President Biden has rolled out the early details of his American Families Plan, which would spend up to $1.8 trillion over the next 10 years on education, child care, health care and “family infrastructure” programs. The President would pay for this spending with new tax hikes on high-income earners and on investment income. While the White House is claiming the tax hikes would affect just a small sliver of taxpayers, significant tax increases on investment and small business income would unfortunately have far larger impacts than a simple income haircut for the wealthiest Americans.
The American Families Plan is the third multitrillion-dollar proposal the President has introduced in the first 100 days of his presidency, following the $1.9-trillion American Rescue Plan (which Congress largely passed into law as is in March) and the $2.7-trillion American Jobs Plan (which President Biden introduced in early April and Congress is yet to consider). You can see our initial analyses of the American Rescue Plan here and the American Jobs Plan here.
The first and foremost concern with each of these plans is the new spending they pile on to already record-high federal spending levels. The American Rescue Plan was largely not paid for, adding to a taxpayer tab for COVID-19 emergency or relief spending that has totaled over $5 trillion in a little over one year. The proposed American Jobs Plan would, unfortunately, pay for massive new spending with tax hikes on businesses that would harm American job, wage, and economic growth -- while also making our tax code less competitive globally compared to highly developed economic peers. And the American Families Plan includes tax hikes that would punish innovation, investment, entrepreneurship, and access to capital, which we detail in full below.
A second, related concern with all three plans is that they spend hundreds of billions of dollars, at minimum, on public benefits that flow to upper-middle class or wealthy households that do not urgently need the support. Such wasteful spending includes tens of billions of dollars in direct checks to six-figure households, billions of dollars in new Affordable Care Act subsidies to six-figure households, an expanded and extraordinarily generous Child Tax Credit (CTC) that flows, in part, to wealthy households, and nearly $200 billion in newly proposed electric vehicle (EV) subsidies when EV subsidies -- thus far -- have mostly benefited well-to-do drivers.
The American Families Plan requires a more thorough analysis, though. While details about the plan are still emerging, NTU’s government affairs team has pulled together a few reasons taxpayers should be concerned about with this third installment of President Biden’s ambitious tax-and-spend plans.
New Taxes Will Punish Innovation, Investment, Entrepreneurship, and Access to Capital
There appears to be four planks to the tax-hike portion of President Biden’s American Families Plan: 1) taxing long-term capital gains and qualified dividends income as ordinary income for households making more than $1 million per year, effectively doubling the tax rate; 2) repealing so-called “stepped up basis,” which allows a person to pass on assets at death without forcing the inheritor to pay taxes on gains earned on the asset during the prior owner’s life; 3) increasing the top individual tax rate for ordinary income from 37 percent to 39.6 percent; and 4) providing the Internal Revenue Service (IRS) with up to $80 billion over 10 years in the hopes of gaining $700 billion in revenue currently missed by tax collectors due to the so-called ‘tax gap’ between taxes owed and taxes paid.
We consider each of these items in turn:
Taxing investment income like ordinary income would have broad, negative economic impacts: The White House has engaged in an early defense of their proposal to nearly double taxes on investment income for some taxpayers by claiming it impacts merely 0.3 percent of taxpayers. If one were to take this argument at face value, it might indeed seem politically reasonable to increase taxes on less than a half a percent of the population to pay for new spending on education, health care, child care, and more. Unfortunately, the impact of significantly increasing taxes on long-term capital gains and qualified dividends is not so simple.
The University of Pennsylvania Penn Wharton Budget Model (PWBM) recently estimated that a standalone increase in the top rate on long-term capital gains and qualified dividends (to 39.6 percent) would actually cause the government to lose money over 10 years, around $33 billion. The reason, PWBM says, is that more taxpayers would hold onto their assets until death, allowing their heirs to take advantage of stepped-up basis. With a 39.6-percent top rate on investment income and repeal of stepped-up basis, the government is estimated to raise around $113 billion over the next decade.
Still, PWBM and other experts report, doubling the investment income tax rate and repealing stepped-up basis would change taxpayer behaviors in a number of ways:
“PWBM expects that realizations would surge in 2021 in anticipation of higher rates; taxpayers with incomes around $1 million would realize more gains in years when taxable income falls below the threshold; and a greater share of business income would be organized via pass-through businesses instead of C corporations in order to avoid the second layer of shareholder tax.”
