstoworkingandmiddleclassfamiliesitcandoso.Putsimply,iftaxreformdirectsfargreaterbenefitstothewealthythanitdoestotheworkingandmiddle-classfamilies,itwillbebecauseCongresschosetodoso.

Taxreformshouldpreserveandexpandtheevidence-backedrefundabletaxcreditsthathelpworkingfamilies,whilerealizingthatthesedonoteliminatetheneedfordirectinvestmentinprogramsandservicesthathelpthesefamiliesthrive.

CongressshouldpreserveandexpandevidencebackedrefundabletaxcreditsliketheEarnedIncomeTaxCreditandtheChildTaxCredit,whileevaluatingtheseexpansionsinthecontextofthebroadertaxpackageinwhichtheyareapart.However,expandingthesecreditswouldnottaketheplaceofdesperatelyneededincreasesininvestmentsinchildcare,paidfamilyleave,andjobtraining.TheEarnedIncomeTaxCreditisdesignedtoencourageandrewardwork,reducepoverty,andprovideassistancetostrugglingfamilies.Thecreditisrefundable,whichmeansthemanyfamilieswhoseincomesaretoolowtogeneratesubstantialfederalincometaxobligationscanstillbenefit.AccordingtotheCenteronBudgetandPolicyPriorities,theEarnedIncomeTaxCreditlifted6.5millionpeople,including3.3millionchildren,outofpovertyin2015.TheChildTaxCredit,whichisonlypartiallyrefundable,alsoprovidesfamilieswithasignificanteconomicboost.Itprovidesworkerswithchildrenataxcreditofupto$1,000perchildandliftedabout2.8millionpeopleoutofpoverty,includingabout1.6millionchildren,in2015.OnepotentialcomponentofataxpackagethisfallwouldbeaCTCexpansionthatfocusesonhelpinglow-tomoderate-incomefamilies.TheseimprovementsshouldincludemeasuressuchasallowingfamiliestoreceiveaCTCrefundfromthefirstdollarofincomeandsubstantiallyincreasingthephase-inrateormakingthecreditfullyrefundable.AnyCTCexpansionshouldincludeaparticularfocusonthepoorestfamiliesandtheyoungestchildrengiventheevidencethatsuggeststhatthebenefitsofadditionalincome—includingimprovedhealthoutcomes,increasededucationalattainment,andhigherexpectedearningsasadults—areclearestforthatgroup.However,therealityisthatimprovingtheEITCandCTCwouldnottaketheplaceofdesperatelyneededincreasesininvestmentsinchildcareorpaidfamilyleave.Withaveragechildcarecostsrangingfrom$3,000to$17,000peryear,expandedtaxcreditsarenotthebestapproachtodealwiththisexpense.Forexample,aCTCexpansionorotherattemptstomakechildcaremoreaffordablethroughthetaxcodewouldnotaddressissueswithaccesstohighqualityreliablechildcare.Addressingfamilies’childcareneedsrequiressignificantpublicinvestmentsinthechildcaresystemasawhole.Anotherpotentialcomponentofataxpackagewouldbeataxcreditforbusinessesthatofferpaidleave.Thesekindsoftaxcreditscanbeineffectiveatincreasingthenumberofemployersofferingpaidleave,especiallyforlow-wageworkers,andthusservetoprovidetaxcutstoemployersthatalreadydo.However,evenwhileineffectiveinincreasingaccesstopaidleave,thecostofthetaxcutswouldstillrequirecutsinotherservicesoroffsettingtaxincreasestopayforthem.Proposalslikethesemayonlyexacerbateinequalitybyofferingtaxcreditstoemployerswhohavealreadyacknowledgedthatthereisvalueofferingpaidleave.

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Moreover,asnotedabove,ifincludedinarevenue-losingpackage,taxcutsforworkingandmiddle-classfamiliesmayofferanapparentboost,butthespendingcutsortaxincreasesnecessarytofinancethemwillmostlikelymakethesefamiliesworseoff,particularlyifthepriceofexpandedbenefitsforworkingandmiddle-classfamiliesisadditionalbenefitsforhigher-incomefamilies.