Saving Incentives: What May Work, What May Not

[Excerpt] Saving is the portion of national output that is not consumed and represents resources that can be used to increase, replace, or improve the nation’s capital stock. The U.S. net national saving rate reached a post-war peak of 12.4% in 1965 and has then trended downward since to a low of 0.8% in 2005. Many analysts claim that saving is too low. Among the Organization for Economic Cooperation and Development (OECD) countries, the United States has the third lowest saving rate. Survey evidence suggests that people know why they should save, but many don’t save, especially lower-income individuals and families. Several reasons have been offered to explain the declining personal saving rate and the relatively high proportion of individuals and families that do not save. Economic reasons start from the premise that individuals and families are rational and make optimal decisions about consumption and saving throughout the life course. Low saving rates are then explained by economic disincentives induced by government policy or by life cycle changes in the propensity to save. Behavioral reasons start from the premise that individuals and families do not always make optimal decisions regarding consumption and saving

Increasing the Social Security Payroll Tax Base: Options and Effects on Tax Burdens

[Excerpt] The payroll tax for Social Security and Medicare is the largest federal tax many lower- income families pay. The Congressional Budget Office (CBO) estimates that the poorest 20% of U.S. households paid about 8.3% of their income on social insurance payroll taxes in 2009. In contrast, these lower-income households paid negative income taxes because of the refundable earned income and child tax credits. Indeed, a justification for the earned income credit (EIC) is “to provide work incentives and relief from income and Social Security taxes to low-income families who might otherwise need large welfare payments.” The tax rate under current law on covered earnings is 12.4% for Social Security and 2.9% for Medicare. Half of the tax rate is paid by the employee and the other half by the employer; the self-employed are responsible for the entire amount. The tax rate for Social Security applies only on covered earnings below the maximum taxable limit, which is $113,700 for 2013. The Medicare tax rate applies to all covered earnings. The Social Security Trustees project that the assets in the two Social Security trust funds will be exhausted in 2033, and after that, Social Security payroll tax revenue will cover about three- quarters of promised benefits. To help close Social Security’s long-term financing gap, some analysts have proposed increasing the Social Security tax base by raising the maximum taxable limit so that 90$186,000 in 2008, almost double the actual limit, so that 90% of covered earnings are taxable. They estimated that this policy could have increased payroll tax revenues by $503.4 billion over the 2010-2019 period. The Urban Institute reports that the Social Security Administration estimates the 2012 maximum taxable limit would have had to been$214,500 so that 90% of covered earnings were taxable. Since 1982, the ratio of taxable earnings to covered earnings has fallen from 90%, reaching 82.7% in 2007. 82.7% in 2007. Although most analysts advocate raising the maximum taxable limit to increase revenues for the Social Security program, some would use the increased revenues for other purposes. For example, one analyst suggested reducing the payroll tax rate and keeping it revenue-neutral by raising the maximum taxable limit. This change would provide payroll tax relief to low- and middle- income workers. This report examines changes in the distribution of the tax burden of four policies involving raising the Social Security maximum taxable limit

An Analysis of the “Buffett Rule”

[Excerpt] Warren Buffett, the chairman of Berkshire Hathaway, noted that he paid 17.4% of his taxable income in income and payroll taxes—“a lower percentage than was paid by any of the other 20 people” in his office. He stated that “the mega-rich pay income taxes at a rate of 15 percent on most of their earnings but pay practically nothing in payroll taxes.” Within a month, the Obama Administration unveiled a plan for economic growth and deficit reduction. The Administration stated that one of its principles for tax reform was to observe the “Buffett rule”—“no household making over $1 million annually should pay a smaller share of its income in taxes than middle-class families pay.” On October 5, Senator Harry Reid introduced the American Jobs Act of 2011(S. 1660), which contains a 5.6% surtax on millionaires to pay for the provisions of the jobs bill. This report examines the Buffett rule, but uses a measure of income that captures the ability to pay taxes and incorporates the effect of the corporate income tax in addition to the individual income tax and the payroll tax. The results of this analysis show that the current U.S. tax system violates the Buffett rule in that a large proportion of millionaires pay a smaller percentage of their income in taxes than a significant proportion of moderate-income taxpayers. Roughly a quarter of all millionaires (about 94,500 taxpayers) face a tax rate that is lower than the tax rate faced by 10.4 million moderate-income taxpayers (10% of the moderate-income taxpayers). Tax reforms that are consistent with the Buffett rule would likely include raising tax rates on capital gains and dividends. For example, the President has proposed allowing the 2001 and 2003 Bush tax cuts to expire for high-income taxpayers and taxing carried interests of hedge fund managers as ordinary income as tax reforms that observe the Buffett rule. Research suggests that these tax reforms are unlikely to affect many small businesses or to deter saving and investment

