How much would an individual tax rate cut add to the deficit?

Reducing tax rates is a guiding principal of most tax reform plans. But how much does Treasury lose when Congress reduces individual tax rates, and which taxpayers benefit the most from the cuts?

J. David Ake/AP/File
A jogger on an early morning run passes the U.S Treasury Building in Washington.

Reducing tax rates is a guiding principal of most tax reform plans. Even Democrats who see reform partly as a tool to boost revenues agree that some money generated by eliminating tax preferences ought to go to rate reduction. But how much does Treasury lose when Congress reduces individual tax rates, and which taxpayers benefit the most from the cuts?

My Tax Policy Center colleague Elena Ramirez has just updated TPC’s estimates and the results are illuminating. A one percentage point across-the-board reduction in tax rates would add $662 billion to the budget deficit over 10 years—about $40 billion in 2015 rising to more than $85 billion by 2024. More than half the benefit would go to the households in the top 20 percent of income, while the highest-income one percent would pocket nearly 22 percent of the rate cut.

Put another way, people making between $10,000 and $20,000 would enjoy about a 0.1 percent boost in after-tax incomes, or about $7 on average. Those making $50,000 to $75,000 would get an additional 0.5 percent or $295. And those making $1 million or more would see their after tax incomes rise by 0.9 percent, or nearly $18,000 on average.

Curiously, taxpayers in the top 95-99th  percentile (those making between about $270,000 and $640,000) would enjoy only a relatively modest benefit. Their after-tax income would rise by only about 0.4 percent, most likely because many would get hit by the Alternative Minimum Tax, or would have to pay a bigger AMT.

TPC also calculated that a 1 percentage point cut in the top rate only would add $108 billion to the deficit over 10 years. Nearly all the benefit would go to those making $1 million or more. Representative Paul Ryan (R-WI), seen by many as the next chairman of the House Ways & Means Committee, has beentalking up a cut in the top rate lately.

Keep in mind that TPC uses a broad definition of income that includes cash income plus tax-exempt employee and employer contributions to health insurance and other fringe benefits, employer contributions to tax-preferred retirement accounts, income earned within retirement accounts, and food stamps. This expanded cash income measure is much broader than Adjusted Gross Income that taxpayers calculate on their 1040s but more accurately measures their true income.

Elena’s estimates are useful benchmarks when you think about tax reform. And they are a good roadmap for lawmakers who search for offsetting reductions in tax preferences. If Congress wants to raise the same amount of revenue as current law, it would have to cut existing tax preferences by an average of $66 billion-a-year to fund a modest 1 percent across-the-board rate cut. That would require lawmakers to take a big bite out of some popular tax subsidies, well beyond their usual bland promise to eliminate “loopholes.”

But the TPC estimates come with an important caveat. Nobody is likely to propose a tax reform that cuts rates by just one percentage point. In fact, many plans aim for rate reductions in the neighborhood of 5 points or more.

Sadly, you can’t figure how much a 5 percent across-the-board tax cut would add to the deficit by simply taking TPC’s new numbers and multiplying by five. Why? In part because as rates are cut, more taxpayers would end up paying the AMT, thus reducing the overall revenue loss.

It is also important to remember that lower rates make tax expenditures less valuable (a 35 percent deduction is worth much more than a 30 percent deduction). As a result, the deeper the proposed rate cut, the more severely tax preferences must be reduced to offset the cost.

Even with those caveats, keep these new estimates in mind when lawmakers start talking about tax reform again. They’ll be a useful benchmark once the reform debate heats up again.

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