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2. Provide Tax Relief for American Families


Highlights of the President's Tax Plan

  • Replaces the current marginal income tax rates of 15, 28, 31, 36, and 39.6 percent with a simplified rate structure of 10, 15, 25, and 33 percent.
  • Doubles the child tax credit to $1,000 per child and applies the credit to the Alternative Minimum Tax (AMT).
  • Reduces the marriage penalty by reinstating the 10 percent deduction for two-earner couples.
  • Eliminates the death tax.
  • Expands the charitable deduction to non-itemizers.
  • Makes the Research and Experimentation (R&E) tax credit permanent.


The President's tax plan is fair and balanced. It addresses two important elements—the need to reduce inequities in the tax code and the need to foster economic growth.

The President's plan gives a tax cut to every American who pays income taxes—the typical family of four will be able to keep at least $1,600 more of their own money when the plan is fully effective. It increases tax fairness by giving the lowest income families the largest percent reduction.

The President's tax plan also recognizes the important role that constructive tax policy plays in generating high rates of long-term growth. Reductions in marginal tax rates encourage greater work effort and provide more inducement to save and invest in business enterprises. The tax plan should also help to shore up near-term growth, acting as an insurance policy against further weakening of the economy.

Rising Individual Tax Burdens

There is a great need for tax relief today. Total Federal revenues have surged as a share of Gross Domestic Product (GDP) since the mid-1990s. In fact, individual income taxes now take up the largest share of GDP on record—even above World War II levels. (See Chart 2–1.)

Recent gains in real wages account for roughly 20 percent of this individual income tax surge. Most of the individual tax code is indexed only for inflation. Thus, when wages gain in excess of inflation, taxpayers' effective tax rate rises. This results from a dilution in the effect of the standard deduction/exemptions/credits and from the fact that some individuals are bumped into higher tax brackets altogether. It is unfortunate that the reward for higher productivity is a higher effective tax rate.

Rising tax burdens limit families' ability to dedicate resources to their most pressing concerns. This is unfortunate since families are the best stewards of their resources, and the best judges of their own needs. Some families need more for education, some need more for child care, some need more for other things entirely—things that no Government or bureaucrat can possibly predict. The wise choice is to put families, not bureaucrats, in charge of these decisions. The President's tax relief plan would do just that.

Providing Fair and Balanced Tax Relief

The President's tax plan provides relief for every income taxpayer; however, it gives the lowest income families the greatest percentage reduction. Indeed, higher income individuals will pay a higher share of income taxes after this plan takes effect. (See Chart 2–2.)

Lower marginal rates will help remove barriers that lower income families face as they try to enter the middle class. It is an unfortunate quirk of the present tax code that many low-income families are now facing higher marginal tax rates than wealthy individuals, due to the combined effect of phase-out of the Earned Income Credit and the Income and Payroll Tax. The President's plan will provide them with vital relief. For instance, the marginal Federal income tax rate for low-income families with two children would fall by over 40 percent and by nearly 50 percent for families with one child. This reduction stems from the establishment of the new 10-percent income tax bracket and the doubling of the child tax credit. (See Chart 2–3.)

The President's tax plan addresses other inequities in the present tax code as well. In particular, it substantially reduces the marriage penalty—a phenomenon whereby couples often have to pay more tax after they get married. It does so by reinstating the deduction for two-earner families which allows the lower-earning spouse to deduct 10 percent—up to $3,000—of the first $30,000 of income.

The President's plan allows all income taxpayers to deduct their charitable gifts, even if they do not itemize. Wealthier individuals have long had the ability to do so. This provision will help the families who give and will likely spur an increase in charitable giving to families in need. This is a win-win outcome.

Enhancing Prosperity

While individuals see the most direct benefit of tax relief in the form of higher take-home pay, tax policy also has an enormous effect on their lives by affecting the economic environment they live in. Well designed tax policy boosts the economy's sustainable long-term growth rate, which ultimately is the governor for how rapidly standards of living will rise over time.

Reduced tax burdens give workers a greater incentive to work harder. It gives entrepreneurs a greater incentive to reinvest in their businesses and in turn, to hire more workers. Cross-country studies have shown the direct link between lower tax burdens and higher rates of economic growth.

The marginal rate cuts contained in the President's plan will be a powerful force in helping to boost long-term growth. Bringing the top marginal rate down from 40 percent to 33 percent will help to reduce the "success tax" on entrepreneurs and lead to more investment. Government should not penalize success. The plan will give over 20 million owners of small business—sole proprietorships, S corporations and partnerships—a tax cut that will increase cash flow and allow them to add jobs.

The President's commitment to eliminating the death tax will also boost risk-taking and wealth creation. The present system is unfair—it taxes income that was already taxed when it was earned and makes it difficult for many families to pass on their business or farm to the next generation. The death tax is wrong both from an equity and economic perspective. Elimination of the death tax will help family businesses and give seniors renewed incentive to save for their children.

The President's tax plan also supports a permanent extension of the Research and Experimentation (R&E) Credit. This credit supports the type of technological developments that have fuelled the recent boom in productivity growth. By making the credit permanent, the President will give firms the incentive to undertake long-term research projects that could well provide the next round of technological breakthroughs for future generations.

Planning Responsibly for the Future

The President's tax plan is fiscally responsible in addition to being pro-growth and fair. It accounts for roughly one quarter of the projected 10-year budget surplus and only six percent of total projected tax receipts over this period. Indeed, the President devotes more than twice as much of the surplus for debt reduction and for stocking a reserve fund for additional needs and contingencies as for his tax relief plan.

Federal Reserve Chairman Greenspan also believes that tax reductions are fiscally prudent at the current time. Given the rise in surplus projections, it now looks likely that the United States will have retired all of the debt that is able to be redeemed by the middle of this decade. After such time, the Government is forecast to accumulate large cash balances, which would need to be invested in the private economy, absent any policy changes. Chairman Greenspan warned that Government investment in the economy could have deleterious economic effects and recommended that policymakers take action now to reduce the projected on-budget surpluses through tax reductions, in order to pre-empt an accumulation of excess cash. The President's plan is in line with the advice of the Federal Reserve Chairman.

The President's tax plan is modest in a historical sense. It will reduce projected revenues by 1.3 percent of GDP by 2006. In contrast, President Reagan's tax cut reduced revenues by 4.5 percent of GDP over a similar period, relative to baseline projections.

Thus, the President's plan is socially, economically and fiscally sound. It will also have near-term benefits now that the economy has slowed markedly. It provides an insurance policy against a further deterioration in the growth outlook and should help the economy rebound more quickly to robust growth rates. This is another reason why the President's tax plan is responsible and well suited for the times.

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