On October 27, ahead of the 2021 United Nations Climate Change Conference in Glasgow (October 31 to November 12), the Urban-Brookings Tax Policy Center and the Brookings Center on Regulation and Markets brought together climate and tax policy experts to examine recent proposals for U.S. energy tax policy. Catherine Wolfram, deputy assistant secretary of climate and energy economics at the U.S. Department of the Treasury, shared her perspective on the Biden administration’s climate strategy. Following her keynote, an expert panel consisting of Gilbert Metcalf (Tufts University), Carole Nakhle (Crystol Energy), and Kurt Van Dender (OECD), moderated by Thornton Matheson (Urban-Brookings Tax Policy Center), further discussed the U.S. approach to energy tax policy.

Viewers submitted questions for speakers by emailing events@brookings.edu or via Twitter using #taxandclimate.

      

Voting rights are the bedrock of democracy, but in many parts of the country, those rights are being eroded. In the aftermath of the 2020 election, while 25 states have enacted laws to improve access to the ballot, 18 states have enacted 30 laws making it harder to vote.

American citizens’ most basic rights should not be dependent on their zip code. Current patterns endanger the basic functioning of our elections and undermine the hard-won victories of the civil rights movement.

Policies encouraging citizens to register to vote when they file their income tax returns could play a crucial part in the protection and expansion of ballot access nationally. Properly implemented, voter registration at tax time has the capacity to augment existing ballot access policies and counteract or even reverse voter suppression policies as they apply to registration.

Tax-time voter registration is almost unique in the potential reach it affords; more than 150 million households file their income taxes every year and 99.5% of the U.S. population appears on at least one federal tax document (such as a W-2 or 1099) every year. About 90 percent of the population appears on a federal income tax return (such as Form 1040). These statistics compare favorably with the percentage of the U.S. public that is licensed to drive, which has been in decline, especially among younger people. Tax-time voter registration also benefits from being an annual process, more frequent than most Americans’ interactions with their departments of motor vehicles. Allowing citizens to register to vote or update their registration when they file their taxes has substantially improved the breadth and accuracy of the Canadian voter rolls; in November 2020, Elections Canada estimated that 96 percent of all eligible voters appeared on the country’s National Register of Electors.

In this report, “Voter registration at tax time: Evidence of efficacy, approaches to implementation,” we present the results of two rounds of field experiments—conducted during the 2018 and 2020 election cycles—that tested the efficacy of a program offering voter registration to lower-income people filing their income taxes through nonprofit Volunteer Income Tax Assistance (VITA) sites. We found that voter registration at tax filing is highly effective and does not slow tax preparation. In 2018, in a randomized controlled trial at seven VITA sites, we found that offering voter registration doubled the likelihood of an unregistered person registering to vote. In 2020, we made voter registration available to VITA clients at 23 sites; among program participants, the unregistered population was cut nearly in half.

This report then reviews possible routes to broad implementation of tax-time voter registration through voluntary channels, at the state level, and via federal action. We assess how nonprofit organizations and philanthropy can effectively encourage the uptake of “Filer Voter” programs at VITA sites, and what the IRS can do to support such programs. We consider how states with automatic voter registration systems can incorporate tax agencies to increase their reach. We examine legislation to mandate voter registration at tax preparation sites and businesses. Finally, we suggest the addition of a voter registration form (“Schedule VR”) to state or federal income tax filing materials.

>> Download the full report <<

      

As of this morning, yields on 10-year Treasury bonds stood at 1.33 percent. The yield on TIPS bonds—which are adjusted for inflation—was negative. These astonishingly low returns, occurring even in the presence of a growing economy and rising inflation fears, are not new. Interest rates on government debt have been falling in many countries for the last several decades, with markets indicating that rates may stay low well into the future. Many experts have focused on how sustained low interest rates fundamentally change the nature of long-run fiscal policy choices. In a new paper, presented today at an NBER conference, we examine a related issue: the implications of sustained low interest rates for the structure of tax policy.

We show that low interest rates (a) reduce the differences between consumption and income taxes; (b) make wealth taxes less efficient relative to capital income taxes, at given rates of tax; (c) generally mute the value of traditional tax preferences for business investment, retirement saving, and capital gains, and (d) substantially raise the valuation of benefits of carbon abatement policies relative to their costs.

At the outset, it is important to distinguish two phenomena: a reduction in all rates of return, and a reduction in yield on government debt relative to other assets. Tax incentives and rules may have different effects on private decisions when the private return to capital is low than when the private return to capital remains high, but government debt yields are low.

In fact, the rates of return on all assets have declined, and safe asset returns have declined relative to returns on risky assets. The fall in return on all assets is commonly attributed to a glut of global saving, due to changing demographics and increased concentration of income and wealth, that has outpaced investment demand. The fall in return on safe assets relative to risky assets is typically attributed to an investor “flight to safety” and a relative worldwide shortage of safe assets. Most projections expect interest rates to remain lower in the future than they were in the 1980s and 1990s.

Several significant issues in tax policy are affected by the presence of sustained low interest rates. One of the longest standing debates in tax policy addresses the relative merits of using consumption versus income as a tax base. At the risk of oversimplifying, income taxes generally burden capital more heavily and are more progressive than consumption taxes. Low interest rates reduce the differences between the two taxes. For example, a pure income tax would burden labor income and all forms of capital income (the normal or “safe” return — the return to waiting; the return to risk; and excess returns from things like luck, skill, and imperfect competition). Consumption taxes burden all the same sources of income except the normal return to capital. In theory, abstracting from differences in the timing of tax collections, as the safe return goes to zero, the differences between the two taxes also go to zero. On the other hand, one must also take account of the one-time lump sum tax on existing wealth that the introduction of consumption taxes creates, and how a lower rate of return affects it. These combined effects of low interest rates may change the attractiveness of adopting a consumption tax.

