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This paper examines how federal tax policy could improve the economic prospects of low- and middle-income working families in cities, with a specific focus on initiatives that improve opportunities for work, child care, retirement saving, homeownership, and health insurance coverage. The significant link between federal tax policies and the welfare of households in cities is an area of growing awareness and increasing importance. The link stems from developments in the nature of both urban policy and federal tax policy.
The notion of what constitutes "urban policy" has undergone substantial transformation in recent years. During the past few decades, as declines in employment and population reduced economic performance in many older cities, urban policymakers often turned to small, targeted programs aimed at distressed neighborhoods, dilapidated housing, or specific constituencies. Now, however, there is growing recognition that the impact of federal fiscal and regulatory policies on urban areas is substantial, and in many cases significantly outweighs the effects of targeted local initiatives.1 Devolution of wide-ranging policy responsibilities to state and local governments, in some cases without accompanying fiscal resources, is one obvious example of the power of federal policies to influence urban areas and residents. Other policies have effects that may be more subtle but are still substantial.2
As a result, a growing number of mayors and county officials have become active participants in national discussions on the future of federal health, transportation, education, and tax programs. For example, local leaders across the United States have mounted outreach campaigns aimed at connecting lower-income residents to the federal Earned Income Tax Credit and stimulating greater economic activity in their local economies.3
At the same time, the nature and scope of federal tax policy have changed as well. Traditionally, federal efforts to help low- and moderate-income families were designed as spending programs. The past 15 years, however, have seen a pronounced shift in the structure of such assistance. Federal tax policy has now come to play a central role in the well-being of poor and moderate-income households.4 Social policy programs now account for about one-quarter to one-third of all federal tax expenditures. Almost all new recent policy expansions for low- and middle-income households have taken the form of tax subsidies rather than direct spending programs. The Earned Income Tax Credit (EITC) has become the largest cash assistance program for low-income families. The largest increase in support of those families in the past decade came by way of the Child Tax Credit (CTC), enacted in 1997 and expanded in 2001. The largest program to build affordable housing is administered not by HUD, but by the IRS: the low-income housing tax credit. Virtually all recent subsidies for higher education and health insurance have taken the form of tax credits and deductions.5
This shift has many causes, including the widely acclaimed success of the EITC, political realities that favor items that can be called "tax cuts" over the same program enacted as a "spending increase," and budget rules in the 1990s that often favored designing new programs as tax expenditures rather than as direct spending. Sweeping welfare reform in 1996 was a watershed in this shift, too, as it moved millions of low-income families into the workforce. Whatever the other merits and flaws of the reform, an unmistakable effect is that it raised the number of low-income people who file a tax return and thus are in a position to qualify for, and benefit from, tax-based assistance.
These changes have fundamentally transformed the way the federal government provides services and collects taxes, and raise issues for both tax and social policy. The fact that big cities continue to house disproportionate shares of lower-income households highlights the critical links between these trends in the structure of federal spending and tax policies, on one hand, and the welfare and economic prosperity of urban areas and residents, on the other.6
In light of these developments, this paper examines how existing federal tax rules, and changes in the rules, affect low- and moderate-income workers and families that reside in urban areas.7 Various public policies are available to provide better economic opportunities and incentives for these households. In particular, policies that expand and modify the child care and dependent care tax credit, the saver's credit, and subsidies for health insurance, and that alter the structure of homeownership subsidies away from mortgage interest deductions and toward credits for homeownership, could improve economic prospects for millions of working families that live in urban areas.
The rest of the paper is organized as follows. Section I discusses the importance of distinguishing between alternative forms of federal intervention. Section II discusses our methodology. Sections III-VI examine policies that affect opportunities for work and child care, saving, health insurance coverage, and home ownership, respectively. Section VII concludes.
Notes from this section
1 See Bruce Katz, "Enough of the Small Stuff! Toward a New Urban Agenda," Brookings Review 18, No. 3 (2000): 4-9; Howard Chernick and Andrew Reschovsky, "Lost in the Balance: How State Policies Affect the Health of Central Cities" (Washington, DC: The Brookings Institution, 2001); and Joseph Persky and Haydar Kurban, "Do Federal Funds Better Support Cities or Suburbs? A Spatial Analysis of Federal Spending in the Chicago Metropolis" (Washington, DC: The Brookings Institution, 2001).
2 These include the mortgage interest deduction, which in many metropolitan areas results in a net transfer from struggling cities to wealthy suburbs. See Joseph Gyourko and Todd Sinai, "The Spatial Distribution of Housing-Related Tax Benefits in the United States" (Washington, DC: The Brookings Institution, 2001).
3 See Alan Berube, "Rewarding Work Through the Tax Code: The Power and Potential of the Earned Income Tax Credit in 27 Cities and Rural Areas" (Washington, DC: The Brookings Institution, 2003).
4 See Frank Sammartino, Eric Toder, and Elaine Maag, "Providing Federal Assistance for Low-Income Families through the Tax System: A Primer" (Washington, DC: The Urban Institute, 2002).
5 A similar transformation has occurred in many states, too. Several states, for example, have used excess TANF funds to help finance the refundable portion of state EITCs.
6 Alan Berube and Thacher Tiffany, "Shape of the Curve: Household Income Distributions in U.S. Cities, 1979-1999" (Washington, DC: The Brookings Institution, 2004).
7 The paper synthesizes, integrates, and extends results from several earlier papers published by the Tax Policy Center as part of this project. See William G. Gale, J. Mark Iwry, and Peter R. Orszag, "Improving Tax Incentives for Low-Income Savers: The Saver's Credit," TPC discussion paper 22; Leonard E. Burman, Elaine Maag, and Jeffrey Rohaly, "Tax Subsidies to Help Low-Income Families Pay for Child Care," TPC discussion paper 23; Leonard E. Burman and Jonathan Gruber, "Tax Credits for Health Insurance," TPC discussion paper 19; and Adam Carasso, C. Eugene Steuerle, and Elizabeth Bell, "Making Tax Incentives for Homeownership More Equitable and Efficient," TPC discussion paper 21.
Note: This report is available in its entirety in the Portable Document Format (PDF).
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