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Overview: The 1997 Tax Act was a disaster for the goal of fair, simple and adequate taxation. Among its defects:
A decade ago, public anger over rampant corporate and high-income tax avoidance spurred a Republican President, a Democratic House of Representatives and a Republican Senate to work together to produce the Tax Reform Act of 1986. While not perfect, that legislation gave us a federal income tax code with relatively few loopholes and, as a consequence, relatively low tax rates (excessively low, one might say, since they were insufficient to pay for public spending).
Unfortunately, Republican House Speaker Newt Gingrich and Democratic President Bill Clinton have never concealed their disdain for the achievements of 1986. Gingrich helped lead an almost successful fight in the House to defeat the '86 reform act, while Clinton has publicly stated that he thinks the 1986 reforms "went too far." Indeed, Clinton's June 1993 description of his 1993 deficit-reducing upper-income tax increase aptly sums up his tax philosophy: "We raised tax rates, but we tried to find ways for people who've been successful, who have money, to lower their taxes."
"Find[ing] ways for people . . . who have money to lower their taxes" was the central
theme of the 1997 tax act, and on this issue Clinton and Gingrich are apparently soul mates--Gingrich, unabashedly, and Clinton, in practice if not always in rhetoric. Only a few
weeks before the 1997 act was finally approved, Clinton promised that he would never
sign anything like the unfair, budget-busting tax bills then pending in Congress. Sadly, that
promise turned out to be an empty one.
1. Capital Gains: The bill provides a bewildering array of new tax rates on profits from selling stocks, bonds, investment real estate and other "capital assets." Depending on the type of assets sold and how long they were owned, taxpayers will choose among six different capital gains tax rate schedules. These include:
Typically, top-bracket individual taxpayers (who have most of the capital gains) will get the equivalent of about a 50% capital gains exclusion (an 18% or 20% capital gains tax rate instead of the regular 39.6% tax rate). The effective percentage exclusion gradually declines to about 33% for less well-off taxpayers.
Ignoring any increased asset sales or likely new tax shelters, the capital gains tax cuts will cut revenues by about $87 billion over the fiscal 1997-2002 period, and by about $201 billion over the 1997-2007 period.
According to the "official" congressional figures, however, the capital gains tax cuts will raise $0.1 billion over the 1997-2002 period! In addition, Congress's figures show a ten-year, fiscal 1997-2007 cost from the capital gains tax cuts of only $21.2 billion.
The $180 billion difference between Congress's ten-year capital gains cost figures and
the apparent ten-year revenue loss reflects the fact that Congress's figures assume a $1.2
trillion increase in capital gains realizations in response to the tax cuts--an increase of
about 40% compared to expected realizations under prior law! Such an increase would be
unprecedented based on the historical record.
2. New Corporate Loopholes: The bill offers an array of new corporate tax breaks (offset
in part by some loophole-closing measures). The largest new loophole is elimination of
most of the corporate Alternative Minimum Tax, which up until now has served to assure
that large, profitable corporations pay at least some federal income tax.(2) Overall, the 1997
tax act reduces corporate income taxes by a net of about $6 billion a year, with the lion's
share of that amount reflecting the gutting of the corporate minimum tax. Heretofore, the
minimum tax had discouraged many companies from bothering to seek out tax dodges, but
now the sky's the limit.
3. Child Credits: The bill offers a $500, unindexed tax credit ($400 in 1998) for children
age 16 or under. While this credit will be quite valuable to families that qualify, only about
57 percent of all dependent children will be eligible for even a partial credit. This reflects
the fact that the credit will not be available to most lower-income families because it can
only be used to offset income taxes, but generally not payroll taxes, which are the main
federal tax paid by less well-off families.(3) In addition, the credit will be gradually phased
out above $110,000 in income for couples (above $75,000 for single parents).
The child credits are expected to cost $85 billion over five years and $183.4 billion over ten years. Because the dollar amounts of the child credit and its phase-outs are not indexed, its annual cost declines by about 2% a year after it becomes fully effective in 1999.
The rules for computing the new child credit are extremely complex, and will
apparently require many millions of families to fill out the complicated Alternative
Minimum Tax form (even though they do not owe that tax). The congressional report on
the 1997 tax act plaintively states that Congress "anticipate[s] that the Secretary of the
Treasury will determine whether a simplified method of calculating the child credit,
consistent with the formula [in the statute], can be achieved."
