Summary and Analysis of the
President's 2005 Budget

Tax Provisions

The Bush Administration has a tax cut for every season and for every reason. In 2001 it proposed tax cuts because the country was enjoying unprecedented surpluses. In 2002, it proposed tax cuts for stimulus. Growth was the theme in 2003. Now, in 2004, with the economy in its third year of anemic expansion, the Bush Administration is trying to justify a fourth round of profligacy. Without the tax cuts being made permanent, the Administration claims, the expansion is in danger of petering out as businesses and consumers alter plans on account of uncertainty. This is a tenuous claim at best, for the world is always a very uncertain place. What is certain, however, is that the tax policies of the Bush Administration are the prime cause of record deficits which create serious financial market uncertainty — and threaten to push up interest rates, crowd out investment, and lower living standards.

Whether or not one believes in the legitimacy of "trickle- down economics," there is little doubt that the Administration's tax policies, taken as a whole, have been highly regressive. For instance, according to the Urban-Brookings Tax Policy Center, when taken together, EGTRRA and JGTRRA resulted in an average tax change of $3 for the lowest income quintile of households ranked by income while resulting in a $30,485 tax change for the richest one percent of Americans. The annual tax change for a taxpayer in the third – i.e., middle – quintile is estimated to be only $685 in 2004. If the sea of red ink causes 30-year mortgage rates to rise from six percent to seven percent, the cost of carrying a $150,000 mortgage will rise $1,200 annually, wiping out the middle class's tax cut two times over.

 

The $3.8 Trillion Tax Agenda
Costs of President's Tax Proposals
Enacted, Proposed, and Hidden

(Trillions of Dollars)

	2005-20014
2001 Tax Cuts	1.060
2002 Stimulus	-0.070
2003 Tax Cuts	0.135
Make Above Tax Cuts Permanent	1.233
AMT	0.549
New Tax Proposals in 2005 Budget	0.163
Subtotal	3.069
Corresponding Debt Service	0.732
TOTAL TAX AGENDA	$3.801

Source: CBO and Joint Committee on Taxation
AMT includes interaction with EGTRRA/JGTRRA permanence
New Tax Proposals are OMB estimates, do not include AMT

The President's budget for 2005 aims to consolidate the policy errors of the past three years by making virtually all temporary provisions in the past three tax bills permanent. This would lock in annual tax benefits of $66,208 for the richest one percent while giving the bottom quintile a meager $19 in tax benefits. The middle quintile would see only a $683 change in their taxes, or roughly $13 extra onto the weekly paycheck.

While the cost of the tax provisions proposed in the budget is nominally $1.1 trillion, in reality it is even higher. The Bush Administration uses several scoring subterfuges to make the overall cost seem lower and to hide the fiscal peril of the federal government.

While previous budgets displayed the budget outlook over a ten-year period, the 2005 budget displays only five years. This display gives the illusion of a convergence between revenues and spending shortly after the five-year window, but as the Administration admits in Chapter 12 of the Analytical Perspectives volume, the government faces deficits over 10 percent of GDP after the retirement of the baby-boom generation. If the Administration were to provide a longer-term perspective, the current round of trillion-dollar tax cuts would seem far less advisable.

The magnitude of revenue policy changes is also made to appear artificially low by including in the revenue baseline the proposals making provisions under previous tax bills permanent. The Administration has attempted to justify this action by claiming that all sunsetting provisions will be routinely extended and should already be considered part of policy. However, when these provisions were drafted, the sunsets were included by Republicans to receive lower cost estimates from Congressional scorekeepers in order to comply with the budget resolution. The Administration wants to evade the consequences of its own previous machinations and cloak the real long-term costs of their policies by changing the rules.

In the same vein, there is widespread consensus that the Alternative Minimum Tax (AMT) will soon need to be reformed. Originally envisioned as a way to ensure that wealthy individuals pay at least some tax, the AMT, due to subsequent inflation and tax cuts, is now affecting a broader cross-section of the public than originally intended. According to CBO, an AMT fix would have far-reaching revenue effects, in large part because of the tax cuts contained in EGTRRA and JGTRRA. The total cost of a comprehensive AMT reform would be at least $500 billion. To keep the overall cost of their tax package from pushing $2 trillion, the Administration provides only a one-year stop gap AMT fix for $23.3 billion. Thus, the Administration postpones AMT reform until later, when the financial situation of the government has further deteriorated.