Recent years have seen increased attention to wealth taxes. In simplified environments, a wealth tax can be expressed as an equivalent tax on capital income. As the rate of return falls, the equivalent income tax rate of any given wealth tax rises. That is, a given wealth tax rate becomes more distortionary relative to a given capital income tax as the rate of return falls.

Policies that address climate change—such as a tax on carbon emissions—induce a stream of future costs (taxes or regulations, for example) and a stream of benefits (a healthier environment and long-term economy). But the benefits are “back loaded” (i.e., postponed) relative to the costs, extending over many generations. Weighing this tradeoff involves many considerations, and there is a major debate about whether to discount future benefits at all. Assuming that future benefits and costs are discounted, the interest rate used has an enormous effect on the net benefits. As interest rates fall, the benefits of a carbon tax rise relative to the costs. Because the benefits are received much after the costs are incurred, the discount rate employed has an enormous impact on the benefit-cost ratio of abatement policies

Finally, and not surprisingly, low interest rates dull the effects of incentives for personal saving and business investment. They also reduce the “lock in” effect that inhibits capital gains realizations through asset sales.

It is always difficult to predict interest rates, but if rates stay low, the implications for tax policy are significant.

The Brookings Institution is financed through the support of a diverse array of foundations, corporations, governments, individuals, as well as an endowment. A list of donors can be found in our annual reports published online here. The findings, interpretations, and conclusions in this report are solely those of its author(s) and are not influenced by any donation.

      

President Biden has launched an ambitious agenda to crack down on people and corporations who aren’t paying the taxes they owe. That agenda, however, is being held up by financial institutions lobbying to avoid new reporting requirements. Common sense would reject their arguments against moving forward, and Congress should, too.

Treasury Department studies project that the tax gap—the difference between what people pay and what people owe—now hovers around $600 billion per year. More than one out of every seven dollars that are owed in taxes are not paid. This has occurred in part because IRS funding and staffing levels have gone downhill over the past 10 years.

The noncompliance rate also depends critically on information reporting. Noncompliance is particularly low where third-party information reporting occurs. For example, employers routinely withhold income and payroll taxes on their employees’ wage, send the funds to the government, and report those amounts annually to the worker. As a result, the estimated noncompliance rate on such income is around 1 percent. In contrast, income from farms and sole proprietorships do not have such withholding or third-party reporting and noncompliance in those and similar areas is estimated to exceed half of all taxes owed.

The noncompliance rate for the wealthiest individuals, who typically earn the majority of their income through investment income (facilitated through financial institutions), is the hardest to detect, but recent estimates suggest it is quite high, with a large majority of evasion committed by high-income individuals. This provides some perspective on whom the financial institutions are protecting by lobbying against the information provisions. In sharp contrast, as noted above, wage earners tend to pay all the taxes they owe.

Enter President Biden. The first part of his plan would beef up IRS technology and staff on a sustained basis. Based on historical estimates of the return to enforcement activities, this would generate about $240 billion in revenues—net of added expenses—over the next decade and presumably more in the years beyond that.

The second part would boost timely information reporting by financial institutions, which the administration estimates would raise a whopping $460 billion over the next decade. The information would materially help the IRS in its efforts to identify likely and actual evasion.

Opponents have put forth two main claims: the reform would not help the IRS as much as predicted, and it would place large burdens on financial institutions. The first claim misses the point that, as noted above, third-party information reporting is essential to increase voluntary compliance and root out evasion. Even if the proposal raises somewhat less than the predicted $460 billion, the revenue effect would be substantial.

The second claim strains credulity. Financial institutions are quite capable of complying with regulations and are prompt, for example, to tell customers about even small overdrafts. Credit card companies are able to record even the tiniest transactions on a near-immediate basis. The rules that the administration proposes would expand the use of an already existing form (the 1099-INT) and would pertain to information that the financial institution already has.

A third argument put forth is that the proposal would somehow burden or harm moderate-income taxpayers, particularly minorities. No additional burden or requirements, however, would be imposed on individuals or (non-financial) businesses. Despite some claims to the contrary, businesses would not be required to reconcile financial accounts and income tax returns. If anything, it would help ordinary (honest) taxpayers by reducing the likelihood that they were targeted with audits. And there does not appear to be an added risk to taxpayer privacy.

Right now, the IRS is trying to fight tax evasion with one hand tied behind its back. President Biden has proposed transformational policies that could substantially reduce tax cheating and thus make the tax system fairer for the large majority of taxpayers who are honest. Republicans and some Democrats have recently expressed concerns about higher budget deficits. Cracking down on evasion would be an ideal way to raise revenue without boosting official marginal tax rates.

The Brookings Institution is financed through the support of a diverse array of foundations, corporations, governments, individuals, as well as an endowment. A list of donors can be found in our annual reports published online here. The findings, interpretations, and conclusions in this report are solely those of its author(s) and are not influenced by any donation.

      

The 2017 Tax Cut and Jobs Act (TCJA) was built on the idea that lower business and corporate tax rates, new domestic investment incentives, and guardrails against international profit shifting would increase investment, make workers more productive, and ultimately raise output and wages.

Did it work? In a new paper with my Tax Policy Center colleague Claire Haldeman, we conclude that, consistent with these goals, TCJA reduced marginal effective tax rates (METRs) on new investment and reduced the differences in METRs across asset types, financing methods, and organizational forms.

But it had little impact on business investment through 2019 (at which we stopped the analysis, to avoid confounding TCJA effects with those of the COVID-related shutdowns that ensued). Investment growth increased after 2017, but several factors suggest that this was not a reaction to the TCJA’s changes in effective tax rates.

First, the timing of the investment response was not consistent with a supply-side response. Much of the investment increase was concentrated in oil and related industries and appeared to be a response to increases in oil prices, not lower tax rates. Indeed, other investment did not grow very much, and even overall investment growth petered out by the end of 2019.

