The American Families Plan (AFP) that President Joe Biden announced on April 28 has understated its cost by nearly $700 billion, will leave the government more indebted, and will lower economic growth in the 10-year budget window. But the administration’s proposals for free education would pay off in the long run, according to Richard Prisinzano, director of policy analysis at the Penn Wharton Budget Model. “It is extra debt now, but there is a productive effect down the line that will offset some of that,” he said in an interview on the Wharton Business Daily radio show that airs on SiriusXM. (Listen to the podcast above.)
Between 2022 and 2031, the AFP would cost $2.5 trillion and not $1.8 trillion as the Biden administration has estimated, according to an analysis by PWBM. By 2050, it would increase government debt by almost 5% and decrease GDP by 0.4%, “as the effects from larger debt on the economy outweigh the productivity gains associated with the new spending programs,” PWBM noted.
The AFP is the third relief program the Biden administration has announced; the other two are the $1.9 trillion American Rescue Plan (also called the COVID Relief Plan) and the $2.3 trillion American Jobs Plan.
Broadly, the AFP has sought to make education more affordable and to provide economic relief for families with tax credits (including for childcare), expanded paid family and medical leave, nutrition assistance, and other measures, all of which will be paid for by higher taxes, especially on the wealthy.
The PWBM brief projected the impact of the AFP on the economy in three distinct settings: (i) including the proposed new spending programs without the new tax changes; (ii) including the proposed tax changes without new spending; (iii) with proposed new spending and taxes combined, including their interactions.
“It is extra debt now, but there is a productive effect down the line that will offset some of that.” –Richard Prisinzano
In the third setting, by 2050 PWBM expected the AFP to increase government debt by 4.6% “as new spending exceeds additional revenues raised” along with a 1.2% reduction in capital stock “due to the crowding-out effect that new debt has on private capital formation.” It also forecast that the average wage rate will be 0.1% higher due to the productivity boost from public investments. “However, those productivity effects are not enough to offset the negative effect of higher government debt on GDP, which ends up 0.4% lower in 2050,” it noted.
Prisinzano described that 0.4% drop in GDP as “modest” and “neutral, not having much effect.” He added that it is “a little bit smaller in magnitude” than the 0.6% increase in GDP with the 2017 Tax Cuts and Jobs Act. He described as “modest” the projected increase in the hourly wage rate, but he expected that to “die out over time as some of the debt effects [of the higher cost of capital] take over.”
Education Aid and Tax Breaks
Specifically, the AFP has proposed free universal pre-school for all 3- and 4-year-olds and two years of free community college “so that every student has the ability to obtain a degree or certificate.” PWBM estimates put the cost of those in the 10-year budget window at $426 billion for pre-school education and $299 billion for community college education.
The AFP also calls for increasing the maximum Pell Grant award by approximately $1,400 with an investment of $85 billion. “Among students of color, nearly 60% of Black, half of American Indian or Alaska Native, almost half of Latino, and over one-third of Native Hawaiian or Pacific Islander students rely on Pell Grants to pay for college,” the AFP fact sheet noted. Similar reforms were proposed in a recent Wharton research paper on boosting college enrollment.
Prisinzano gave high marks to the AFP’s plan to provide four free years of education, calling it “productive spending.” “Extra education on either end of the school life, pre-K or college, makes workers more productive, and that does offset some of [the AFP’s] cost as workers become more efficient,” he said.
“Investing in education is a down payment on the future of America,” the Biden administration noted in its AFP fact sheet. “Leading economic research has shown that the investments proposed in the American Families Plan will yield significant economic returns — boosting productivity and economic growth, producing a larger, more productive, and healthier workforce on a sustained basis, and generating savings to states and the federal government.”
The American Rescue Plan that Congress passed in March had expanded several tax benefits that the AFP now seeks to make permanent or extend their duration. It proposes making permanent the ARP’s expansion of tax credits for child and dependent care and earned income tax credit for childless workers, and reductions in health insurance premiums.
It is in calculating the full cost of those tax credits and education programs that the PWBM’s spending estimates differ from those of the Biden administration. For instance, the AFP has proposed permanent programs such as universal pre-K, and the PWBM has assumed that the additional spending on those will continue beyond the 10-year budget window.
Financing the AFP
According to PWBM estimates, over the 10-year budget window, the AFP’s tax credit provisions would cost about $1 trillion, while its revenue-raising tax provisions would raise a little more than $1.3 trillion. By those estimates, the government would raise $275 billion in net revenue from AFP’s tax provisions.
“These taxes will be borne by the ultra-wealthy, or the very wealthy.” –Richard Prisinzano
The PWBM brief summarized the main tax increases on high-income households:
- Increasing the top individual rate from 37% to 39.6%,
- Taxing unrealized capital gains above $1 million at death,
- Taxing long-term capital gains and qualified dividends at ordinary rates for individuals making more than $1 million,
- Taxing carried interest at ordinary rates,
- Disallowing deferral of tax on like-kind exchanges for gains greater than $500,000,
- Forcing all income above $400,000 to face the 3.8% Medicare tax, and
- Extending the limitation of business losses for noncorporate taxpayers.
“The tax changes hit the people that, by design, the administration has said are high-income earners,” said Prisinzano. “These taxes will be borne by the ultra-wealthy, or the very wealthy.”
One notable feature in the AFP that Prisinzano highlighted is its proposal to change the tax treatment of capital gains at death. The plan is to end the tax exemption for investment appreciation when a taxpayer dies, and that “would be a profound change to a provision that has been in the tax code for 100 years,” according to a Wall Street Journal report.
Current law allows what is known as the “step-up in basis,” and by changing it, the untaxed gains on investments held at death — such as stock, land, or a home — would likely be taxed at a top rate of 39.6% above an exemption of $1 million per individual, plus $250,000 more for a home, the report explained. The step-up saves taxpayers more than $40 billion a year, according to the congressional Joint Committee on Taxation, and the new proposal would take back some of that to help pay for social programs.
“That’s a really valuable change, and there’s revenue there,” said Prisinzano, adding that the current provision could be called a loophole. Higher taxes on the very rich helps pay down government debt and eases that burden on people lower down in the income distribution, he noted.
Strengthening the IRS
The new revenue sources in the AFP include almost $480 billion from enhanced IRS tax collection enforcement. Helping materialize that will be increased IRS funding by $80 billion over 10 years, which will be spent mostly on audits, IT modernization and a new information reporting regime for financial institutions. The PWBM plans to publish a separate brief on its modeling of greater IRS enforcement on revenue.
The Congressional Budget Office has estimated “a real return” from investments in getting the IRS “up to speed with better computers and training for auditors,” Prisinzano said. He pointed also to a proposal in the AFP to require taxpayers to provide more information in their returns. “Typically an IRS auditor could get that information in an audit, but here [taxpayers will be required] to provide it before an audit.” This will allow the IRS “to better select people to audit,” which then will potentially make those audits more efficient from the standpoint of collecting unpaid taxes.
According to Prisinzano, “it’s not a real burden” on anyone to provide the additional information the IRS would require. “They’re just providing it at an earlier stage. If we were audited, we would be asked for this information almost immediately.”