Under the rubric of promoting savings, the Administration has reprised Retirement Savings Accounts and Lifetime Earnings Accounts (RSAs/LSAs). These accounts would appeal especially to the five percent of taxpayers who are able to deposit the maximum amount into their 401(k)s. Because neither deposits nor distributions are taxed under these proposals, the accounts would prove very expensive in the long run. However, in the first five years of the accounts, it is estimated that they would be a net source of revenue, as taxpayers transferred their funds from tax-deferred accounts, much as happened with Roth IRAs. Thus, these provisions are classified as overall revenue raisers for both five- and ten-year periods, even though they will cost billions once they are in full effect.

Finally, the Administration also masks the true cost of its proposal by assuming non-existent cuts. A proposal to provide refundable tax credits to the uninsured would require an outlay of $65 billion. In the same mandatory spending section, the Administration also assumes that $65 billion in offsetting cuts will be found in consultation with Congress. The Administration can then take credit for a rare proposal that benefits the working poor, offset the cost in its budget with nonexistent cuts, and finally abandon the measure once the offsetting cuts fail to materialize — and blame Congress for the failure.

The Bush Administration continues to promote tax policies which (1) have little relation to the spending realities of nation, (2) disproportionally favor those who were doing quite well already in the years leading up to 2001, (3) keep large amounts of investment income out of the tax base, discriminating against wage income and in favor of unearned income, and (4) disregard the need for national savings in the face of a major demographic shift. Descriptions of specific provisions follow.

• Extends Expiring Tax Cuts — To mask the full magnitude of their 2001 and 2003 tax cuts, Congressional Republicans added sunsets to numerous provisions in both packages. The budget makes these provisions permanent, adding more than $1.0 trillion to the national debt over ten years. Over 75 years, the cost of extending these tax cuts exceeds the combined shortfalls in Social Security and Medicare. If the Congress allowed those provisions that disproportionately benefit the best off to expire, it would go a long way toward restoring fiscal balance. The budget makes permanent the following tax cuts:
  1. Child Tax Credit – Under current law, the child tax credit will revert from $1,000 to $700 in 2005. The credit will remain at $700 through 2008, increase to $800 for 2009, and increase to $1,000 for 2010 and 2011, before expiring at the end of 2011. The President's 2005 budget keeps the credit at $1,000 in years after 2004 and makes it permanent. The cost of this provision is $114.9 billion over ten years. This does not include and additional $47.8 billion in outlays.
  2. "Marriage Penalty" Relief – JGTRRA made the standard deduction for married couples exactly twice the amount it is for single taxpayers in 2003 and 2004. Under current law, it will revert to 1.74 times the deduction for single taxpayers thereafter. Making the provision permanent in 2005 and beyond costs $50.5 billion over ten years. This does not include an additional $5.7 billion in outlays.
     
  3. Ten Percent Individual Income Tax Rate Bracket — JGTRRA increased the thresholds of the ten percent tax bracket to $7,000 for single taxpayers and $14,000 for couples in 2003 and adjusted them for inflation in 2004. Making the change in brackets permanent for 2005 and thereafter would cost $422.6 billion over ten years.
  4. Dividend Tax Rate Structure — Under previous law, dividends were taxed as ordinary income. JGTRRA changed the treatment of dividends, taxing them in a manner similar to capital gains through 2008, dropping the rate they are taxed at to between zero and fifteen percent. Making permanent the current tax treatment of dividends costs $81.3 billion over ten years.
  5. Capital Gains Structure — JGTRRA lowered the capital gains tax rates from 20 percent and 10 percent for investments held for more than one year to 15 and five percent respectively (zero in 2008) through 2008. It has never been adequately explained why a capital gains tax of 20 percent was a barrier to investment. The provision would cost $50.0 billion through 2014.
  6. Expensing for Small Business — The Administration has proposed making permanent a provision that would allow small businesses to expense up to $100,000 in capital investment. Under current law, the provision does not apply beyond 2005. If the provision is not extended, the amount that can be written off will revert to $25,000 as under previous law. The provision would cost $24.8 billion through 2014.
  7. Repeal of Estate Tax — EGTRRA reduced estate taxes and raised the unified credit for the estate tax to $3.5 million by 2009 and repealed the estate tax altogether in 2010. To comply with the budget resolution, however, the provision reverts to current law in 2011. The estate tax was instituted in 1916 and enjoyed bipartisan support for most of its existence. It has not proven an impediment to the resourceful and hardworking in accumulating wealth. In fact, it was no deterrent to any of the many Americans who amassed substantial fortunes in the 1990s. Contrary to Republican assertions, there are provisions in the law to keep family farms and small businesses in the family. Permanent repeal of the estate tax would cost $180.1 billion through 2014. It would do little to spur additional entrepreneurial activity but would give huge windfalls to the wealthiest families.
  8. Extension of AMT Relief for Individuals — There is widespread acknowledgment that taxpayers who were not intended to be subject to the AMT have become so because of inflation and deep cuts in the ordinary income tax enacted in 2001 and 2003. By 2012, 39 million middle-income taxpayers will see their taxes raised because of the AMT. There is also consensus that some type of reform is necessary. A recent estimate by CBO put the full price tag of AMT reform at over $500 billion. This budget hides the true cost of AMT reform by proposing only a one-year extension of higher exemption amounts at a cost of $23.3 billion.