Investment growth across asset types such as equipment, structures, and intellectual property did not correlate with the law’s changes in METRs. The types of capital that saw the biggest cuts in tax rates also saw the smallest increases in investment.

In addition, the growth rate of business formation did not rise post-TCJA, and surveys suggest that only a small minority of businesses made TCJA-induced investments. Growth of employment and median wages slowed in 2018 and 2019 relative to the pre-TCJA years of 2016 and 2017. The much-vaunted bonuses that some firms provided employees at the end of 2017 were tiny relative to wages. And they appear to have been motivated mainly by political considerations or by the opportunity for firms to accelerate pay into 2017, when costs could be deducted against a 35 percent corporate tax rate, rather than 2018, when the deduction was worth only 21 cents on the dollar.

The impact of TCJA on GDP growth is more difficult to pin down. The economy did grow faster after 2017 than had been predicted before TCJA, but many other factors also affected the economy between 2017 and 2019.

Despite the ardent claims of its advocates, TCJA significantly reduced federal revenue relative to what would have been generated had the law not passed. That is, it never came close to achieving the Laffer Curve promise that supply side tax cuts would generate so much economic growth that they would increase tax revenues.

Despite the substantial reduction in the corporate tax rate and the new provisions that target cross-country tax avoidance, TCJA reduced international profit shifting only modestly. And it had little effect on efforts of U.S. firms to reduce their U.S. tax liability by being acquired by a firm headquartered in a lower-tax country.

The TCJA provision that allowed firms to return overseas profits to the U.S. without paying U.S. tax created a one-time spike in repatriated funds. But rather than boosting investment or wages, it generated a wave of corporate stock repurchases.

Our study comes with several caveats. First, it is not always easy to establish a compelling story of what the economy would have looked like absent the TCJA. This is particularly true for GDP growth, where the supply-side effects of TCJA were confounded by the increase in disposable income TCJA created and by contemporaneous changes in oil prices and monetary and fiscal policy. President Trump’s aggressive tariffs made it especially difficult to tease out the effects of the TCJA.

Second, by analyzing results only through 2019, we focused only on short-term effects, which may be a poor guide to the long run. Short-term growth dynamics typically are dominated by changes in aggregate demand while long-term growth stems from changes in supply.

Both experts and advocates emphasize that the supply-side process may take a significant amount of time to take full effect.

Overall, the TCJA’s advocates promised many supply-side benefits and promised they would materialize quickly. But at least for the first two years, the Act failed to deliver its promises on investment and growth, leaving the country instead with higher deficits and a less equal distribution of after-tax income.

Read the full report here.

      

The Tax Cut and Jobs Act (TCJA) of 2017 created the most substantial changes in business taxation in decades. But in a new analysis, published in today’s issue of Tax Notes and cowritten with my Tax Policy Center colleague Claire Haldeman, we find that, while the law promoted efficiency by reducing the level and dispersion of marginal effective tax rates on new investments, it also included many poorly designed provisions, especially in the treatment of income by multinational corporations and pass-through businesses such as partnerships. We propose several ways to fix these problems, in some cases reforming the changes and in some cases going back to the old, pre-TCJA approach.

The TCJA created a 20% deduction for certain forms of income earned through unincorporated businesses, cut the corporate income tax rate from 35% to 21%, and made a variety of changes that shifted the tax base toward cash-flow taxation for both corporations and pass-through businesses.

The newly created 20% deduction for pass-through income makes arbitrary distinctions among different forms of business ownership and is far more beneficial to high-income households than others. It is also unlikely to stimulate investment by existing firms or the creation of new businesses. By cutting the tax rate on income, the deduction finances windfall gains to business owners who are profiting from investments made in the past.

As a result, the tax subsidy generates a smaller “bang for the buck” than if it were targeted to new investment. Repealing the pass-through deduction and moving toward universal expensing and elimination of the interest deduction would be better for stimulating investment.

On the international front, TCJA eliminated the tax on repatriations of actively earned profits by foreign affiliates of U.S. parent companies (coupled with a one-time transition tax on previously accumulated but unrepatriated foreign profits). To help stop profit shifting and encourage domestic activity, TCJA also created an alphabet soup of tax changes including a minimum tax on global intangible low-taxed income (GILTI), a base-erosion anti-abuse tax (BEAT) and a companion deduction for foreign-derived intangible income (FDII).

TCJA’s increase in repatriations, however, did nothing to stimulate investment, as corporations that held a lot of funds offshore also tended to have large domestic cash balances.

Going forward, Congress could tighten GILTI’s minimum tax provisions considerably by requiring taxes be based on country-by-country profits rather than global profits. There are many arguments for repealing FDII provisions, most notably that they subsidize monopoly profits and encourage exodus of physical capital, not to mention that they probably violate World Trade Organization standards. The BEAT provision is also flawed and burdensome compared to alternatives such as the SHIELD program proposed by the Biden administration.

While all tax laws require Treasury and IRS guidance, regulations played an outsized role in the implementation of TCJA. Because Congress passed the law so quickly, TCJA contained many mistakes and ambiguities. In addition, provisions such as the pass-through deduction and many of the international provisions had no precedent in prior law. We find that the Treasury Department overstepped its authority in several regulatory rulings. As a result, the 2017 law in practice provides bigger tax cuts than Congress indicated, especially for banks and real estate.

Our proposals are similar to those in President Biden’s budget but do not raise corporate tax rates by as much, focus more on reforming the corporate base, and explicitly acknowledge that the pass-through provisions were a mistake. One potential challenge to our proposals: the President’s pledge to avoid tax increases on households with income below $400,000. A potential compromise would be to remove the pass-through deduction only for higher-income households. Even this limited change would substantially reduce the cost, regressivity, and complexity of the provision.