It would also exacerbate the problem of double taxation on corporate earnings, which are currently taxed at 21 percent at the business entity level (and would be taxed at 28 percent under Biden’s American Jobs Plan) and either 15 or 20 percent at the shareholder level (for long-term capital gains and qualified dividends; Biden’s American Families Plan would change the 20-percent top rate to 39.6-percent rate for taxpayers making more than $1 million). Biden’s plan, in combination with the 3.8-percent Net Investment Income Tax (NIIT) on high earners under the Affordable Care Act (ACA) and state taxation of investment income, would raise the average combined tax rate on capital gains to 48 percent according to the Tax Foundation. Add that to a combined, average 32.77-percent rate on corporate income and corporate earnings that flow to certain shareholders could be taxed at an effective rate of around 65 percent.
Will repeal of stepped-up basis address numerous long-standing concerns with similar proposals? A thorough 2019 paper from the Tax Foundation goes into the various tradeoffs apparent in repealing stepped-up basis. While doing so could make the “tax code more neutral and remove a tax expenditure” it would come at a considerable cost. It would lead to an “increase[d] tax burden on capital and increase[d] compliance burdens for taxpayers.” Indeed, it could subject capital to double taxation. The non-partisan Congressional Research Service (CRS) adds, “[t]he primary stated rationale for [restoring stepped-up basis in 1980] was the concern that carryover basis created substantial administrative burdens for estates, heirs, and the Treasury Department.” This includes administrative concerns and the ability for heirs to liquidate assets and pay taxes owed through the repeal of stepped-up basis. While the White House pledges the “reform will be designed with protections so that family-owned businesses and farms will not have to pay taxes when given to heirs who continue to run the business,” we have yet to see the details of such protections. And those exceptions would not address concerns about increasing the tax burden on capital, especially in combination with the doubling of the rate on investment income mentioned above.
Increases in individual income tax rates could hit small businesses and would worsen the current tax code’s marriage penalty: Two major problems accompany President Biden’s proposal to increase the top individual income tax rate from 37 percent to 39.6 percent, neither of which the White House addresses in its initial outline. The first is that a higher top individual income tax rate could impact thousands of small businesses. For millions of businesses that are not C corporations, business income “passes through” to the individual or individuals who own and/or operate the business, meaning that an increase in the individual income tax rate is a tax hike on these small businesses, including S corporations, partnerships, and sole proprietorships. A second issue is that any increase to the top rate exacerbates the marriage penalty in the current tax code. The top, 37-percent income tax rate kicks in at $523,601 for single individuals in 2021, but at only $628,301 for married couples filing jointly. For the lower brackets in the code, the income level for married couples filing jointly is double the level for individual filers. This part of the code effectively penalizes married couples at a certain income level. A couple where both spouses make $315,000 per year each, for example, would pay taxes at a 37-percent rate (and a 39.6-percent rate under the Biden plan) whereas an individual making $315,000 per year would pay taxes at a 35-percent rate (and would keep their 35-percent rate under the Biden plan). The American Families Plan appears not to address either of the above concerns.
Closing the so-called carried interest “loophole”: President Biden calls on Congress to change the way carried interest is treated, from a capital gain income to labor income. Critics refer to this as a “loophole,” but taxing carried interest as capital gains is appropriate. Carried interest is the share of long-term profits that flow to investment managers who partner with investors. There is an inherent risk in such arrangements and the current tax treatment of carried interest appropriately reflects the “sweat equity” of fund managers. According to the Internal Revenue Service, there are over 4 million partnerships in the U.S. with more than 27 million partners. Many of these individuals would face higher tax burdens due to this proposed change. As the American economy continues to get back on its feet, lawmakers should resist disincentivizing long-term investments in small businesses and startups. Growing businesses rely on startup capital, and these investments result in increased innovation and job creation. However, taxing carried interest as labor income would reduce capital liquidity and stifle economic growth.
There is also little benefit when weighed against the harm of this tax hike. A 2020 report from the the Congressional Research Service found that treating carried interest as labor income would only generate $14 billion over 10 years. This would be a drop in the bucket compared to the trillions of dollars proposed in this plan. As the Tax Foundation notes, this revenue generated would be enough to fund the government for just a few hours. While some progressives are eager to change the tax code to attempt to punish Wall Street, the cascading effects would raise taxes on long-term investments and be passed onto middle-class investors. NTU continues to support a fairer and less complex tax system, but the proposed change to carried interest would not close a loophole or simplify the tax code.
Closing the ‘tax gap’ remains important, but the President’s estimated return on investment is suspect: The White House projects they can raise $700 billion in revenue over the next 10 years by increasing the IRS budget by $80 billion over the same time period. That’s a return of $8.75 in revenue for every $1 spent, an extraordinary return on investment. Unfortunately, this estimate may be too good to be true.