The budget also contains several new tax cuts, including the following measures:

• RSAs/ LSAs — The budget creates scaled-down versions of last year's proposed RSAs and LSAs. RSAs allow tax-free deposits and withdrawals into an account that could be drawn down by the owner after age 58. Annual contributions would be capped at $5,000. Unlike the current-law IRAs and 401(k)s, funds deposited into RSAs are completely sheltered from taxation, creating a substantial drain on the national tax base in future years. LSAs are similar to RSAs except that distributions may be made tax-free for any purpose. In effect, LSAs would allow affluent taxpayers to shelter up to $5,000 from taxation without guaranteeing any real accumulation of capital. In the short run, these provisions may actually prove to be revenue positive, because taxpayers are allowed to cash out tax-deferred instruments such as IRAs to take advantage of these new accounts. According to an analysis by the Urban Institute - Brookings Tax Policy Center, the drain on federal revenues could be as high as $50 billion annually once the program reaches maturity.
  
  
• Employer Retirement Savings Accounts (ERSAs) — Under current law, workers may participate in a variety of employer-based savings plans at work. Examples include 401(k), SIMPLE 401(k), and 403(b) plans. In light of the decline in defined-benefit plans, these plans are usually the prime savings vehicle a worker has to guarantee a secure retirement. To guarantee that these plans are not used primarily as a shelter for highly paid managers and proprietors, employers must meet a set of nondiscrimination criteria. The 2005 budget replaces existing accounts with ERSAs which would have significantly more relaxed nondiscrimination rules.
  
  
• Refundable Tax Credit for Purchase of Health Insurance — To offer working Americans more access to health insurance, the budget allows taxpayers to claim a refundable tax credit against health insurance premiums. The credit would be equal to a percentage of the premium not to exceed $1,000 per adult and $500 per child. Depending on the age and health of the families and individuals covered, health insurance premiums for comprehensive plans can be in excess of $20,000 per year. The percentage amount of the credit would be 90 percent for low-income workers, and be phased out at $30,000 for singles and $60,000 for families. According to the Treasury, the credit for a family of four making $40,000 per year would be $1,714. The proposal costs $70.1 billion in combined revenue losses and outlays for taxpayers whose tax liabilities have been reduced to zero. The high cost of health insurance is due in large part to market inefficiencies and mispricing of risk. The Administration has made no effort to tackle these underlying factors. While no numbers have been offered by the Administration, it seems clear that this provision will not have a significant effect on the problem of the uninsured in the United States.
  
  
• Above-the-Line Deduction for Premiums Paid for Catastrophic Health Insurance — Health Savings Accounts (HSA) became law as part of the recently enacted Medicare legislation as the successor to Archer Medical Savings Accounts. HSA allow tax-free deposits and withdrawals for qualified medical expenses. To participate in the program, an individual must purchase a high-deductible catastrophic health insurance plan. The budget further compounds the drain on the Treasury by making premiums for catastrophic health insurance fully tax deductible. This proposal costs $24.8 billion on top of the cost of the HSA provision already in the law. See Function 570 (Medicare) for details on HSA.
  
  
• Charitable Contribution Deduction for Nonitemizers — Under current law, nonitemizers receive a standard deduction covering all deductible expenses including charitable contributions. This initiative allows nonitemizers to claim a deduction of up to $250 for the amount of a charitable contribution in excess of $250. This provision would be extremely difficult and cumbersome for the IRS to verify and costs $12.0 billion over 10 years.
  