By repealing or reforming many business tax provisions of TCJA, Congress could raise revenues while making business taxation more efficient, more equitable, and more resistant to profit shifting. Business taxes would be more neutral–across industries, business forms, and financing methods–as well as more certain, less complex, and better enforced.

Read the full report here. 

      

American political leaders are currently focused on policies to address the health and economic implications of the COVID-19 pandemic. Nevertheless, it is not too soon to consider policy changes that could be beneficial to implement after the crisis has passed.

The U.S. faces two related and persistent threats to long-term, shared prosperity: growing inequality and rising federal debt. Inequality, especially wealth inequality, has risen sharply over the past 40 years. Children from different socioeconomic backgrounds do not have the same opportunities to achieve the American Dream. The Black-white gap in social mobility is especially concerning. The government’s budget outlook has long been a concern, with the federal debt projected to rise continually relative to the size of the economy, because of an aging population, rising healthcare costs, and inadequate revenues. The pandemic has made each problem more difficult to solve.

Policy makers should be looking for ways to address both issues. One place to start is by raising taxes on the most well-to-do households. During the Democratic primary, there were several proposals for a wealth tax, which would target the richest Americans and raise substantial amounts of revenue. Although a wealth tax would face difficult questions regarding its administrability and constitutionality, proposals for such taxes have re-energized the debate about taxing the wealthy. In some ways, the discussion has shifted from debating whether the rich should pay more in taxes toward determining the best way to achieve that goal.

In this policy brief, we consider the virtues of expanding the estate tax. Coupled with the gift and generation-skipping tax, the estate tax directly targets the intergenerational transfer of wealth. Whether it is ultimately borne by decedents or inheritors, the estate tax is extremely progressive. Inheritances are a major contributor to growing wealth inequality—large inheritances tend to flow to already wealthy heirs. The top ten percent of households by wealth receive 56 percent of all intergenerational transfers, while the bottom half receives only eight percent.

The estate tax is already part of the tax code. It has been administered – albeit imperfectly – for decades.

As a backstop to the income tax, the estate tax raises a significant share of its revenue from taxing the capital gains that wealthy decedents have avoided paying while alive. The estate tax also encourages charitable giving, both by providing a deduction for charitable gifts and by amplifying the effect of the income tax deduction for charitable giving.

Using a newly developed model based on household-level wealth and a mortality adjustment based on recent academic research, we present  revenue estimates that show that under a variety of policy scenarios – including returning the (inflation-adjusted) exemption threshold and the estate tax rate schedule to their values in recent decades – an expanded estate tax could raise significant amounts of revenue.

Building an Estate Tax Calculator

To generate household and aggregate wealth, we use data from the 2016 Survey of Consumer Finances (SCF), a triennial survey conducted by the Federal Reserve Board. The SCF provides detailed information on households’ assets and liabilities and oversamples high-wealth households.¹

In married households, each member of the couple is assumed to own half the wealth for tax filing purposes. Thus, every single householder and both members of a married couple are potential decedents for the purpose of predicting estate tax filings.

The probability of death for each potential decedent derives from a model of differential mortality based on recent work from Raj Chetty and his colleagues. This model is highly differentiated at the top of the distribution, making it well suited for predicting the distribution of deaths among people who are likely to be subject to the estate tax. A gross estate filing occurs when a potential decedent with wealth above the tax filing threshold is simulated to die in the current year.

Following established IRS practices, we apply a series of market value adjustments across four broad SCF asset classes: financial assets like stocks and bonds, businesses, real estate, and an “other” category that includes assets like art and vehicles.² There are inherent uncertainties associated with the value of assets like businesses and real estate. We make downward adjustments in these values since the IRS routinely accepts a value at the lower end of the plausible range for tax filing purposes.

Using Census population data, we reweight the 2016 data to “age” the population forward to 2020. We then use Financial Accounts data to inflate real asset values from 2016 to 2020 across the same four broad wealth types used in the valuation adjustments. This produces the 2020 estimates of the distribution of household wealth. By construction, the sum of population-weighted inflated asset values grows in line with Financial Account aggregates between 2016 and 2020.

To produce estimates of taxable estate, we start with each potential decedent’s gross estate and apply a series of deductions, including spousal, charitable, attorney fees, funeral expenses, and executor fees, to mimic the behavior under the current estate tax.

We then run taxable estates through an estate tax calculator, yielding a revenue estimate.³

Benchmarking the Estate Tax Calculator

Table 1 shows the historical number and value of gross estates for the years 1995, 1998, 2001, and 2004, generated using the historical SCF data files for each of those years. The actual and simulated values are similar, suggesting that our model does a good job of predicting the value of estates. While the simulated value of closely held businesses is high, some of that gap is likely due to misclassification of business versus financial assets.

Table 1. Actual and Simulated Gross Estate Filings, 1995 to 2004

Table 2 shows that our estimates also match the historical number and value of taxable estates fairly well. There is some variability at the top of the distribution—the model generally simulates too much taxable wealth among estates between $10 million and $20 million, and too little in the greater than $20 million range, which may be due to the relatively small SCF samples in those years combined with the probabilistic assignment of spousal and charitable deductions, which often make a large (gross) estate non-taxable.

Table 2.  Actual and Simulated Taxable Estate Filings, 1995 to 2004

Because the model simulates taxable estates well, applying the brackets and rates in force during the given year will generate simulated revenues that are close to actual values, with the caveat that gift taxes, generation-skipping taxes, and state death tax credits need to be addressed. The IRS publishes several concepts of estate tax liability in its annual reports, and the concept closest to what comes directly out of our simulation model is “tentative tax” less “unified credit.” The IRS reported value for that measure of estate tax liability averaged $25 billion over the four years (1995, 1998, 2001, and 2004) we use in the benchmark exercise. The model generates a value of $30 billion.