In a 2019 summary of their budget resolution, House Budget Democrats -- citing former President Trump’s fiscal year (FY) 2020 budget request -- report that “[increased IRS] enforcement activities will generate roughly $3 in additional revenue for every $1 in IRS expenses.” If the return on investment in President Biden’s plan was only 3:1, rather than 8.75:1, his IRS investments would only raise $240 billion in additional revenue over the next decade, leaving a $460-billion hole in his financing plan. Given the closing of the ‘tax gap’ is the largest single revenue-raiser in President Biden’s plan, the White House owes taxpayers a clear and full explanation of how it intends to raise $700 billion in revenue from $80 billion in IRS budget increases.
As NTU President Pete Sepp recently shared with The Wall Street Journal, policymakers must also ensure taxpayers’ rights are protected as the IRS increases enforcement activities:
Before Congress considers this proposal, it should make sure the IRS has appropriate oversight so there are safeguards as law enforcement expands, said Pete Sepp, president of the National Taxpayers Union, a conservative-leaning taxpayer-rights group.
“No one has properly assessed the risks of this proposal, thinking that it’s some magical pot of gold at the end of the rainbow,” he said. “They’re not ready for it. The taxpayer rights protection structure is not ready for it. They have not adequately thought through how and where this money can be best spent.”
The suspect revenue estimate and outstanding concerns about taxpayers’ rights and due process make the ‘tax gap’ portion of President Biden’s plan one of the most questionable inclusions at this time.
Spending Should Be Curtailed for Upper-MIddle Class and Wealthy Households
While there is plenty to digest and analyze in President Biden’s ambitious spending efforts in the American Families Plan, three provisions in particular concern us at this time for their lack of means-testing: the expanded Child Tax Credit (CTC), the expanded Child and Dependent Care Tax Credit (CDCTC), and the expanded Premium Tax Credit (PTC). President Biden proposes permanently expanding the CDCTC and PTC, at a cost of roughly $280 billion in the first 10 years according to the Committee for a Responsible Federal Budget. Biden proposes a four-year extension of the more expensive CTC expansion, through 2025, at a cost of anywhere from $400 billion to $450 billion depending on estimates. That’s between $680 billion and $730 billion over 10 years on three tax credits, where a significant portion of the benefit flows to upper-middle class or even wealthy households that likely do not need to benefit from inherently limited taxpayer dollars.
More details below on how each of these tax credit expansions benefits the upper-middle class, and how President Biden could conservatively cut tens of billions of dollars from the cost of his plan -- if not more -- by limiting the benefits to households that actually need the assistance.
More than 40 percent of CTC benefits flowed to six-figure households in 2020: The American Rescue Plan made several changes to the Child Tax Credit. Here’s our summary from earlier this year:
| CTC Before 2018 | CTC 2018-2020 (TCJA) | CTC 2021 (ARP) |
Standard Credit Amount | $1,000 per child per year | $2,000 per child per year | $3,000 per child per year |
Additional Benefit for Children Ages 0-6? | $0 | $0 | $600 per child per year |
17-Year-Old Children Eligible for Benefit? | No | No | Yes |
Benefit Distributed Annually or Monthly? | Annually | Annually | Monthly |
Credit Begins Phasing Out At Income Threshold Of... | $55,000 for married couples filing separately, $75,000 for single parents, $110,000 for married couples filing jointly | $200,000 for single parents and married couples filing separately, $400,000 for married couples filing jointly | $75,000 for single parents and married couples filing separately, $150,000 for married couples filing jointly |
Refundable? (i.e., taxpayers with less owed in taxes than the value of the credit can receive the credit) | Partially (up to $1,000 per child per year) | Partially (up to $1,400 per child per year) | Fully |
Estimated Annual Cost to Taxpayers | ~$55 billion (five-year average annual cost before TCJA) | ~$118 billion (tax year 2018 estimate) | ~$225 billion (tax year 2018 estimate + JCT estimate for CTC expansion) |
Sources: Congressional Research Service; Joint Committee on Taxation; American Rescue Plan Act | |||
For the pre-ARP CTC, however, more than 40 percent of benefits flowed to six-figure households:
Distribution of Child Tax Credit Benefit by Income, Tax Year 2020 | |
Income Class | Percentage Distribution of CTC Benefit |
$0-$10,000 | 0.7 |
$10,000-$20,000 | 6.1 |
$20,000-$30,000 | 7.6 |
$30,000-$40,000 | 8.2 |
$40,000-$50,000 | 8.6 |
$50,000-$75,000 | 16.1 |
$75,000-$100,000 | 12.6 |
$100,000-$200,000 | 28.4 |
$200,000+ | 11.7 |
Source: Congressional Research Service | |
In other words, around 40 percent of the benefit flowed to the top 20 percent of households in 2020. The bottom 40 percent of households saw only 30 percent of the benefit. The remaining 30 percent of the benefit went to households in the middle and fourth income quintiles (i.e., between the 40th and 80th percentiles of household income distribution).
