The other day I discussed the Tax Policy Center’s distributional analysis of the Bowles-Simpson tax proposal. As you may recall, a key feature of the proposal we considered (“Option 1”) is that it eliminates almost all existing tax breaks and reduces tax rates on most types of income (but raises them on capital gains and dividends).
We subsequently learned that we misinterpreted one aspect of the Bowles-Simpson proposal. As a result, we posted an updated distributional analysis yesterday. Let me turn the mike over to Howard Gleckman at TaxVox:
One of the most dramatic elements of the tax reform plan offered by the chairs of President Obama’s deficit commission, Erskine Bowles and Alan Simpson, was their proposal to eliminate tax breaks for employer-sponsored health insurance, contributions to retirement plans, and other employee benefits. When the Tax Policy Center did its first analysis of that proposal on November 16, our modelers assumed (perfectly reasonably) that if these benefits were now subject to income tax, workers would have to pay Social Security and Medicare payroll taxes on them as well.
Because these tax subsidies are so generous, a payroll tax on their value would generate a lot of money—more than $100 billion a year. And that extra levy would have a noticeable impact on the how taxes would be distributed among various earners under the plan. But after we published our analysis, the Bowles-Simpson staff told us they did not intend to hit workers with payroll tax on this income as well.
So TPC has run a new distributional analysis for the Bowles-Simpson plan without those extra payroll taxes. It turns out that everyone still pays more tax on average, but less, of course, than if they were hit with bigger payroll taxes. The lowest 20 percent of earners (who will make an average of about $12,000 in 2015 and who pay far more in payroll tax than in income tax) would pay about $200 more than they do today, instead of an average of $400 if they took a payroll tax hit as well. Their typical after-tax income would be cut by 2 percent, instead of 3.4 percent if they had to pay that extra payroll tax.
Middle-income earners (who’ll make about $60,000) will pay about $1,000 more instead of $1,900. Their after-tax income would be cut by about 2.2 percent instead of 4 percent. People at the top 0.1 percent of the economic food chain would also save about $1,000. But when you’re making an average of $9 million, and paying a half a million in new taxes, an additional thousand bucks is easily lost in the sofa cushions.
You can also see the importance of the payroll tax effect in the debt reduction proposal released on Wednesday by a Bipartisan Policy Center task force on which I served. In that proposal, the rollback affects both payroll taxes and income taxes. The extra Social Security revenues from phasing out the tax exemption for employer-sponsored health insurance account for about one-third of the plan’s overall improvement in Social Security solvency.
Bottom line: When you are cutting tax breaks, it’s a big deal whether you do that for payroll taxes as well as income taxes.