Let’s Have a Real Middle-Class Tax Cut
Obama’s tax credits won’t stimulate the economy.
President-elect Barack Obama is right: America needs a real and meaningful middle-class tax cut. Unfortunately, despite the rhetoric, that is not what his proposals offer.
Mr. Obama’s tax plan includes creating or expanding nine or more federal income tax credits mostly focused on low- and moderate-income earners, with an estimated cost of $1.3 trillion over 10 years. These tax credits are provided for certain social purposes, such as child care, health care, education, housing and retirement. Buried amid these is Mr. Obama’s purported tax cut for the middle class.
For the bottom 40% of income earners, who pay no federal income taxes on net today, these refundable income tax credits will not reduce tax liability but instead result in new checks from the federal government for the targeted social purposes. That’s not a tax cut. It’s welfare.
These tax credits will do little or nothing to promote economic growth because they do not reduce marginal tax rates — the rate on the next dollar of income — to provide powerful, meaningful incentives for productive activities such as investment, entrepreneurship and work. A tax credit is effectively a cash grant that can only affect incentives up to the amount of the grant. Indeed, such tax credits would likely reduce economic growth because the credits are phased out as income rises, and so effectively impose higher marginal tax rates over those income levels.
For a real middle-class tax cut, we should cut the 25% income tax rate that now applies to single workers earning $32,550 to $78,850, and married couples earning $65,100 to $131,450. We should reduce that rate down to the 15% rate paid by workers below these income levels. That would, in effect, establish a flat-rate tax of 15% for close to 90% of American workers.
Marginal tax rates for middle-income families in the 25% tax bracket are too high. Add in effective payroll tax rates of 15% and state income taxes, and these workers are laboring under marginal tax rates of close to 50%. No wonder middle-income wage growth has slowed sharply. Reducing the marginal tax rates for these middle-income earners would lead to income increases for middle-income workers, just as reducing excessive marginal tax rates for higher-income workers did, going all the way back to the Kennedy tax cuts of the 1960s.
This 40% cut in middle-class income tax rates would provide a powerful boost to the economy, greatly expanding incentives for savings, investment and work. This would be much more effective than Mr. Obama’s tax plan with it’s $1.3 trillion in redistributive tax credits, as well as yet another so-called stimulus package based on another $300 billion or more in increased government spending.
Taxing or borrowing from the economy and then spending hundreds of billions more through government bureaucracies will have zero effect in promoting economic growth, as did the failed stimulus package adopted by the Bush administration this year.
We could add to this alternative tax proposal an increase in the personal exemption from $3,500 to $7,000. The package would then cut taxes for all taxpayers, including those in the lower tax brackets. Of course, reducing the top income tax rates of 28%, 33% and 35%, capital gains tax rates, and the excessive 35% corporate tax rate, would boost the economy even more. But these are the “hate” rates imposed on those who liberals think are too productive, work too hard, and earn too much. Liberals deride these taxpayers as corporate fat cats and “the rich.”
Fine. Leave those rates for a future initiative. For now we should focus on the middle-income tax rates that are attractive to cut in the current political climate. This would continue the tax cuts for low- and moderate-income workers Republicans have been adopting for 30 years now.
Because of the highly beneficial effect of these middle-class rate reductions on our economy, and the freedom they would give workers to spend, save or invest their money as they choose, this proposal would likely enjoy broad public support and present a viable alternative to the liberal social purposes of President-elect Obama’s tax credits.
Mr. Gingrich is the former speaker of the House. Mr. Ferrara is director of entitlement and budget policy for the Institute for Policy Innovation.