While the distribution of the expanded CTC would look different because the Biden administration made the CTC fully refundable, the administration could likely save tens of billions of dollars by reverting the more generous CTC to its pre-2018 income thresholds -- $55,000 for individuals and $110,000 for married couples. The current thresholds -- $75,000 and $150,000 under the $3,000 or $3,600 per-child ARP benefit, and $200,000 and $400,000 under the TCJA benefit -- are much too high.
Nearly three-quarters of CDCTC benefits flowed to six-figure households in 2020: ARP also made significant changes to the CDCTC:
| CDCTC Before ARP | CDCTC 2021 (ARP) |
Maximum Credit Amount | $1,050 for taxpayers with one child, $2,100 for taxpayers with two or more children | $4,000 for taxpayers making under $125,000 per year with one child; $8,000 for taxpayers making under $125,000 per year with two or more children |
Credit Begins Phasing Out At Income Threshold Of... | $15,000 | $125,000 |
Terms of Phase Out | Credit value (35 percent of qualified child care expenses) phases down to 20 percent for any taxpayer making $43,000 or more | Credit value (50 percent of qualified child care expenses) phases down to 20 percent for any taxpayer making $183,000 or more, and then at $400,000 phases down again to 0 percent for any taxpayer making $438,000 or more |
Completely Phases Out? | N/A | $438,000 |
Refundable? (i.e., taxpayers with less owed in taxes than the value of the credit can receive the credit) | No | Yes |
Estimated Annual Cost to Taxpayers | ~$4.7 billion (five-year average annual cost from 2020-2024; pre-ARP) | ~$12.7 billion (CRS estimate of FY 2021 and FY2022 CDCTC costs + JCT estimate for CDCTC expansion) |
Sources: Congressional Research Service; Congressional Research Service; Joint Committee on Taxation; American Rescue Plan Act | ||
For the pre-ARP CDCTC, nearly three-quarters (73 percent) of benefits flowed to six-figure households:
Distribution of Child and Dependent Care Tax Credit Benefit by Income, Tax Year 2020 | |
Income Class | Percentage Distribution of CDCTC Benefit |
$0-$10,000 | 0.0 |
$10,000-$20,000 | 0.0 |
$20,000-$30,000 | 0.3 |
$30,000-$40,000 | 1.8 |
$40,000-$50,000 | 4.0 |
$50,000-$75,000 | 10.6 |
$75,000-$100,000 | 9.7 |
$100,000-$200,000 | 41.6 |
$200,000+ | 31.9 |
Source: Congressional Research Service | |
A paltry six percent of the benefits went to households in the bottom 60 percent of households by income, making the CDCTC even more regressive than the CTC. Though distribution for the expanded CDCTC would be different because it is refundable, the Biden administration’s proposed permanent expansion would save billions of dollars by limiting the benefit to households making less than six figures per year.
President Biden’s expansion of PTCs benefits six-figure households: Back when the American Rescue Plan became law, NTU warned that taxpayers “should assume that policymakers will both a) push to make these provisions permanent in 2022, and b) frame opposition to making these provisions permanent as a tax hike on individuals and families purchasing ACA coverage.” Sure enough, in his joint address to Congress, President Biden said the following about this (currently temporary) expansion of PTCs:
The American Rescue Plan lowered healthcare premiums for 9 million Americans who buy their coverage under the Affordable Care Act. I know that’s really popular on this side of the aisle. But let’s make that provision permanent so their premiums don’t go back up.
Unfortunately, the push from the President and many Congressional Democrats to make this PTC expansion permanent would not change the numerous flaws the policy suffers from. As we pointed out in March:
- Expansion is expensive (a $212 billion deficit impact over 10 years, according to the nonpartisan Congressional Budget Office);
- Targeting generous PTCs to households making six figures or more is a poor use of limited taxpayer dollars; and
- PTCs are not designed to bend the cost curve for private health coverage, and will only increase in cost as premium hikes outpace wage increases.
It would be better if, at minimum, policymakers pushing permanence eliminated the ability for households making above 400 percent of the federal poverty level to access PTCs. We see no reason that inherently limited taxpayer dollars should flow to helping six-figure households purchase health coverage. It would be best, though, for lawmakers to simply allow the expanded PTCs to expire, rather than making them permanent.
Conclusion
The American Families Plan includes several significant components that deserve further analysis and that we have not yet considered in full. However, there is much for taxpayers to be concerned about already, from tax hikes that would punish investment and entrepreneurship to spending that would flow to six-figure households. At minimum, the Biden administration would be wise to significantly curtail the size and scope of this plan, and to more precisely target the benefits to low-income families that actually need the support.