President Obama famously said during the campaign that he thinks
the economy works best when "we spread the wealth around." He is
wasting no time pursuing this redistributionist agenda, and he is
using the tax code to do it.
The Wrong Medicine
The so-called "stimulus" bill (H.R. 1, the American Recovery and
Reinvestment Act of 2009) created the refundable Making Work Pay
Credit, increased and made refundable the Hope Scholarship Credit
(now renamed the American Opportunity Education Credit), and
increased the two largest existing refundable credits, the Earned
Income Tax Credit (EITC) and the Child Tax Credit. To the extent
these credits are refundable, they are really spending run through
the tax code and as such will do nothing to boost the ailing
economy.
These Credits Will Not Stimulate the
Economy
These credits are accurately described as spending programs,
because they are all refundable. Refundable credits send checks to
low-income taxpayers when their value is more than the taxpayer's
income tax liability. For example, if a taxpayer with an $800
income tax liability claims a refundable credit worth $1,000, he
will pay no income taxes and receive a check for $200 from the
IRS.
It is impossible to cut taxes for a taxpayer who pays no taxes.
Thus, refunds to taxpayers who pay no income taxes cannot, by
definition, be a tax cut. The checks sent to taxpayers from
refundable credits are spending pure and simple, and it is
misleading to pretend otherwise. So low-income taxpayers that claim
the refundable portion of these credits will have their entire
income tax liability wiped out and receive checks from the IRS.
This spreads income to low-income groups and those engaged in
preferential behaviors while doing nothing to encourage economic
growth.
Increased government spending does not increase economic growth
in the near term because Congress cannot create purchasing power
out of thin air. Before it can spend, it must first take money out
of the economy through taxes or borrowing.[1] No new spending power is
created; it is merely redistributed from one group of people to
another. In this case, the credits spread income to low- and
middle-income taxpayers because they are not available for
upper-income taxpayers. Single taxpayers who earn over $95,000 and
married taxpayers earning over $190,000 receive no benefit from any
of the credits.
Making Work Pay Credit.The Making Work Pay Credit is a
refundable credit on wages (called "wage income") up to $400 for
individuals and $800 for married couples. It phases out at 2
percent for taxpayers with over $75,000 ($150,000 for married
couples) of adjusted gross income (AGI) until it is completely
phased out for taxpayers with AGI over $95,000 ($190,000 for
married couples). The credit applies only to wages, so it
specifically targets low- and middle-income workers.
The Making Work Pay Credit is the most widely available of the
credits affected by H.R. 1 because it can be taken by all taxpayers
earning wage income so long as they are working, but it is not
applicable to income from other sources such as interest,
dividends, pensions, or Social Security. The Making Work Pay Credit
is a step toward fulfilling Obama's campaign promise to cut taxes
for 95 percent of workers, but rather than providing a general tax
cut for all, it provides a tax cut for some, an expansion of
welfare payments to others, and absolutely nothing to others.
American Opportunity Education Credit. The
American Opportunity Education Credit is a $2,500 credit applied to
college tuition and related expenses for four years. It is
refundable up to 40 percent of the credit, so it could send checks
of up to $1,000 to low-income taxpayers who qualify. It begins to
phase out for taxpayers with AGI of $80,000 ($160,000 for married
couples) and completely phases out at $90,000 ($180,000 for married
couples). Alarmingly, a provision in the bill requires the Treasury
secretary to study the feasibility of requiring students to perform
community service in order to receive the credit.
The American Opportunity Education Credit reduces the costs of
investing in education, but requiring community service in exchange
for the credit is an astonishing use of the tax code. Attending
college and performing community service are certainly positive
activities, but making the benefit of a tax provision contingent on
additional favored behavior is not tax relief but social
engineering.
Child Tax Credit. The Child Tax Credit is $1,000
for every qualifying child claimed on a taxpayer's return and
phases out for taxpayers with AGI over $75,000 ($110,000 for
married couples). It is refundable at 15 percent of a taxpayer's
income over $3,000. H.R. 1 reduced the floor above which the credit
is refundable from $8,500 to $3,000. For example, a family needed
to earn above $8,500 per year to qualify for the refundable portion
of the Child Tax Credit before passage of H.R. 1, but now the same
family could receive a refundable benefit at only $3,000 of
earnings.
Unfortunately, the expansion of the refundability of the Child
Tax Credit in H.R. 1 would do nothing to encourage workers to work
more, investors to take on more risk, or businesses to expand
operations: All it does is redistribute income to low-income
families.
Earned Income Tax Credit. The EITC is a refundable
credit for low-income working families and individuals. Its value
ramps up at lower levels of income until it reaches a maximum point
where it begins to phase down. The amount of the credit depends on
the number of children in the family. For example, credits for
qualifying families with no children are calculated at 7.65 percent
of earned income, while payments to families with two or more
children are calculated at 40 percent. H.R. 1 created a new
category for families with three or more children and increased the
amount of credit they can claim by raising their credit rate from
40 percent to 45 percent. The higher rate increases the value of
the credit and therefore the amount of money these families receive
through the credit's refundable portion.
H.R. 1 also increased the value of the credit to all married
couples claiming the EITC, regardless of number of children, by
lifting the level of income the EITC begins to phase out by $1,880
to a maximum of $21,420. Just like the expansion of the Child Tax
Credit, the expansion of the EITC spreads income to low-income
families but does nothing to stimulate economic growth.
Spreading More Income Around
The tax changes in H.R. 1 focus on rewarding targeted groups or
behaviors, largely covering the President's campaign promises to
"spread the wealth around." In doing so, the President missed an
opportunity to actually stimulate economic growth and put money in
the pockets of those he wanted to help at the same time by cutting
tax rates, especially those on income and investment.[2]
H.R. 1 is the first step in President Obama's plan to "spread
the wealth around." Step two is the President's proposed tax
increases on high-income earners, as outlined in the recently
released "Budget Blueprint," which limits deductions and increases
tax rates for high-income earners.
Curtis S. Dubay is a Senior
Analyst in Tax Policy in the Thomas A. Roe Institute for Economic
Policy Studies at The Heritage Foundation.