Revenue Estimates of an Expanded Estate Tax—Historical Examples

Over the past 80 years, the estate tax has shrunk in importance as a revenue source. The top estate tax rate has fallen from 77 percent in 1976 to 40 percent currently. A series of legislated changes raised the exemption threshold from $600,000 in 1987 to $11.6 million today ($23.2 million for married couples). The tax was even temporarily repealed in 2010. Most recently, the exemption threshold was doubled in the Tax Cuts and Jobs Act of 2017.

We apply three historical estate tax regimes—1982, 2001, and 2004—to the 2020 data. To do so, we adjust the exemption thresholds and tax brackets for inflation using PCE and apply the relevant tax rates.⁴

Table 3 shows the exemption threshold and rate schedules for these three regimes. The inflation-adjusted 1982 regime has an exemption level of $520,000. The rates rise steadily up to a maximum of 65 percent for every dollar above $9,330,000. For 2001, the rate schedule begins after $940,000 and rises to 55 percent after $4,160,000. The 2004 schedule is the simplest of the three. The exemption level is $1,970,000 with a fairly flat rate schedule that maxes out at 48 percent after $2,620,000.

Table 3. Historical Estate Tax Regimes Adjusted for Inflation

Figure 1 shows the annual revenue estimates for these three historical examples. As expected, the 1982 regime would raise the most revenue, collecting about $169 billion, closely followed by the 2001 regime, collecting about $145 billion. For context, the former estimate is about ten times more than the revenue collected from the estate and gift taxes in 2019. The 2004 schedule yields about $98 billion, a significantly smaller, but still sizable amount.

Table 4 shows the estimated average tax rates – the ratio of taxes to gross estate – by gross estate size class. Under each regime, as size class increases, so does the average tax rate. However, over time, the estate tax burden has declined across the distribution. Under 1982 law, estates in all size classes would pay at least a modest amount, with the largest estates paying about 21 cents per every dollar. Under 2001 law, the estate tax would effectively not tax estates worth less than $1 million and the largest estates have an effective tax rate of 19 percent. Finally, using the 2004 law would levy virtually no tax on estates less than $2 million. The top effective rate would be lower under 2004 law (16.2 percent) than under 1982 law (21.4 percent).

Table 4. Effective Tax Rates by Size Class for Historical Estate Tax Regimes

Revenue Estimates of an Expanded Estate Tax—Hypothetical Examples

We now turn to three hypothetical estate tax schedules. The first has an exemption threshold of $1 million and a flat rate at 40 percent. The second has a low exemption threshold with a highly progressive rate structure that reaches 75 percent for taxable estates worth more than $20 million. The third has an exemption threshold of $5 million with a 55 percent flat rate. Table 5 shows the full specifications.

Table 5. Hypothetical Estate Tax Regimes

Figure 2 shows the annual revenue estimates for these three alternatives. The first raises about $118 billion. The second raises a similar amount, about $130 billion. The third alternative raises the least – about $61 billion.

Table 6 shows the average tax rates for each proposal. The first alternative would create modest tax liability for estates between $1 million and $2 million. Average tax rates rise steadily to a maximum of 16 percent for estates between $10 million and $20 million. Estates worth greater than $20 million pay at a slightly lower rate of 14 percent. Under the second alternative, burdens would be low for estates between $1 million and $2 million. Average tax rates would rise with gross estate size—the largest estates would pay 23 cents for every dollar. Under the third alternative, tax liability would be zero for taxable estates below $5 million. Average tax rates increase to 17 percent for estates worth more than $20 million.

Table 6. Effective Tax Rates by Size Class for Hypothetical Estate Tax Regimes

The Case for an Expanded Estate Tax

We show that an expanded estate tax can raise significant amounts of revenue. Reverting to 2001 law (adjusted for inflation) would raise about $145 billion per year. Converting the current system to a 40 percent flat rate with a $1 million exemption would raise almost $120 billion. For comparison, revenue from the estate and gift taxes totaled about $17 billion in 2019.⁵

We also show that effective tax rates on gross estates are progressive, but low, reaching a maximum of 23 percent even in our most aggressive specification, where the highest marginal tax rate is 75 percent. In some cases, the largest estates do not face the highest effective tax rates. Low average rates and the slight decline in the average tax rate for the wealthiest decedents occur because of the deductions in estate tax law. Deductions for debts, spousal transfers, charity, and other expenses greatly reduce tax liability.

We recognize that an expanded estate tax, especially the more aggressive proposals, is not immune to gamesmanship. Ideally, an expanded estate tax would be coupled with increased funding to the IRS to cover more auditing and enforcement. We also recognize the need to reform capital gains taxation. For example, eliminating step-up basis would directly target unrealized capital gains and raise about $100 billion over ten years.

The long-term threats of unsustainable federal debt, rising inequality, and the need for government investments should compel policymakers to seek new ways to raise substantial revenue from the well-to-do. An expanded estate tax would raise large amounts of revenue, be highly progressive, and directly target a major source of wealth inequality.

John Sabelhaus, visiting scholar at the Washington Center for Equitable Growth, did not receive financial support from any firm or person for this article or from any firm or person with a financial or political interest in this article. He is not currently an officer, director, or board member of any organization with a financial or political interest in this article.

      

Wealth accumulation is of interest for several reasons. At the household level, wealth provides a source of future consumption, as well as insurance against adverse economic shocks. At the aggregate level, wealth finances domestic and foreign investment, affects current consumption spending, and influences the efficacy of monetary and fiscal interventions. More broadly, as discussed further below, the sheer magnitude of changes in aggregate household wealth relative to GDP in recent decades merits attention.

Documenting and determining the causes of changes in the level and distribution of household wealth and its components across generations and over time is an extraordinarily ambitious goal. This paper takes several initial steps in that general direction, building on Gale and Pence (2006), Gale, Gelfond, and Fichtner (2019) and Gale and Harris (2020) and using data from the 1989 to 2016 waves of the Federal Reserve Board’s Survey of Consumer Finances (SCF).  We obtain several key results.

