CHN: Tax Reform: A Long Shot

Republicans have started to set their sights on enacting tax reform and on more spending cuts, by making these goals the price of raising the federal debt limit. On May 7, the Washington Post quoted House Budget Committee Chairman Paul Ryan (R-WI) as saying, “The debt limit is the backstop…we need to get a downpayment on the debt; we need entitlement reform; we’re very serious about tax reform because we think that it is critical to economic growth and job creation.”  In addition, interest in reforming the tax code has led to bi-partisan work in House and Senate committees to spell out options.
The flurry of activity and rhetoric around tax reform should not be interpreted as a signal that Congress is about to pass comprehensive tax reform anytime soon.  Most agree that a stand-alone tax reform bill in this Congress is unlikely and that the best possible chance to enact tax reform might be in the context of a deficit reduction deal later this year when the limit on the debt ceiling will need to be increased.

Many Democrats believe that any deficit reduction deal should replace the sequester cuts ($1.2 trillion – $85 billion in military and non-military spending cuts in 2013 and 8 more years of cuts through 2021).  The replacement they envision would generate net new revenues (be ‘revenue positive’) by closing individual and corporate tax expenditures or loopholes and by cutting programs in a more targeted way.  [Tax expenditures are special exemptions and exclusions, credits, deductions, deferrals, and preferential tax rates that result in foregone federal revenue.]  The revenue gained would be used to reduce the deficit and/or fund investments in education, building bridges and roads and other programs that would strengthen the economy and accelerate economic recovery.  Republicans whose goal is to reduce the size of the federal government are not concerned about the $1.2 trillion in cuts, especially the non-military ones, and would like to add significant reductions to entitlement programs.  Their perspective on tax reform is that it should not generate new revenue (be ‘revenue neutral’) with the savings achieved by closing loopholes used to lower both the individual and corporate tax rates.  Like most Democrats, the President seeks to replace the $1.2 trillion through a combination of selective program cuts and net increases in taxes on individuals.  Advocates are disappointed that he supports revenue neutral corporate tax changes.

Each party’s approach to tax reform is mirrored in the 10-year House and Senate budgets.  The Republican House-passed budget proposes to drop the individual income tax down to just two tax brackets, 10 and 25 percent, and it reduces the corporate income tax rate to 25 percent.  Reducing the top individual rate from its current 39.6 percent down to 25 percent provides a windfall to millionaires, who stand to gain an average of at least $200,000 each just in 2014, as shown by this analysis from Citizens for Tax Justice. The House budget proposal is also specific in saying that its tax changes will be revenue neutral. But other than a general statement about closing tax loopholes, it says nothing about how the trillions of dollars in tax cuts would be made up.  There are not enough loopholes for rich individuals to offset the cost of the huge income tax rate reductions they would receive.  That means the only way to pay for the rate reduction would be to raise taxes on low- or middle-income taxpayers.

The Democratic Senate-passed budget includes $975 billion in tax increases over ten years. It does not specify the precise nature of the tax increases, except to say that it is the intent of the Committee that the increases come from the wealthiest individuals and from large corporations. The budget discusses the opportunities for increasing revenues by reducing tax expenditures that provide the greatest benefit to upper-income taxpayers, without specifying which should be reduced or eliminated. It is specific in suggesting limits on the value of tax deductions or other preferences for the top two percent, and recommends reducing business tax loopholes.

Thus far only $600 billion in deficit reduction has come from revenue increases; those enacted in the January 1, 2013 American Taxpayer Relief Act (PL 112-240).  All of the revenue in the Act comes from the individual side of the tax code, none from the corporate side.  Individuals’ taxes increase slightly in 2013 for all income groups because of the expiration of the two percent payroll tax holiday, and somewhat more for upper-income households as their marginal tax rate increases from 35 percent to 39.6 percent.  Even with these changes the individual income tax system is still only modestly progressive. (A progressive system is one where the wealthiest pay a greater proportion of their income in taxes.)  Contrary to popular belief the wealthiest do not pay a vastly disproportionately share of taxes relative to their income.  When all taxes are considered (federal, state, and local) the lowest 20 percent of earners pay an effective tax rate of 18.8 percent of their income in taxes and the wealthiest one percent of earners pay an effective rate of 33 percent.  (For more details see Citizens for Tax Justice report.)  Advocates believe the individual tax code should be made more progressive through tax reform.

A common myth in the tax world is that corporate tax rates are too high (citing the 35 percent highest marginal rate), making corporations less competitive in the global market and therefore in need of lower taxes.  That might be true if corporations were actually paying the 35 percent rate but many are paying a significantly smaller amount, and in some cases they are paying no taxes.  The reality is that corporate profits are soaring. Profit margins are at an all-time high, while corporations are paying employees’ wages that are at an all-time low as a share of the GDP (total economic output), and the corporate share of taxes paid to the IRS continues to decline.  According to the Treasury Department, total federal corporate taxes collected in the U.S. in 2010 were 1.3 percent of GDP.   The most recent data from the Organizations for Economic Cooperation and Development (OECD) shows that corporations in the other 34 OECD countries that are the main U.S. trading partners paid 2.8 percent of their combined GDPs in taxes in 2010.

According to a recent Government Accountability Office report there are an estimated 80 tax expenditures that corporations use to avoid paying taxes.  In 2011, these resulted in $181 billion in revenue lost to the federal government, approximately the same as the total amount collected from corporations.  Companies among the profitable Fortune 500 from a range of sectors have legally used loopholes and expenditures in the tax code to avoid paying any taxes, and in fact, some have a negative tax liability and receive rebates from the federal government.  A Citizens for Tax Justice report is illustrative of companies that have paid no taxes and have received rebates over the past five years (2008-2012); among them are Apache, Facebook, General Electric, Principal Financial, Pepco Holdings, Ryder System and Tenet Healthcare.

Two of the biggest corporate tax breaks are one that allows companies to accelerate depreciation of machinery and equipment, and another that allows big multinational corporations to postpone paying U.S. taxes on foreign earnings until they bring those profits home which sometimes they never do. Estimates are that corporations have accumulated close to $2 trillion in offshore profits.  Many analysts believe that as Congress looks to revamp the tax code, a good starting point would be to examine the plethora of loopholes in the corporate code and make changes to ensure that profitable corporations pay their fair share.

Bi-partisan efforts are underway in the House Ways and Means Committee and in the Senate Finance Committee to lay the groundwork for tax reform.  In February, Ways and Means Committee Chairman Dave Camp (R-MI) and Ranking Member Sander Levin (D-MI) announced the formation of 11 working groups to review current law in designated areas, research relevant issues, and compile feedback from stakeholders.  The report with the results of their work was published on May 6.  In March the Senate Finance Committee members started a series of weekly meetings to discuss tax policy focusing each week on one topic.  Their work continues.

Enacting tax reform legislation will be an uphill climb for multiple reasons. Neither the Ways and Means nor the Finance Committees began their discussions with a set of operating principles, for example, stating whether tax reform overall will be revenue positive or revenue neutral. Multinational corporations and small businesses are not in agreement about which loopholes and expenditures should be kept or eliminated.  The most expensive tax deductions in the individual code – for mortgage interest, charitable giving, state and local taxes, employer-provided health care – all have powerful constituencies that will fight to keep them in place.  Finding a legislative vehicle to move tax reform will also be a challenge. Leading Democrats reject the notion that tax reform should be linked to the debt ceiling.  Stay tuned.

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