Permanent capacity building law likely requires tax hikes for the middle class

The Congressional Budget Office (CBO) gave us a glimpse of our budgetary future under the Build Back Better Act (BBBA), estimating that if all the policies in the bill were made permanent, $ 3 trillion would be added to the budget. national debt over the next 10 years. This adds up to more than $ 7 trillion in deficits over the past two years, leading to a total national debt of $ 21 trillion held by the public this year (roughly the size of GDP). Under current law, the CBO predicts that the national debt held by the public will reach $ 36 trillion by 2031, or 106% of GDP, the highest debt in US history.

President Biden and Congressional Democrats have pledged to fully offset the budgetary cost of expanding the BBBA, but have so far not specified how. In practice, the only proven way to increase this type of income is to increase taxes on a large scale on the middle class, usually through higher income and wage taxes or by introducing a new tax. on consumption such as a value added tax (VAT), similar to what is done in European countries, where the tax-to-GDP ratio is much higher than US levels.

For example, Denmark currently has the highest personal income tax rate in Europe at 55.9%. The BBBA would exceed that figure by raising the highest tax rate in the United States to 57.4 percent, including the expected return of the highest federal rate to 39.6 percent, the broader application proposed. Net Investment Income Tax (NIIT) of 3.8 percent on income over $ 400,000, the 8 percent Surtax on Modified Adjusted Gross Income (MAGI) over $ 25 million, and state taxes. The difference is that Denmark’s top tax rate applies to all income over 1.3 times the average income, which in the US would be equivalent to taxing all income over $ 70,000. at the highest tax rate.

Needless to say, no one in the United States is proposing a broad-based Danish-style income tax increase, but it is one of the few options left to generate enough income to pay the BBBA and fight our debt. imminent under current law. For example, according to our modeling, applying an additional 5% tax rate to all taxable income would generate $ 6.5 trillion in income over 10 years. It would also reduce the economy by more than 2% in the long run and remove more than 2 million jobs. Alternatively, raising income tax rates by 10 percent would increase income by $ 2.1 trillion over 10 years, while shrinking the economy by almost 1 percent and wiping out nearly a million dollars. ‘jobs.

Because the U.S. income tax is so progressive, in fact more progressive than the income tax in Europe, a complete flattening of the U.S. income tax would actually increase large amounts of income while stimulating l ‘economy. For example, replacing the current progressive income tax with a 20% flat tax rate applicable to all taxable income would generate $ 1.1 trillion in tax revenue over 10 years, increase GDP by 1.3% and create 1.2 million jobs. However, this would be a sharp increase in taxes for the middle class, reducing the after-tax income of the average quintile of wage earners by around 5% initially and 3% in the long run.

It is also possible to raise large sums while cleaning up the income tax code by eliminating various deductions and exemptions, usually tax preferences used by middle and high income earners. For example, eliminating the local and state tax deduction (SALT) would bring in $ 1.6 trillion over 10 years, and eliminating the mortgage interest deduction would increase by nearly 1.1 trillion. of dollars. Each reform would reduce the after-tax income of the middle class by almost 1% in the long run.

Another option to increase income is to increase payroll taxes. In Germany, France, Italy and several other European countries, payroll taxes for the average worker are over 30%, more than double what they are in the United States. If the United States increased payroll taxes by 3 percentage points, it would raise $ 2 trillion over 10 years, while reducing GDP by 0.5% and eliminating about 500,000 jobs.

Most countries outside of the United States, including all European countries, charge VAT on goods and services, with tax rates in Europe typically around 20%. It is the main source of tax revenue in Europe. If the United States introduced a VAT at a rate of 5%, it would generate $ 6.1 trillion in tax revenue over 10 years, while reducing GDP by 1.2% and eliminating about 900,000 jobs. The after-tax income of the middle class would fall by about 4% in the long run.

Another option is a carbon tax, which is commonly used in Europe to reduce carbon emissions. Introducing a new carbon tax at a rate of $ 60 per metric tonne would generate $ 2.3 trillion in tax revenue over 10 years, while reducing GDP by 0.4% and eliminating about 350,000 jobs. The after-tax income of the middle class would fall by more than 1% in the long run.

None of these tax increases are popular, so it’s no wonder they weren’t offered as part of the BBBA. However, if enacted, the BBBA would exacerbate an already unsustainable debt trajectory, ultimately forcing a serious review of European-style taxes on the middle class.

It should be noted that there are two other tax outcomes where such unpopular tax increases could be avoided, but neither are very likely to occur. First, government spending could be cut, but there isn’t much precedent in the United States or any other developed country. Second, the United States could inflate a substantial part of the Federal Reserve’s debt by increasing the money supply (arguably already underway, but we are not yet talking about high and sustained inflation levels as we see, for example, in Turkey).

The currently high inflation rate, close to 7%, partly attributable to current and planned deficit spending, is enough to illustrate some of the dangers. More inflation would be worse, not only because it greatly reduces the purchasing power of American consumers, but because it penalizes savers and investors, raising taxes through the drift of brackets and characteristics. of the tax code that are not indexed to inflation.

Ultimately, policymakers and taxpayers should understand the extent of the tax changes needed to fully pay for the large-scale social spending programs that would be launched under the Build Back Better Act. It certainly does not cost zero, and the costs will most likely be borne largely by the middle class in the form of higher tax burdens, inflation and reduced economic opportunities.

Impact of tax increases that could pay in full to build better
Long-term GDP Long-term full-time equivalent jobs (millions) Long-term after-tax income of the middle class Static tax revenue over 10 years (trillions of dollars)
Add a 5% flat-rate personal income tax -2.1% -2.2 -4.4% $ 6.5
Increase personal income tax rates by 10% -0.9% -1.0 -1.1% $ 2.1
Replace parentheses with a flat tax rate of 20% 1.3% 1.2 -3.3% $ 1.1
Eliminate the SEL deduction -0.7% -0.5 -0.8% $ 1.6
Eliminate the mortgage interest deduction -0.7% -0.4 -0.9% $ 1.1
Increase payroll tax by 3 percentage points -0.5% -0.5 -2.9% $ 2.0
Adopt a 5% value added tax -1.2% -0.9 -4.0% $ 6.1
Adopt a carbon tax of $ 60 per tonne -0.4% -0.3 -1.4% $ 2.3

Note: The middle class is defined as the average quintile of employees.

Source: General equilibrium model of the Tax Foundation, May 2021.

Was this page useful for you?

Thank you!

The Tax Foundation works hard to provide insightful analysis of tax policy. Our work depends on the support of members of the public like you. Would you consider contributing to our work?

Contribute to the Tax Foundation


About Natalee Broderick

Natalee Broderick

Check Also

Trends and tax purposes in 2022

The new year aoffstarted here, and it would be prudent to start the year off …