The Distribution of the 2001-2006 Tax Cuts: Updated Projections, November 2006

www.taxpolicycenter.org The Distribution of the 2001-2006 Tax Cuts: Updated Projections, November 2006 Greg Leiserson and Jeffrey Rohaly Since 2001 Congress has passed a major tax bill almost every year. Most have reduced taxes significantly and, since they were not accompanied by spending cuts, the resulting deficits have also increased the national debt. The largest was the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), which had a ten-year revenue loss of $1.35 trillion. The Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) cut taxes by another $350 billion. Subsequent legislation cut taxes by another $146 billion in 2004 (WFTRA) and $142 billion in 2006 (TIPRA and PPA).1 The tax cuts total approximately $2 trillion over ten years, and that total may be vastly understated if some or all of the tax cuts are extended beyond their scheduled expiration at the end of 2010.2 As Congress considers whether to extend the tax cuts, pare them back, or simply allow them to expire as scheduled, an important consideration is how the benefits of the tax cuts are distributed as well as how tax burdens would be altered when options to finance the resulting deficits are considered. The long-term effect of the 2001-2006 tax cuts on the distribution of income will depend on how they are paid for, but their immediate effect has been skewed in favor of those with high incomes. In 2006, for example, the tax cuts are equivalent to 2.5 percent of after-tax income for the middle quintile of the income distribution compared with 4.1 percent of income for those in the top quintile. Households in the bottom quintile receive a benefit of 0.3 percent of income. For taxpayers in the top one percent, the benefits are scheduled to increase even more as additional cuts – primarily to the estate tax – phase in between now and 2010. Compared to pre-EGTRRA law, taxpayers in the top one percent will enjoy a 5.4 percent increase in after-tax income in 2006 and a 6.7 percent increase in 2010. Over the long-term, tax cuts must be financed through spending cuts, other tax increases, or a combination of the two. The financing approach chosen will significantly affect the ultimate distributional impact of the cuts. For example, if the revenue loss from the 2001-2006 tax cuts is offset by an additional tax levied in proportion to cash income, taxpayers in the bottom four quintiles will all face a drop in after-tax income in 2010. Taxpayers in the lowest quintile will suffer a 2 percent drop in after-tax income while taxpayers in the top quintile will see a 0.4 Leiserson is a research assistant, and Rohaly is the director of tax modeling, for the Urban-Brookings Tax Policy Center. Views expressed are those of the authors alone and do not necessarily reflect the views of The Urban Institute, its Board or its funders. We thank Len Burman for helpful comments and suggestions. 1 WFTRA is the Working Families Tax Relief Act of 2004; TIPRA is the Tax Increase Prevention Reconciliation Act of 2005; and PPA is the Pension Protection Act of 2006. 2 For an analysis of the cost of making the tax cuts permanent, see Auerbach, Gale, and Orszag (2006). percent increase. Taxpayers in the top one percent will see a 3.3 percent increase in after-tax income. This review presents a brief summary of the major provisions of the tax cuts, traditional distribution tables for the tax cuts by cash income class and cash income percentile, the distribution of tax units by the size of tax cuts and individual characteristics, and distribution tables for the tax cuts by cash income class and cash income percentile for three different illustrative financing options.3 Summary of the Laws4 In May 2001, Congress passed the Economic Growth and Tax Relief Reconciliation Act (EGTRRA), sweeping legislation that reduced individual income tax rates; gradually phased out the estate tax; doubled the child tax credit and made it partially refundable; reduced marriage penalties (and increased marriage bonuses); enhanced the child and dependent care credit; increased contribution limits on tax-deferred retirement savings vehicles, such as IRAs and 401(k)s; expanded credits and deductions for education-related expenses; and temporarily increased the alternative minimum tax (AMT) exemption. To keep the official 10-year cost estimate of the legislation to $1.35 trillion, Congress phased in many provisions over several years and allowed the entire bill to “sunset,” or expire, at the end of 2010. Two years later, Congress passed the Jobs and Growth Tax Relief Reconciliation Act (JGTRRA), which accelerated the individual tax rate reductions in EGTRRA that were not scheduled to take full effect until 2006. It also sped up other major provisions in EGTRRA, such as the increased child credit and some marriage-penalty relief provisions. In addition, the legislation reduced the tax rate on most long-term capi