  
• Tax Administration — The budget includes several measures designed to improve tax administration. First, the IRS is allowed to enter into installment agreements with taxpayers who only partially repay the outstanding tax liability. Second, the IRS may withhold vendor and other non-periodic Federal payments under the Federal Payment Levy Program. Third, the IRS is permitted to contract with private collection agencies to collect unpaid taxes. Fourth, States will be required to update their laws to prevent employers from manipulating their risk ratings under the Unemployment Insurance program in order to avoid paying higher premiums. These and other smaller tax administration measures raise $2.1 billion over ten years.
  
  
• Extend Research and Experimentation (R&E) Tax Credit — Firms receive a credit of 20 percent of R&E expenses above a certain amount, depending on their R&E expenditures in previous years. The credit will expire on June 30, 2004 if no action is taken. The 2005 budget makes the credit permanent and studies options to make it more effective. Critics of the credit point to its complexity and the fact that it can unequally reward firms with identical behavior in a given year. The provision costs an estimated $78.4 billion over ten years.
  
  
• Leasing Transactions with Tax-Indifferent Parties — State and local governments own large amounts of physical infrastructure. If the infrastructure were owned by a private company, that company would write off depreciation against profits for tax purposes. Taking advantage of the tax law, certain municipalities have sold physical assets to private firms and then immediately leased those assets back. Municipalities have in effect used the tax benefits of depreciation as a new source of funds. The President's budget limits the amount of the deduction to the taxable income earned for the year on the transaction. Disallowed deductions can be carried forward to future years. The purchasing firm will eventually be able to claim all previously disallowed deductions upon disposal of its interest the property. This measure raises $33.4 billion over ten years.
  
  
• Repeal of Disallowance of Certain Deductions of Mutual Life Insurance Companies — Dividends paid to policyholders by mutual life insurance companies have traditionally been deductible while ordinary dividends paid to shareholders are not. Since 1984, the tax code has included an adjustment based on industry earnings data. In seven of the past ten years this adjustment has been zero. As a result, policyholder dividends have been fully deductible. Because of the complexity of calculating the adjustment, the problems in calculating tax liability based on industry-wide data, and widespread demutualization, this provision was temporarily repealed by the 2002 tax bill. The budget permanently repeals the provision at a cost of $471 million over ten years.
  
  
• Work Opportunity Tax Credit and Welfare-to-Work Tax Credit — The Work Opportunity Tax Credit (WOTC) allows employers to claim a 40 percent tax credit on the first $6,000 of wages paid. For summer youth jobs, employers can claim the credit up to $3,000. For part-time employees, the credit is 25 percent of qualified workers' wages. The Welfare-to-Work (WTW) Credit allows employers to claim a 50 percent credit on the first $10,000 in wages for the first year of employment and 35 percent in the second year. Qualified workers for both programs generally must be from a set of underemployed populations, especially TANF recipients. Educational assistance can be included in the wage base for WTW. The 2005 budget combines the two programs. The eligible wage base would be $10,000 for welfare-to-work employees, $6,000 for other groups, and $3,000 for summer youth. A second year would be available for TANF recipients. There would be a two-year transition period. The provision cost $768 million over ten years.
  
  
• Qualified Zone Academy Bonds — State and local governments are allowed under the law to issue Qualified Zone Academy Bonds ( QZABs). Investors who purchase QZABs are not paid interest by the issuing entity; instead, they claim a tax credit on their federal income tax returns in lieu of interest. Issuers may then use the proceeds from the sale of QZABs to finance capital improvements, equipment purchases, and teacher training. Under previous law, State and local governments could issue up to $400 million in QZABs each year from 1998 through 2003. The Administration will authorize the issue of $400 million in QZABs for 2004 and 2005. The provision would cost $254 million over ten years.
  
  
• Authority to Issue Liberty Zone Bonds — Under current law, the State of New York and New York City have the authority to issue $8 billion in exempt facility bonds that are not subject to the general private activity bond volume cap. The proceeds must be used in reconstruction projects in the area designated as the New York Liberty Zone in lower Manhattan (the site of the 2001 terrorist attack). The 2005 budget extends the authority through December 31, 2009. The provision would cost $616 million through 2014.

   

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