The voices of Urban Institute's researchers and staff
March 14, 2014

Five ideas to strengthen the middle class

March 14, 2014

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In yesterday’s Senate Finance Hearing on innovative ways to sustain and expand the middle class, panelists broadly agreed on the benefit of simplifying the tax code.

During Q&A, much of the discussion turned to impediments to employment built into the tax code and regulations affecting small businesses. The panelists— including Urban-Brookings Tax Policy Center Director Len Burman—agreed that tax simplification could make it easier for businesses to make long-term plans and for families to take advantage of work, child, and other incentives built into the tax code.

But, as Burman testified, over the past few decades, middle earners’ wages have stagnated. What policy changes could we make to improve the wages and savings of middle earners, while ensuring that recent productivity gains accumulate to all workers?

In his written testimony, Burman proposed several concrete ideas. Here are five:

1. Improve access to education and training. Technological advances in recent decades have replaced many workers entirely while creating new positions in which workers need specialized skills. The first item on a middle-class agenda should be higher education and retraining opportunities to fill these gaps.

To expand education and training access, the government can clarify and simplify the rules surrounding support and incentives for higher education. In addition, the government can ensure that taxpayer education support goes to education institutions with a proven track record of improving students’ outcomes.

2. Slow healthcare spending. Because workers ultimately pay for rising health care costs through lower wages, controlling health care costs would be enormously helpful, especially for households with incomes too high to qualify for substantial subsidies under the Affordable Care Act.

3. Eliminate tax subsidies to “carried interest.” When private equity managers purchase public corporations, restructure them, and then sell them for a profit, they earn a substantial portion of their income in “carried interest.” This income is taxed at a favorable 20 percent, rather than the 39.6 percent that applies to ordinary (wage) income.

This restructuring often involves layoffs and cuts to wages and benefits. There is no reason the tax code should subsidize such activity over other kinds of productive work.

4. Encourage saving. The personal savings rate in the United States is near historic lows, compromising families’ ability to weather job loss or health crises, invest in education, and live comfortably in retirement.

The government could sponsor Universal Savings Accounts in which a $300 refundable tax credit would be automatically deposited into a 401(k)-type account for low- and moderate-income households. These families would also be eligible for a dollar-for-dollar match up to a maximum total contribution of $1,000 per year. The automatic contributions would phase out at higher income levels, but higher-income savers would be eligible for a 50 percent match on voluntary contributions up to the $1,000 maximum. Low-cost accounts would be available to guarantee that even those with small balances could earn competitive returns on their savings.

Helping all low- and moderate-income families establish their own nest eggs could make it easier to adopt sensible reforms to Social Security, an issue growing in urgency as it approaches insolvency.

5. Use the tax code to partially offset wage stagnation. Income tax brackets are indexed to inflation, meaning that tax brackets and other parameters are automatically adjusted to reflect rising price levels.

A potentially radical alternative would be to instead index tax parameters to reflect changes in income inequality. If inequality continues to grow, the adjustments would be concentrated on low- and middle-income households, rather than spread uniformly through all income levels. The alternative would have the same effect on the federal budget as inflation indexing (i.e., total tax revenues would stay the same) but would acknowledge that factors other than inflation can harm households at different income levels.

Photo by Zach McDade. Follow him on Twitter (@zmcdade).

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