First, while the Great Recession in 2007–2009 reduced wealth in all age groups, the broader long-term trend has been that the wealth of older age groups has increased, while the wealth of successive cross-sections of younger age groups has fallen.  A significant share of these changes, in both directions, can be explained by the evolution of household demographic and economic characteristics. Second, we show that the millennial generation—people who were born between 1981 and 1996 and hence were between the ages of 20 and 35 in 2016—had less median and mean wealth in 2016 than any similarly aged cohort between 1989 and 2007.

Predicting future wealth accumulation patterns is difficult, but we note that the millennials have certain advantages over previous generations in terms of wealth accumulation. They are the most educated generation in history and generally have higher earnings than their predecessors.  Because of the evolution of the pension system toward defined contribution (DC) plans, millennials may well work longer than any previous generation, giving them additional years to save.  And millennials may well end up inheriting more than any prior generation.

Millennials also face numerous disadvantages. Their careers had a rocky start because of the financial crisis and Great Recession in 2007-2009. They will be employed in contingent workforce jobs (which are more uncertain and have weaker benefits than traditional jobs) to a greater extent than previous generations. They are marrying, buying homes, and having children later. Longer lifespans mean that they have to accumulate more wealth, all else equal, to maintain pre-retirement living standards in retirement.  Because their parents are living longer than previous generations did, millennials will also receive inheritances later in life. They will face increased burdens from any eventual resolution of the government’s long-term fiscal shortfalls in general, and the financial imbalances in Social Security and Medicare in particular. They face an economic future with projections of lower rates of return and economic growth than in the past.

Third, we highlight the role that minorities will play in determining wealth prospects for millennials. Minorities constitute a substantially larger share of the millennial population than they do in any previous generation. Using cross-section and pooled regressions, we show that minority status is negatively associated with net worth, controlling for other household characteristics. The difference in wealth between Black and white households appears to be growing over time, controlling for other factors.

One overarching caveat to all of the results and analysis is that the paper applies to the period before the COVID-19 pandemic, an enormous shock that will clearly have significant impacts on wealth accumulation patterns for a wide range of birth cohorts. The paper is thus best interpreted as addressing generational wealth patterns through 2016 and providing a pre-COVID benchmark against which future studies can be compared.

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The authors did not receive financial support from any firm or person for this article or from any firm or person with a financial or political interest in this article. The authors are not currently officers, directors, or board members of any organization with a financial or political interest in this article.

      

With the economy in decline and the deficit rising sharply due to several major coronavirus-related relief bills, a growing chorus of voices is asking how we will pay for the policies that were enacted and arguing that further actions should be curtailed.

But this is not the time to get wobbly.  Additional federal relief would produce substantial benefits at low costs. We can learn from history and avoid policymakers’ knee-jerk tendency to cut off stimulus too quickly after a recession.  During the Great Depression, in the 1990s in Japan, and in the past decade—in the U.S. but especially in the U.K. and continental Europe— law makers’ premature moves to austerity held back recoveries and, in some cases, created new recessions. The risks of doing too little now far outweigh the risks of doing too much.

To be clear, there is no question that the COVID-19 pandemic has significantly hurt the fiscal outlook. Earlier this year, the Congressional Budget Office (CBO) projected an annual deficit of about $1 trillion for 2020. Now, that figure is set at $3.7 trillion (almost 18 percent of GDP).  In contrast, even during the Great Recession, the deficit never exceeded 10 percent of GDP.  Before the pandemic, the stock of outstanding public debt was projected to be 81 percent of GDP by the end of the year. Now CBO expects that figure to reach 101 percent this year and 108 percent next year.

This would shatter the previous record, a debt-to-GDP ratio of 106 percent, reached just after World War II. Notably, however, there was no fiscal crisis after the war. Instead, the debt-to-GDP ratio gradually dwindled to 28 percent over the ensuing 35 years, an outcome that contains both good and bad news for the current long-term fiscal shortfall. Between 1945 and 1980, interest rates on government debt were often below the economic growth rate, which helped to reduce the debt-to-GDP ratio. Likewise, interest rates are currently projected to remain below growth rates for the next 30 years. That’s the good news.

The bad news is that, unlike today, the federal government maintained balanced primary budgets (excluding interest payments) on average over the 1945-1980 period. In contrast, recent projections (made before the pandemic) show future primary deficits exceeding 3 percent of GDP on average over the next 30 years. These primary deficits—sufficiently large to cause projected debt to grow steadily and inexorably relative to GDP despite low interest rates—could be even larger after the pandemic’s effects are taken into account. This problem, though, should be addressed after the pandemic has passed and the economy has recovered.

The case for additional actions now is strong. First, the benefits of additional policies would be substantial. For example, funds targeted to state and local governments would help mitigate the recession and retain vital human services. States face balanced budget rules and thus would otherwise have to cut spending as their revenues decline, deepening the downturn.

Second, not all debt is bad. What distinguishes good and bad debt is how it is used. Bad debt is unproductive. Good debt serves genuine national investments. Debt used to finance military efforts in the second World War averted an existential international threat. Likewise, new debt issued today would be fighting an unprecedented world-wide viral pandemic and restarting the economy.

Third, U.S. public debt is not going to trigger a crisis like the one Greece faced in the wake of the 2008 recession. The U.S. borrows in its own currency.  We can pay our debts for decades to come. And interest rates as low as ours signal that government bonds remain in demand. Even in 2008, when the U.S. literally exported a financial crisis, the rest of the world responded by sending funds here because we were a safe place to invest.

In fact, the costs of additional actions would be small. Adjusted for projected inflation, interest rates on government debt are negative over most horizons. Indeed, there may not be any net costs at all, once the impact on the economy is accounted for.

