The Middle-Class Tax Cut That's Really a Hike

Jason Furman (PIIE)

November 8, 2017

Last week Speaker Paul Ryan introduced the House GOP tax bill, claiming it would "deliver real relief for people in the middle." Specifically, he said a "typical family of four would save $1,182 a year on their taxes." Mr. Ryan reiterated the number four more times during a three minute briefing. This is true, but only for the first year of the tax bill. After that the story gets grimmer.

The cuts Mr. Ryan trumpeted would phase out over time, as David Kamin, a law professor at New York University, has shown. By 2024 Mr. Ryan's hypothetical middle-class family making $59,000 would actually face a small tax increase. By 2027 that increase would grow to more than $450. Add in the effects of reducing or eliminating tax benefits many middle-class families now claim—for child care, major medical costs and higher education—and the "real relief" promised by Mr. Ryan starts looking more like a burden. Using the American Enterprise Institute's TaxBrain model, economist Ernie Tedeschi estimates the plan would result in more than 20 million households sending larger checks to the Internal Revenue Service in 2018. By 2027 more than 60 million households would be paying higher taxes.

This isn't surprising given that, in the aggregate, the House bill raises taxes on individuals. Over 10 years the plan cuts taxes by $1 trillion on businesses, $230 billion on individuals and $170 billion on estates, according to the Joint Committee on Taxation. While the business- and estate-tax cuts grow after that, the individual tax cuts shrink—disappearing entirely in 2024 and transforming into a net tax increase of $28 billion in 2027.

This is partly due to the necessity of holding down the bill's headline costs by sunsetting the family tax credit. This budget gimmick means the ultimate cost of the House plan would exceed the claimed $1.4 trillion. But even if the family tax credit were made permanent, the net individual income tax increase would only be delayed by a few years. The number of households facing a tax increase would fall only slightly.

As a matter of straightforward accounting, this bill will not provide middle-class families with the individual income tax cut President Trump and Speaker Ryan unambiguously promised. A complete analysis of the effect this bill would have on middle-class households would also incorporate the economic impact and incidence of two other elements of the House bill: a $1 trillion reduction in business taxes and the increase in the debt needed to finance the plan, which will likely be even larger.

Proponents of the tax bill argue that it will lead to dramatic increases in wages. Such claims are dubious. Mr. Trump's Council of Economic Advisers has claimed that a $4,000 per household raise constituted the "very conservative . . . lower bound" of the wage effects stemming from the bill's corporate rate cut. This claim has since been rejected by six of the economists the council cited to make its argument. Every specific analysis by a right-leaning economist or think tank that I am aware of has come in below the CEA's lower bound.

The Penn Wharton Budget Model finds the small wage boosts produced by the House bill could dissipate over time, eventually becoming small wage declines.

Beyond the wage claims, however, projections from conservative economists either ignore or don't address adequately the macroeconomic effects of higher debt stemming from the loss of revenue to the federal government due to the tax cuts. The costs of reduced capital accumulation and increased foreign borrowing will reduce national income over time. The Penn Wharton Budget Model—run by Kent Smetters, who helped build the dynamic scoring models used by the George W. Bush Treasury—finds the small wage boosts produced by the House bill could dissipate over time, eventually becoming small wage declines.

More important, the debt financing will likely have to be paid for through tax increases or benefit cuts on the same middle-class families Mr. Ryan surrounded himself with at last week's press conference. Unfortunately, the cost of this ill-advised reform will eventually be paid by future generations of American taxpayers.

Winners and losers are inevitable in any serious overhaul of the tax code. The House plan contains some commendable elements—like limiting the mortgage-interest deduction—that could be part of a sensible reform and spur economic growth. But by raising taxes on middle-class families and delivering so many of the long-run benefits to households making more than $1 million, the House plan as currently constructed will not deliver the broad-based relief Mr. Ryan is promising.

Reforming the tax code to foster economic growth benefiting all Americans will require a plan that is less tilted toward large cuts for high-income households, less likely to increase the national debt, and less of a burden on middle-class households. Congress should go back to the drawing board.