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Revenue and Distributional Effects of the Individual Income and Estate Tax Provisions of Senator Thompson's Plan for Tax Relief and Economic Growth

Leonard E. Burman, Greg Leiserson, Jeff Rohaly

Published: December 10, 2007
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The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.

The text below is an excerpt from the complete document. Read the full paper in PDF format.


Abstract

Republican Presidential Candidate Fred Thompson has announced a tax plan that combines tax cut extensions, additional tax cuts, and an election to pay tax under a new alternative tax system that would substitute a larger standard deduction for all current deductions and credits and have two rates of 10 and 25 percent. Thompson's plan would reduce federal revenues by $6–7 trillion over ten years, amounting to a reduction of almost 20 percent below current projections, and would be highly regressive. This article describes the proposed changes in the individual income and estate tax and examines their implications for revenue and the distribution of tax burdens.


Introduction


Republican Presidential Candidate Fred Thompson announced a tax reform plan that permanently extends the 2001–2006 individual income tax cuts; permanently repeals the federal estate tax; repeals the individual alternative minimum tax (AMT) at an unspecified future date while indexing the AMT exemption for inflation until that time; lowers the corporate tax rate to no more than 27 percent; permanently extends small business expensing; and shortens depreciation schedules. In addition, the plan creates a second individual income tax system based on a proposal put forward by the Republican Study Committee (RSC). The RSC's alternative or "simplified tax system" would eliminate all deductions and credits in the current tax code and instead provide a much larger standard deduction. The simplified tax system would have just two tax rates: 10 and 25 percent. Taxpayers would need to make a largely irrevocable choice to join the new system at some point in the next 10 years. Taxpayers would then be allowed one additional switch between tax regimes at any point during their lifetime as well as a switch at the time of marriage, divorce, or a spouse's death.

This note considers how the individual income tax and estate tax provisions would affect federal revenues and the distribution of tax burden if they were enacted starting in 2009. The most striking feature of the plan is that it would represent, by far, the largest tax cut in history—much larger than the tax cuts enacted in 2001 or 1981. Over 10 years, individual income and estate taxes would fall by about $6 to $7 trillion—or as much as 20 percent of overall revenues—before allowing for any behavioral responses. Accounting for the likelihood that lower tax rates cause taxpayers to report more income on their tax returns because they work harder, save more, and shelter less income from tax would reduce the revenue loss by about $1 trillion over 10 years, resulting in a cost of about $5 to $6 trillion. The tax cuts increase sharply with income. The regressive nature of the cuts is more pronounced after 2010, when the 2001–2006 tax reductions expire under current law. In 2009, the cuts in the Thompson plan amount to 0.3 percent of income for the bottom quintile, 2.3 percent for the middle quintile, and 5.8 percent at the top. By 2011, the top quintile receives a tax cut equal to 9.5 percent of income, compared with 4.6 percent for the middle and 0.7 percent for the bottom quintile.

(End of excerpt. The entire paper is available in PDF format.)