The nation needs to address its long-term fiscal shortfalls, which are certainly worse now than they were before the pandemic. But it is also clear that we now face a different problem that dwarfs the federal debt in severity. The only way to achieve a strong long-term budget is to first generate a strong economy. And we can’t fix the economy until the virus is under control.  Federal stimulus can help deal with the virus and the economy and thus can strengthen our long-term economic and budget prospects even as it increases the current deficit. Being timid in our policy solutions during this crisis would be a mistake.

I thank Grace Enda and Claire Haldeman for outstanding research assistance.

      

The Coronavirus Aid, Relief, and Economic Security (CARES) Act, passed by the Senate on March 25 and expected to be rapidly approved by the House and President, is the largest aid package in history. The bipartisan deal allocates $2 trillion in an effort to mitigate the mounting fallout from the COVID-19 pandemic, including $1.5 trillion in spending and tax cuts and $500 billion in loans—$454 billion of which was allocated to the Federal Reserve as the basis for additional lending

The Act hits the mark in several key respects. It is big, it is timely, and it directly helps individuals, businesses, and state and local governments. Naturally, a mammoth package that moves rapidly through the Congress will have shortcomings. But the CARES Act is not the last COVID-19-based package Congress will need to enact, so there will be opportunities to correct mistakes and fix oversights. Here are 10 perspectives on the Act.

1. Relief more than stimulus

Though many have compared this legislation to the 2009 American Recovery and Reinvestment Act that Congress and President Obama enacted during the Great Recession, CARES is more appropriately thought of as relief—not stimulus.

What’s the difference? Relief addresses immediate fallout while stimulus aims to restore robust economic activity. This bill is relief; it ­cushions people and businesses from the immediate losses caused by COVID-19 and makes it easier for them to comply with public health guidelines and mandates. Stimulus programs will come later. Only after the disease is under control can pre-pandemic levels of economic activity be safely restored.

2. A Martial Plan, Not a Marshall Plan, for Health Care

The CARES Act allocates about $150 billion in funds to enhance hospital capacity, expand the strategic national stockpile of personal protective equipment, support the public health efforts of the Centers for Disease Control and Prevention (CDC), and underwrite vaccine and therapeutic research. Senate minority leader Chuck Schumer has called this a “Marshall Plan” for health care, but this is not rebuilding after the war, this is the war effort itself. Indeed, this is part of what Senate majority leader Mitch McConnell has aptly called “a wartime level investment in our nation.”

3. Direct payments may not reach key groups

CARES provides direct payments to individuals: $1,200 for single filers with adjusted gross income (AGI) below $75,000 and head of household filers with AGI below $112,500; $2,400 for joint filers with AGI below $150,000. Filing units will receive $500 for each child (defined as a dependent under the age of 17).  The payment phases out at higher income levels depending on filing status and number of children (and reaches zero, for example, for a single filer with no children and AGI of $99,000).

The IRS will use 2019 tax returns (or 2018 returns if the 2019 return is not yet available), Social Security benefit statements, and Railroad Retirement benefit statements to calculate the direct payment owed. Almost three quarters of tax filers will qualify for aid; the others will be disqualified on account of high incomes. As a result, the distribution of the direct payments is progressive.

But it bears emphasis that many low-income or otherwise vulnerable households may struggle to obtain a payment, especially people who may not have filed a 2018 or 2019 return. These include workers who earn less than the standard deduction ($12,200 for single filers in 2019, $24,400 for joint filers, and slightly more respectively for seniors) and people who earn cash income but don’t report it. Dependents over the age of 17, such as cared-for parents and disabled children, are not eligible for the direct payment, but their caretakers also will not receive a $500 benefit for them. The CARES Act also excludes tax filers without Social Security numbers (SSNs), requiring both taxpayers and their spouses to have SSNs if their payments are determined from a joint return. The choice to give payments only to households with SSNs leaves out Dreamers and families of filers with only Individual Taxpayer Identification Numbers.

The law gives the Treasury discretion to get direct payments to some of these households using certain information that the federal government can access, but it remains to be seen how fully that discretion will be deployed. Many millions of low-income or otherwise vulnerable households may need to file an informational return in order to claim the direct payment. Previous experience with direct payments in 2008 and 2009 shows that many of these households will not file.  Filing will only be harder now, when people are isolating and unable to get face-to-face help from family members or government agencies.

4. Direct payments aren’t universal basic income

Direct payments are not universal basic income (UBI). The CARES Act payments are a one-time event and are limited by income. Nevertheless, a pandemic certainly makes UBI proposals more attractive. Just as the drop in housing prices in the Great Recession would have been less damaging if homeowners had previously established low loan-to-value ratios, so the short-term economic distress caused by a pandemic would be smaller if households were guaranteed a non-trivial income. But pandemics are—or, at least, have been—rare events, so it may make more sense to build in social insurance mechanisms that are automatically triggered by adverse circumstances rather than to provide permanent guaranteed income. At the very least, the pandemic has exposed significant holes in the social safety net.

5. Don’t Expect Flawless Administration

There will certainly be snafus in the implementation of payments to individuals, both because of the sheer magnitude of the number of payments and because IRS operations are already stressed by deep cuts to its inflation-adjusted budget and staffing over the past 20 years. And the IRS staff and office are affected by the same public health measures other workplaces are facing. Treasury Secretary Steven Mnuchin is pushing for quick issuance of the payments, expecting households for which the IRS has direct deposit information to receive their payments within a month.

The direct payments in the CARES Act are much larger than previous payments made in the 2001 and 2008 tax cuts, but they are structured similarly. In 2001 single filers received $300 and joint filers received $600, while in 2008 each person received between $300 and $600, and married couples received up to $1200. In 2008, it took three months to get payments to households and the IRS had started working on this mechanism before the stimulus bill was enacted. One factor that may expedite payments this year is that the share of filers who opted to use direct deposit for their returns grew from 51 percent in 2009 to 59 percent in 2019. But payments will be slower for those who must first file qualifying returns.

