Nostalgia for 1990s Individual Income Tax Rates Is Misguided

The Congressional Budget Office is projecting the federal deficit to hit as much as 7.3% of gross domestic product by 2033. This has prompted a debate over the root cause of the federal government’s budgetary problems. Some argue that if we had kept the tax code of the 1990s, we wouldn’t be in the fiscal situation we are in today.

Keeping “Friends"-era tax rates certainly would have generated more federal revenue. However, households at every income level would be paying more; nearly one in four tax filers would be subject to the alternative minimum tax, and marginal tax rates would be higher on work, saving, and investment.

Instead of blindly suggesting we turn back the clock on individual income tax, we should debate specific reforms that could improve the income tax and the federal government’s finances.

Back to the Future

Since the late 1990s, lawmakers of both political parties enacted several significant tax changes that primarily reduced individual income tax revenue. Near the end of his second term, President Bill Clinton signed the 1997 Taxpayer Relief Act. President George W. Bush passed two temporary tax cuts in 2001 and 2003.

President Barack Obama’s tax increases were more than offset by the extension of the Bush tax cuts—the permanent alternative minimum tax “patch” in 2013 and a handful of tax cuts in the 2015 Protecting Americans from Tax Hikes Act. Then-President Donald Trump enacted the 2017 Tax Cuts and Jobs Act.

If the tax code had remained where it was on Jan. 1, 1997, statutory tax rates would be higher. Instead of the seven rates that range from 10% to 37%, there would be four ranging from 15% to 39.6%.

Tax rates on capital income would be higher—the top capital gains tax rate would be 28% and qualified dividends would be taxed at 39.6%. Both are taxed at a maximum rate of 23.8% today.

The standard deduction would be about half as large, but the personal exemption would be restored. The child tax credit wouldn’t exist and the earned income tax credit would no longer provide additional benefits to households with three or more children, nor would it have an adjustment for joint filers.

Section 199A, the 3.8% net investment income tax, Roth-style individual retirement accounts, the Medicare surtax, education tax credits, and a handful of above-the-line deductions wouldn’t exist. Alternative minimum tax parameters would revert to their 1997 levels and no longer would be adjusted for inflation.

These differences in the income tax would have several important implications for federal government finances, taxpayers, and the economy.

First, individual income tax revenue would be significantly higher. If 1997’s individual income tax were in force today, the federal government would raise $724.1 billion more revenue. The largest single change would be the higher statutory tax rates, which would raise $419.8 billion.

Other major sources of additional revenue would be from repealing the child tax credit ($129.6 billion) and reverting the alternative minimum tax back to 1997 parameters ($123.7 billion). Changes to capital taxation would raise an additional $101 billion.

These individual income tax increases would raise projected federal tax revenue as a share of GDP to 20.4% from 17.8% and reduce the projected budget deficit to 3.1% of GDP from 5.8% in 2024.

Second, all this new revenue would mean higher taxes for taxpayers in every income group. Effective tax rates for all income groups would rise, but the 95th to 99th percentile income group would face the largest increase, going to 28.1% from 23%. A household earning roughly $43,500 a year would face $3,053 in higher income taxes every year.

Third, millions more taxpayers would be subject to the alternative minimum tax. By not indexing parameters for inflation, 49.4 million, or nearly 1 in 4 tax filers, would be subject to the tax by 2024. That includes 700,000 middle-income households. Roughly 200,000 high-income households face the alternative minimum tax today.

Finally, reversing more than a quarter century of tax cuts would have important implications for the economy. Higher statutory tax rates mean higher marginal tax rates on work, saving, and investment. For example, the weighted average marginal tax rate on labor would rise to 39.4% from 33.7%.

Using a labor supply responsiveness in line with Congressional Budget Office assumptions, this would reduce total economic output and hours worked by 1.5%, or 1.8 million full-time equivalent jobs.

Returning to 1997’s individual income tax also would reverse partial corporate integration introduced in the Bush-era tax cuts. The overall statutory tax rate on distributed corporate profits would be as high as 53.2% if the corporate rate remained at 21%.

This would be far higher than the 40.7% statutory income tax rate on other forms of income and would increase the incentive for taxpayers to recategorize income and further discourage the use of the C corporate form.

Saying No to Retro

The changes to the tax code since 1997, while not all ideal, did make improvements to the individual income tax. When lawmakers start debating how to deal with growing federal debt, they should approach this issue looking for the best way forward—not backward—to structure our tax code.

They should focus on broadening the income tax base by, for example, further limiting itemized deductions and taxing currently exempt employer-provided benefits. These reforms could raise hundreds of billions of dollars while reducing economic distortions.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Kyle Pomerleau is a senior fellow at the American Enterprise Institute, where he studies federal tax policy.

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