Changes in the Distribution of Income Among Tax Filers Between 1996 and 2006: The Role of Labor Income, Capital Income, and Tax Policy

[Excerpt] This report examines changes in income inequality among tax filers between 1996 and 2006. In particular, the role of changes in wages, capital income, and tax policy, especially the 2001 and 2003 tax cuts, is investigated. During this period, there were changes in the sources of income that differed by income category and there were changes in tax policy. The years 1996 and 2006 are examined for several reasons. First, both years were at approximately similar points of the business-cycle with moderate inflation (about 3%), a modest unemployment rate (about 5%), and moderate economic growth (3.7% in 1996 and 2.7% in 2006). Second, 2006 was the year before the August 2007 liquidity crunch and the onset of the severe 2007-2009 recession. Third, there were major tax policy changes between these two years. Fourth, both 1996 and 2006 were three years after the enactment of tax legislation that affected tax rates and are unlikely to be affected by short-run behavioral responses to these changes

The Bush Tax Cuts and the Economy

[Excerpt] A series of tax cuts were enacted early in the George W. Bush Administration by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA; P.L. 107-16) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA; P.L. 108-27). These tax cuts, which are collectively known as the Bush tax cuts, are scheduled to expire at the end of 2010. Beginning in 2011, many of the individual income tax parameters (such as tax rates) will revert back to 2000 levels. The major tax provisions in EGTRRA and JGTRRA that are part of the current debate over the Bush tax cuts are the reduced tax rates, the reduction of the marriage penalty (and increase in the marriage bonus), the repeal of the personal exemption phaseout and the limitation on itemized deductions, the reduced tax rates on long-term capital gains and qualified dividends, and expanded tax credits. This report examines the Bush tax cuts within the context of the current and long-term economic environment

Taxes and the Economy: An Economic Analysis of the Top Tax Rates Since 1945

Income tax rates have been at the center of recent policy debates over taxes. Some policymakers have argued that raising tax rates, especially on higher income taxpayers, to increase tax revenues is part of the solution for long-term debt reduction. For example, the Senate recently passed the Middle Class Tax Cut (S. 3412), which would allow the 2001 and 2003 Bush tax cuts to expire for taxpayers with income over $250,000 ($200,000 for single taxpayers). The Senate recently considered legislation, the Paying a Fair Share Act of 2012 (S. 2230), that would implement the “Buffett rule” by raising the tax rate on millionaires. Other recent budget and deficit reduction proposals would reduce tax rates. The President’s 2010 Fiscal Commission recommended reducing the budget deficit and tax rates by broadening the tax base—the additional revenues from broadening the tax base would be used for deficit reduction and tax rate reductions. The plan advocated by House Budget Committee Chairman Paul Ryan that is embodied in the House Budget Resolution (H.Con.Res. 112), the Path to Prosperity, also proposes to reduce income tax rates by broadening the tax base. Both plans would broaden the tax base by reducing or eliminating tax expenditures. Advocates of lower tax rates argue that reduced rates would increase economic growth, increase saving and investment, and boost productivity (increase the economic pie). Proponents of higher tax rates argue that higher tax revenues are necessary for debt reduction, that tax rates on the rich are too low (i.e., they violate the Buffett rule), and that higher tax rates on the rich would moderate increasing income inequality (change how the economic pie is distributed). This report attempts to clarify whether or not there is an association between the tax rates of the highest income taxpayers and economic growth. Data is analyzed to illustrate the association between the tax rates of the highest income taxpayers and measures of economic growth. For an overview of the broader issues of these relationships see CRS Report R42111, Tax Rates and Economic Growth, by Jane G. Gravelle and Donald J. Marples. Throughout the late-1940s and 1950s, the top marginal tax rate was typically above 90%; today it is 35%. Additionally, the top capital gains tax rate was 25% in the 1950s and 1960s, 35% in the 1970s; today it is 15%. The real GDP growth rate averaged 4.2% and real per capita GDP increased annually by 2.4% in the 1950s. In the 2000s, the average real GDP growth rate was 1.7% and real per capita GDP increased annually by less than 1%. There is not conclusive evidence, however, to substantiate a clear relationship between the 65-year steady reduction in the top tax rates and economic growth. Analysis of such data suggests the reduction in the top tax rates have had little association with saving, investment, or productivity growth. However, the top tax rate reductions appear to be associated with the increasing concentration of income at the top of the income distribution. The share of income accruing to the top 0.1% of U.S. families increased from 4.2% in 1945 to 12.3% by 2007 before falling to 9.2% due to the 2007-2009 recession. The evidence does not suggest necessarily a relationship between tax policy with regard to the top tax rates and the size of the economic pie, but there may be a relationship to how the economic pie is sliced