6. A timely expansion of unemployment insurance

The Act expands unemployment insurance by extending the duration of benefits by 13 weeks, increasing payments by $600 per week for 4 months, and makes gig economy workers and the self-employed newly eligible recipients. Crucially, these new expansions of unemployment insurance are federally funded.

By increasing benefits, the UI provisions may encourage some people to leave the workforce, especially when coupled with the health and safety concerns surrounding some jobs.  The reduction in the labor force would not be wholly inappropriate—some jobs are impossible to perform under the social distancing rules that current conditions require.  In any case, workers may not rush to quit jobs, valuing the stability of continuing employment more than a brief bump in income. And it is worth emphasizing that people who quit jobs voluntarily (other than for good cause – which includes substantial risk to health and safety) are not eligible for UI to begin with.

7. Back to the Future: Net Operating Loss Rules

Given all of the controversies regarding the $500 billion loan fund for businesses in distress, less attention has been paid to changes in tax rules regarding net operating losses, which will help small businesses significantly.

Before 2017, businesses that had net operating losses could claim refunds for taxes paid in the prior two years. This so-called ‘loss carry-back’ served as an automatic stabilizer, helping firms during downturns and reflecting the fact that a firm’s natural planning horizon may not coincide with the tax year. In the 2009 stimulus, the look-back period was temporarily extended to five years, but the 2017 Tax Cut and Jobs Act eliminated the look-back provision.

The CARES Act reinstates the carryback period to five years for net operating losses sustained in 2018, 2019, or 2020. This will provide welcome tax relief for businesses at a time when their revenues may be profoundly constrained, supplementing the Act’s provisions that provide liquidity for businesses.

8. Helping states and localities weather the storm.

State and local governments, constitutionally barred from running deficits or facing the risk of bond-downgrades, will suffer reduced revenues as demands for spending increase. In the absence of federal aid, they would be unable to meet their constituents’ needs. The CARES Act provides $150 billion in direct support to state and local governments to help fight the coronavirus. This aid comes on top of the Family First Coronavirus Aid Package, enacted last week, which increased the federal share of Medicaid payments through the emergency period by 6.2 percentage points and provided reimbursements to states for the cost of expanding certain public assistance programs. To some extent, these transfers should free up other state and local resources for other uses.

But subfederal governments will need even more assistance. State revenues fell 9 percent during the Great Recession, equivalent of $246 billion today. If budget constraints prompt state and local governments to lay off workers, it will deepen the economic contraction by lowering consumer spending and depriving people of services they need. States and localities will need to tap into rainy day funds (or budge on longstanding and ingrained balanced budget rules). At least some states will need additional assistance because of the severity of this situation and heterogeneity in state finances.

9. America’s got debt but that’s not the point.

The CARES Act will raise U.S. debt substantially relative to a scenario where the economy did not have coronavirus. But, of course, that is not a relevant counterfactual. When the alternative scenario is an economy with coronavirus but without the CARES Act, the new legislation will have a much smaller impact on debt, because it will help prop up the economy, reduce the severity (and possibly the duration) of the recession, and leave the economy in a stronger situation to bounce back after the virus has been neutralized. And with interest rates staying low, we have an enormous amount of fiscal space to focus on the economy rather than the budget. The economy is more important than the budget, and people’s health is paramount. Deficits will have to take a back seat to preventing a Depression and supporting public health.

10. What next?

Together with the first two Acts that Congress enacted in response to COVID-19, the CARES Act makes significant changes in policy, boosting health care spending and providing direct aid to key sectors of the economy. Still, there is a lot left to do.

Controlling the virus will take time. So will the economic recovery. The bills enacted to date do not address the challenge of what may be a long-lasting recession. During the Great   Recession, support for additional economic stimulus evaporated after the stimulus bill passed, even though most economists thought that additional fiscal stimulus was desirable. Congress should avoid repeating that error if, as seems all but certain, additional stimulus and more direct payments turn out to be necessary.

Second, recent legislation provided homeowners some limited protection against foreclosure and forbearance on federally-backed mortgages, and protection against eviction for tenants of federally-assisted rental properties. The CARES Act offers no additional forbearance regarding mortgage and rental payments. Additional action may be needed.

Third, the safety net should be strengthened. The 14 states that have not yet expanded Medicaid coverage, as permitted by the Affordable Care Act, should do so immediately. Further steps to move the nation to universal coverage should be taken now.

The Families First Coronavirus Act waived work requirements for the Supplemental Nutrition Assistance Program (SNAP), formerly known as food stamps, and a federal court recently issued a national injunction against recent cuts to the program. Benefit levels could be increased, at least in times of acute economic distress. In the Great Recession, SNAP benefits were increased, which helped in reducing poverty, reducing food insecurity, and boosting the economy through higher consumer spending.

Fourth, state and local government will need cash infusions to deal with their impending massive revenue loss—the Act only provides support for COVID-related payments.  Likewise, the non-profit sector faces unique historical burdens in this episode but has been somewhat “lost in the shuffle” in the policy discussion so far (with the notable exception of a generous payment to the Kennedy Center). Charities, universities, and other non-profit organizations may merit a new round of support as events unfold. (Disclosure: the authors work at a non-profit.)

Lastly, policy makers should be making contingency plans for the uncertainty that marks the future path of COVID-19 and the economy. It is currently unclear what the worst-case scenario is and there are a number of high-impact options to mitigate potential catastrophe. For example, policy makers could offer prizes for the creation of a COVID vaccine.

The CARES Act is a much-needed relief package but policy makers and the public will need to keep an eye on the virus and the economy and be ready to respond quickly as the situation inevitably changes.