Two Cheers for the Bipartisan Tax Deal

A rare bipartisan agreement in Congress would create a larger child tax credit for parents and extend some key business tax breaks in the 2017 (Trump) tax reform bill that have expired. Democrats are said to favor the former and Republicans the latter.

Opinions on the accord are all over the map, with pros and cons—both on the right and the left. I give it two cheers. If it were funded by reducing means-tested welfare spending, I would give it a third cheer.

But first things first.

The only sensible policy question to ask about the new agreement is: Does it move us in the direction of a better fiscal system? That’s a hard question to answer unless we have a well-defined idea of what a good fiscal system looks like. Yet standing in the way of clear understanding are false and misleading statements by representatives of both political parties.

Consider these two facts:

1. The American federal tax system is the most progressive in the entire developed world—largely because of Republican tax legislation, for reasons I explain below. Yet Republicans never boast about this fact, and Democrats routinely accuse them of favoring the rich.
2. As recently as 2018, it was virtually impossible for a parent with children to be poor if he or she worked full time at the minimum wage—again because of Republican tax legislation. Yet, Republicans never boast about this fact, and Democrats routinely accuse them of caring nothing about the poor.

These facts are well known by economists. But they are virtually unknown by most television commentators and the general public.

Sixty years of tax reform. When the top tax rate was lowered from 91 percent to 65 percent during the Kennedy administration and all the way to 28 percent under President Reagan, these were bipartisan changes. They got strong support from the leadership in both parties. However, in recent years, tax legislation has become increasingly partisan and the rhetoric increasingly misleading.

For that reason, some readers may be surprised to learn that more than half of all households today pay no income tax at all. That’s because every Republican tax bill—going all the way back to Ronald Reagan—threw more and more people off the income tax rolls. Through this and other provisions, Republicans have been shifting the tax burden to the rich every time they have legislated. Both private and government analyses confirm that the same is true of the 2017 (Trump) tax reform bill.

Sixty years of welfare reform. Not only is our tax system more progressive than other countries, our entire welfare system is more progressive. That is, we distribute more from the top to the bottom than any other country. Other countries may have more social insurance, but we have more redistribution.

One of the most important vehicles for reducing poverty is based on the idea of a negative income tax, proposed by Milton Friedman in 1962. The legislative version, first introduced in 1975, is called the Earned Income Tax Credit. Closely related is the child tax credit, created by a Republican Congress in 1997. Because of these two measures, by 2018 it was virtually impossible for a working mother to be poor (in terms of cash income), even if she earned only the minimum wage!

Aid to the poor. Under the War on Poverty—originated by Democrats in the 1960s—health care money goes to doctors and hospitals; housing money goes to landlords and developers; food stamp money goes to agribusiness; education money goes to school bureaucracies, etc. Very little War on Poverty cash ever went to people who were poor.

What difference does this make? Special interests use their political influence to shape and mold the structure of these programs for their benefit—not for the benefit of low-income families. Studies find that Medicaid enrollees, for example, value their coverage at as little as 20 cents on the dollar.

By contrast, every refundable tax credit dollar is worth a full dollar.

During the Biden administration, Democrats in Congress seriously contemplated a Build Back Better plan, with a ten-year cost of almost $5 trillion. The proposal contained all manner of cradle-to-the-grave ideas, including day care for children, home care for seniors, hearing, dental and eye care under Medicare, and more spending for Medicaid and the Affordable Care Act (Obamacare) health insurance.

The proposal did include tax credits for low-income families—but only to extend the more generous provisions that had been enacted as temporary measures to combat the economic effects of Covid. Roughly 80 percent of the cost (the new spending) was to end up in the pockets of non-poor people—who in many cases would be providing services to the poor.

After the Build Back Better proposal floundered, congressional Democrats passed the Inflation Reduction Act (IRA) instead—which was largely a climate change spending bill.

All this suggests that congressional Democrats have a very weak commitment to putting cash in the hands of people who need it most. They would rather spend it on “anti-poverty” programs, which create more public sector employees, who are likely to join public sector unions and support Democratic politicians.

Even so, congressional Democrats are apparently willing to sign on to a proposal that spends half the money on business tax cuts and the other half on what is essentially a Republican approach to poverty amelioration. That’s a deal Republicans should seriously consider accepting.

Business tax cuts. The latest studies show that the 2017 corporate tax cuts have had a major impact on domestic investment. The Tax Foundation estimates that extending the provisions that have expired would increase the capital stock by about 1 percent and add more than 100,000 jobs.

On the other side of the aisle, the Democratic IRA bill has all kinds of tax subsidies for green business. So, both parties implicitly agree that taxes affect business behavior.

Unfortunately, that hasn’t stopped liberal critics from claiming that the Trump corporate tax cuts were a gift to the rich.

The most meticulous scholarly study of the matter, however, shows that corporate taxes mainly fall on labor. That means a cut in corporate income tax leads to higher worker wages and higher corporate taxes lead to lower wages.

Earning the third cheer. Critics of the budget deal on the right claim that the work requirements for the child-care credit are too weak and that the proposal is not fully funded.

However, when the credit had no work requirement at all (during the pandemic), it apparently had no impact on labor market participation. At a minimum, the new proposal is work-neutral.

Far greater disincentives to work are found in the rest of the welfare/entitlement state. If someone at the bottom of the income ladder earns an additional $5,000 in wages, he could lose his eligibility for Medicaid and other noncash benefits. If he obtains $5,000 in food stamps, he loses nothing. In this way, our fiscal system is discouraging work and encouraging welfare dependency.

Since the child tax credit is at least work-neutral, let’s fund it by reducing spending on programs that discourage work.