4. Education Tax Credits: Families would be allowed a non-refundable tax credit equal to 100% of the first $1,000 in college expenses and 50% of the next $1,000, for each of the first two years of college per child, for a maximum credit of $1,500 a year. For later years of college or graduate school, a 20% tax credit is allowed for the first $5,000 in expenses (rising to $10,000 in expenses after 2002). Starting in 2002, all the dollar amounts except the maximum expenses for the 20% credit are indexed for inflation.
The education credits would generally be unavailable to lower-income families. In
theory, the credit would also be phased out between $80,000 and $100,000 in income for
couples ($40,000 to $50,000 for others), but many well-off families will find it easy to get
around these limits by shifting income to their children. The credits are estimated to cost
$31.6 billion over five years, and $76 billion over ten years (with little growth thereafter).
5. Tax-Free Investment Income:
A. Education savings accounts: Families with the means to do so would be allowed to set up education savings accounts and contribute up to $500 a year to them. Accumulated earnings would be tax-free if used to pay school expenses (elementary, secondary, college and graduate school). Eligibility to make such contributions is phased out between $160,000 and $170,000 for couples (and between $95,000 and $110,000 for others).
B. Expanded retirement savings accounts: Better-off taxpayers now ineligible for Individual Retirement Accounts because they have employer-paid pension plans would be allowed to set up either deductible IRAS or a new kind of "Backloaded IRA."
- The income phase-out range for deductible IRAs would be gradually increased from the current $40,000-50,000 for couples ($25,000-35,000 for singles) to $80,000-100,000 for couples ($50,000-60,000 for singles).
- In the case of backloaded IRAs, contributions to the accounts (up to $2,000 a year for singles and $4,000 for couples) would not be tax-deductible, but the income earned on the money invested would be permanently tax-exempt if held until retirement. Eligibility for these accounts would be phased out between $150,000 and $160,000 for couples and $95,000 to $110,000 for singles.
These new investment-income tax breaks are officially estimated to cost $7.1 billion
over the first five years, and to cost $30.6 billion over the following five years. The cost
will continue to grow rapidly (by 13% a year) thereafter.
6. Estate Taxes: The $600,000 estate tax exemption would be gradually increased to $1
million (over 9 years). For estates consisting mainly of family-owned businesses, the
exemption would rise to $1.3 million starting in 1998. There would be a number of other
revenue-losing changes in estate taxes. When fully phased in, the estate tax cuts will slash
taxes by more than $10 billion annually on the 2% of estates big enough to be subject to
7. Excise Taxes: The expiring excise tax on airline tickets would be made permanent (with
modifications). The cigarette tax would be increased from 24-cents per pack to 34 cents in
2000 and 2001, and to 39 cents in 2002 and thereafter (an increase of 63%). There also
would be a number of other, smaller excise tax changes. The total excise tax hike is
estimated to be $39.5 billion over five years and $98.9 billion over ten years.
Notes: In general, proposals were analyzed using the Institute on Taxation & Economic Policy Microsimulation Tax Model. Estimates for proposed estate tax reductions are based on Joint Committee on Taxation, “Methodology and Issues in Measuring Changes in the Distribution of Tax Burdens,” 1993. Estimates for the education tax credits and savings accounts (ESAs) are estimates based on the proposed statutory rules, distribution of college-age children, college attendance rates, etc.. Child credits, education tax credits, and excise taxes are shown as the average amounts over the next five years, at 1997 levels. Other provisions are shown fully effective at 1997 levels.
Citizens for Tax Justice, August 18, 1997
1. Assets sold between May 7, 1997 and July 28, 1997 (except collectibles) qualify for the new lower long-term capital gains tax rates if they were held for more than one year (rather than 18 months).
2. Technically, the tax act does not repeal the corporate AMT, but achieves much the same result through the back door by allowing companies to use the key tax loophole that now triggers the minimum tax, accelerated deprecation, in computing whether they owe the minimum tax.
3. For families with three or more kids, the child credit can be used to offset payroll taxes in excess of the earned-income tax credit. This provision helps a few low-income families, but not much. Only 2.4% of dependent children in families making less than $12,600 (the lowest-income 20% of all taxpayers) will receive even a partial credit, and those partial credits will average only $150 per child over the 1998-2002 period (in 1997 dollars). Only 38% of children in families making between $12,600 and $22,600 (the second 20%) will be eligible for even a partial credit, and those partial credits will average $282 per child.