All tax cuts are not created equal
At the federal and state level, in governments run by both Republicans and Democrats, policymakers are cutting taxes. The federal American Rescue Plan, passed with no Republican votes, featured one of the largest one-year tax cuts in modern U.S. history. The Ohio House’s Republican-backed state budget bill features a 2% income tax cut across the board.
Part of this bipartisan consensus around tax cuts owes to economic conditions and part owes to ideological considerations. On the rebound from a sharp recession, both parties are interested in jump-starting the economy with cash while also supporting families and businesses struggling due to social distancing measures.
Meanwhile, policy recommendations coming from leading wonks at prestigious research institutions to celebrity political candidates have extolled the virtue of cash as a tool for alleviating poverty and providing flexible support for families in the 21st century.
Looking at these two plans, however, the divide between Republican and Democratic administrations becomes clear. Despite prominent Republicans like Mitt Romney, Marco Rubio, and Mike Lee backing pro-poor cash programs, federal polarization still led them to “no” votes on the American Rescue Plan. At the state level, there is more crossing the aisle: Democrats were split on their votes for the state budget, though many who voted for it were likely more drawn to the inclusion of school funding reform than the income tax cut.
While the American Rescue Plan directs funds to low-income households, the Ohio House tax cuts accrue more heavily to high-income households. This is because the Ohio House’s budget is more interested in reducing state reliance on income tax overall.
This isn’t necessarily bad policy. Income taxes tend to be higher in the United States than in most developed countries, which rely much more heavily on taxes on goods and services. The U.S. in fact taxes goods and services lower than any OECD country.
This may seem counter to our understanding of Europe since income taxes impact the poor less than sales taxes, but sales taxes distort the economy less than income taxes. Coupled with payments to low-income families, a high-sales tax, low-income tax scheme can balance equity and efficiency goals effectively.
For instance, the Legislative Service Commission estimates the income tax cut in the House budget will reduce revenues by $380 million over the next two years. In 2019, my firm estimated that a 10% federal match refundable state earned income tax credit (a tax cut targeted toward low-income working families) would cost about $210 million a year, which would amount to $420 million over two years.
This is in the same ballpark as the House cut in size, but with an average of $250 going to each low-income worker compared to the $0-1 tax cut cited to accrue to poor and low-income families under the current plan. Thus, an earned income tax credit expansion could reduce income taxation while simultaneously promoting equity goals.
It’s easy to characterize tax cuts themselves as good or bad, but in today’s current political environment, tax cuts are a consensus tool for improving the economy and promoting equity. The question is what kind of tax cuts we want, and the economic evidence available to us tells us that all tax cuts are not created equal.
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