The Heritage Foundation

Executive Summary #1219es on Taxes

September 9, 1998

September 9, 1998 | Executive Summary on Taxes

BG1219es:  How Congress Can Return the Surplus toTaxpayers:  Three Approaches to Tax Cuts and Social SecurityReform

Congress's commitment to reducing today's record tax burden is being tested during the current debate over what to do with the budget surplus. Tax revenues now consume about 21 percent of U.S. economic output, and government spending continues to break new heights with each passing budget. As these revenues pile up in the Treasury, Congress and President Clinton dither over whether the forecasted $1.4 trillion in ten-year budget surpluses should be allocated to tax cuts or to Social Security reform.

In truth, Congress can attend to both of these urgent issues. The budget surplus forecasts of the Congressional Budget Office provide policymakers with an expected inventory of financial resources that should be used creatively to reduce income taxes now. These forecasts also give them the basis for beginning the crucial movement to worker-controlled personal savings accounts (PSAs).

If Congress and the President do not act, the broken tax and Social Security systems will continue to constrain the economy and threaten future U.S. financial and economic security. Current tax policy discourages savings and investment, imposes enormous compliance costs on taxpayers, callously shifts the payment of taxes to low- and moderate-income households through higher prices, and distorts economic decision-making. The current Social Security system yields such low returns for a lifetime of tax payments that low- and moderate-income workers stand to lose thousands of dollars in potential retirement income. Social Security's retirement program faces enormous financial challenges in ten years that threaten either to bankrupt the government or to drain more dollars from workers through higher taxes, thus further reducing the rate of return for the retirement program.

There are many ways Congress could return the budget surpluses to taxpayers through tax cuts and Social Security reform. Three approaches are described in this paper.

  • Plan A, the Heritage Plan, calls for the creation of PSAs for all workers using 5 percentage points of their Social Security payroll tax. It also calls for immediate elimination of the marriage penalty, a top capital gains tax rate of 10 percent, immediate repeal of federal death taxes, expanded educational savings accounts, repeal of the Federal Unemployment Tax Act (FUTA) surtax, and reform of Section 125 ("cafeteria plan") rollover provisions for health care expenses. The income tax changes equal $574.3 billion over ten years. The creation of PSAs that equal 5 percentage points of the payroll taxes puts $1.9 trillion in payroll taxes under the control of the workers who earned them.

  • Plan B allocates approximately 60 percent of the surplus to beginning Social Security reform and 40 percent to income tax reform. The plan calls for $574 billion in income tax cuts over ten years, the result of eliminating the marriage penalty to repealing the FUTA surtax. The ten-year difference between the surplus and the income tax cuts, $792.7 billion, would be reserved for reforming Social Security's retirement program through the creation of personal retirement accounts financed by reductions in the payroll tax.

  • Plan C allocates 70 percent of the surplus to Social Security reform and 30 percent to income tax reform. The plan incorporates many of the proposals in Plan A but substitutes the cut in the capital gains tax (from 20 percent to 15 percent) proposed by House Speaker Newt Gingrich (R-GA) and the phaseout of federal death taxes proposed by Representatives Jennifer Dunn (R-WA) and John Tanner (D-TN) for Plan A's 10 percent capital gains tax rate and immediate repeal of death taxes. The amount of the surplus remaining after these income tax changes ($937 billion over ten years) is allocated to restructuring Social Security's retirement program.

--William W. Beach is John M. Olin Senior Fellow in Economics and Director of the Center for Data Analysis at The Heritage Foundation.

About the Author

William W. Beach Director, Center for Data Analysis and Lazof Family Fellow
Center for Data Analysis