Discredited - tax credits

National Review, August 9, 1999 by Amity Shlaes

How tax credits block tax cuts.

Miss Shlaes is a member of the Wall Street Journal's editorial board and the author of The Greedy Hand: How Taxes Drive Americans Crazy and What to Do About It.

Taxation is culture, and in the fall of 1997, eager to observe that culture at first hand, I signed up for a crash course in tax preparation at my local H & R Block in Brooklyn. As I made my way to the dusty storefront, I wondered if I had chosen too locally. Brooklyn today is on the upswing, but it is still a modest borough, and this was a modest corner of it. Block customers in this office are apt to be court stenographers and policemen. How complicated could their taxes be? Surely their returns were a straightforward matter of withhold-and- refund. Perhaps I should have signed up at H & R Block's Wall Street office, a place that would feature the complex code in full flower, complete with the exotic write-offs that were once the subject of New Yorker cartoons.

I needn't have worried. Even in the off season, the Brooklyn office gave off the unmistakable hum of commerce. The place was filled with customers. Taxes were clearly an intricate and earnest business in this part of the world, a fact that my also-earnest teacher confirmed at one of our first classes. Taxes were complicated, she told us-"I won't even tie up your brains with how complicated." But she made one thing clear: The device to be understood was the tax credit. For any taxpayer who could claim credits, particularly a species known as the Earned Income Credit, "there is money to be made"-often thousands of dollars. In a poster that hung on the wall, my teacher's employer made a similar assertion: Under the image of a young man standing beside a car- presumably purchased with money generated by a tax credit-were the words, "Thanks, H & R Block."

"Thanks, GOP," the poster may just as well have read. For it is indeed thanks to the Republicans' 15-year-long romance with the tax credit that municipal employees and busboys now display the sort of preoccupation with taxes formerly to be found only among the cocktail- shaker set. Gone is the old advocacy of the elite deduction, whose value is highest to the classic Republican constituency. In its place is the credit, structured to provide maximum benefit to the lower or middle earner. Year after year, in the name of winning the support of the factory worker or the much-craved "soccer mom," Republicans have hawked the Earned Income Credit, the dependent-care credit, the child credit, etc. When they haven't taken the lead in credit legislation, Republicans have as often as not joined Democrats in pushing it. And nearly every one of these new credits is phased out at higher income levels, which makes them of absolutely no use to bigger earners.

This is a policy that has its costs, costs that are proving all too visible as Republican majorities in Congress struggle to pass a tax-cut package this summer. Creditmania has combined with progressivity, the other looming feature of our tax law, to generate a new and powerful division between the wealthy on the one side and middle and lower earners on the other. Today the wealthy are taxed extraordinarily heavily: Households earning more than $200,000-a group that takes in just 2 percent of the income in this country-carry a full 40 percent of the tax load. Owing in good measure to credits, earners at the other end, particularly those households under the $40,000 line, pay very little tax indeed. According to the House Ways and Means Committee, a full 48 million people-something like 35 percent of the taxpaying public-pay no income tax at all. As a result, any call for meaningful tax cuts, such as reductions in top marginal rates, makes the ugly charge that Republicans are rewarding the rich more accurate than ever.

This is ironic, given that Republicans agreed to credits in the first place precisely to protect the marginal-rate cuts, which were far more significant. Take the Earned Income Credit, brightest star in the tax- credit firmament. It was born in the 1970s, when Republicans were hoping to cut income taxes but instead found themselves fighting off plans to increase welfare and hike the minimum wage. In search of a method to encourage low-earning parents to work and stay off the dole, they came up with the EIC, a credit for any low earner with children. The EIC's charm lay in the fact that it went beyond traditional credits, which offset any taxes owed, producing a tax bill of $0. The EIC was that rare thing in the tax world-a genuine rebate. If a taxpayer's EIC was $200 and his tax liability was only $100, he actually got back $100. This remarkable gift seemed especially important in a period when lower earners were paying the highest Social Security taxes in history. Conservatives backed the EIC because they felt comfortable with its pedigree: It was a cousin of an idea put forward by Milton Friedman, the negative income tax.

In the grueling 1986 battle to roll back the top marginal rate to 28 percent, the Republicans therefore found themselves again deploying the EIC. They knew that their dramatic top-rate cut stood a chance of passing only if they also gave something to lower earners. (In tax lingo, this is known as being "distributionally neutral.") As a result, a large expansion of the EIC came to be included in the 1986 law, the average credit per low-earning family rising from $281 to $450.