I have invited several of my colleagues to join me on ataxingmatter in considering how Obama might best meet the challenges--particularly in economic and tax policy--that will face him upon assuming the presidency. The following is the first of these guest bloggings, a posting by Jonathan Barry Forman, Alfred P. Murrah Professor of Law University of Oklahoma College of Law, and author of Making America Work.
I’m hoping that the Obama Administration will be able to synchronize our tax and welfare systems. We should adopt policies that increase the economic rewards for low-income workers and reduce their effective marginal tax rates.
First, we should reform the tax system. In order to have low tax rates, the tax system must have a broad base. We should repeal as many special-interest tax breaks as possible, including, for example, the preferences for dividends and capital gains. At the same time, we should reduce the taxes imposed on earned income. At present, the combination of income taxes, Social Security payroll taxes, and the phase out of the earned income tax credit often results in extraordinarily high tax rates on earned income, and the highest rates are imposed on single parents earning around $30,000 a year. If it were up to me, I would combine the income and Social Security taxes into a single income tax system—with a broad base and low rates.
Second, we should reform the welfare system. Right now, something like 85 separate federal programs provide income-tested welfare benefits. To keep costs down, virtually every one of those programs phases benefits out as family income increases. Unfortunately, those phase-outs combine with income and Social Security taxes to impose confiscatory tax rates on many recipients. The current welfare system also has financial penalties that can discourage marriage.
The best solution would be to replace the current tax system and most of the current welfare system with a comprehensive tax and transfer system. The general idea is to “cash out” as many welfare programs as possible and use that money to help pay for refundable tax credits. This new, comprehensive tax and transfer system could have just two tax rates—say, 20 percent on the first $50,000 of income and 35 percent on income over $50,000—and it should have a few refundable tax credits.
First, we should replace personal exemptions, standard deductions, child tax credits, and most of the current welfare system with a universal, $2,000-per-person refundable tax credit. Under this approach, a single parent with two children would receive $6,000 a year in personal tax credits, and a married couple with two children would receive $8,000 a year.
Second, we should replace the current, family-based earned income tax credit with a $2,000 per worker credit, computed as 20 percent of the first $10,000 of earned income. (Along these lines, Obama has already suggested that we adopt a refundable “Making Work Pay Credit” of 6.2 percent of the first $8,100 of earned income.) The current earned income credit provides up to $4,824 a year for families but no more than $438 a year for childless workers. Pertinent here, the United States has the highest incarceration rate in the world—496 adults per 100,000 in 2006. And the number of people behind bars has increased from ½ million in 1980 to 2.3 million today. Almost 90 percent of those in prison or jail are men, and almost 56 percent are under the age of 35. A $2,000 per worker credit would help encourage those hapless young men to choose honest work over lives of crime.
Third, we should adopt Obama’s proposal to make the child and dependent care credit refundable, and we should expand the credit so that it reimburses low-income workers for up to 80 percent of their child care expenses. Child care can easily cost more than $100 a week per child, but government agencies provide child care assistance to less than 15 percent of low-income families, and the current non-refundable child and dependent care credit provides almost no help.
Fourth, we should adopt Obama’s proposal to expand the Hope education tax credit into a refundable credit of 100 percent of the first $4,000 of college expenses.
Fifth, we should adopt Obama’s proposal to make the saver’s tax credit refundable and change it to a 50 percent match of the first $1,000 of contributions.
Sixth, we should replace the current exclusion for employer-provided health care coverage with a refundable health care tax credit. The current exclusion costs the Treasury more than $100 billion a year, but it is poorly targeted. Some 47 million Americans lack health care, and most of them are working. We should cap the current health care exclusion and gradually replace it with a refundable health care tax credit (not unlike the one that Senator John McCain suggested). Of course, these refundable tax credits should be paid out on a monthly basis. Each individual would present something like the current IRS Form W-4, Employee’s Withholding Allowance Certificate, to her employer—or to a bank. Employees would then receive advance payment of their credits from their employers in the form of reduced withholding, while other beneficiaries would have their payments directly deposited into their bank accounts.
This new, integrated tax and transfer system would be simpler than the current system. It would encourage low-skilled workers to enter and remain in the workforce. It would minimize marriage penalties. And it would help ensure that low-income families actually get their benefits. Temporary Assistance to Needy Families (TANF) currently reaches just 52 percent of eligible families, and food stamps reaches just 62 percent. On the other hand, the earned income tax credit reaches 86 percent of eligible households, and it does so without any welfare stigma or loss of privacy. In short, we should replace the current system with a comprehensive tax and transfer system—with large personal tax credits, large worker credits, and low tax rates on earned income.
Jonathan Forman
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