Taxes and the Economy: An Economic Analysis of the Top Tax Rates Since 1945 (Updated)

[Excerpt] Advocates of lower tax rates argue that reduced rates would increase economic growth, increase saving and investment, and boost productivity (increase the size of the economic pie). Skeptics of this view argue that higher tax revenues are necessary for debt reduction, that tax rates on high-income taxpayers are too low (i.e., they violate the “Buffett rule”), and that higher tax rates on high-income taxpayers would moderate increasing income inequality (change how the economic pie is distributed across families). This report attempts to explore whether or not there is any evidence of an association between the tax rates of the highest income taxpayers and economic growth. The analysis in this report does not provide a comprehensive model to examine all the determinants of economic growth. Data are analyzed to illustrate the association between the tax rates of the highest income taxpayers and measures of economic growth

Income Inequality, Income Mobility, and Economic Policy: U.S. Trends in the 1980s and 1990s

[Excerpt] Income inequality has been increasing in the United States over the past 25 years. Several factors have been identified as possibly contributing to increasing income inequality. Some researchers have suggested the decline in unionization and a falling real minimum wage as the primary causes. Others have argued that rising returns to education and skill-biased technological change are the important factors explaining rising inequality. Most analysts agree that the likely explanation for rising income inequality is due to skill-biased technological changes combined with a change in institutions and norms, of which a falling minimum wage and declining unionization are a part. Since most people are concerned with upward mobility, and given the central importance of income mobility to the debate over income inequality, this report examines the relation between income mobility and inequality. Income mobility studies are an important complement to income inequality studies — income inequality does not address the issue of whether or not the poor are getting poorer, whereas income mobility does. While there appears to be considerable relative income mobility (about 60% of individuals change income quintiles over 10 years), it is not far — about 60% of those individuals who changed income quintile in the 1980s or 1990s only moved to the next quintile. But most individuals in the poorest quintile in 1980 experienced an increase in their real income between 1980 and 1989 — half saw their real income increase by more than 36%. Of those in the richest quintile, almost half saw their real income fall by 10% or more during the 1980s. But there are differences in income changes between the 1980s and the 1990s: those in the poorest income quintile may have done slightly better in the 1990s than in the 1980s, while individuals higher up in the income distribution (quintiles 2-5) appear to have done better in the 1980s than in the 1990s. In both the 1980s and 1990s, income growth was progressive and had an equalizing effect on the income distribution, but the equalizing effect had a larger absolute value in the 1990s than in the 1980s. Mobility, however, had a disequalizing effect and, in fact, outweighed the progressivity effect, thus increasing the annual inequality. In both decades, the long-term income inequality is lower than the income inequality in the first year of the decade. The results suggest that mobility had a greater equalizing effect on long-term inequality in the 1990s than in the 1980s. Three broad types of government economic policy affect income growth and mobility, and hence income inequality: (1) regulation, (2) the tax system, and (3) government transfers. Economic policies to reduce the growth of income inequality may work, in part, through their effects on income mobility. Reducing income mobility (that is, stabilizing incomes) may reduce the rising trend in income inequality, but it could also increase inequality of longer-term income