CHN: Tax Reform Primer: Differing Goals Make Action Elusive
Tax Reform Primer: Differing Goals Make Action Elusive
The last major comprehensive federal tax reform legislation was passed in 1986. Since then, the federal tax code has been filled with changes making it more complicated and, for individuals and corporations who can afford tax lawyers, easier to find legal ways to avoid paying taxes. Chairmen of both the House and Senate tax-writing committees say they are preparing to introduce major tax reform bills this year. To emphasize their point, Senate Finance Committee Chairman Senator Max Baucus (D-MT) and House Ways and Means Committee Chairman Representative Dave Camp (R-MI) embarked on a joint tax reform tour. The first stop was on July 8 in Minneapolis to seek ideas from large businesses. The focus of their July 29 trip to Philadelphia was to talk with small businesses. The tour followed months of meetings with committee members and staff discussing various options for tax reform. Both chairmen are determined to forward legislation during their remaining time in the driver’s seat – at the end of 2014 Senator Baucus will retire and Representative Camp’s tenure as Ways and Means chairman will end. Enacting reform will be a heavy lift, and advocates are concerned about the nature of tax reform under their leadership.
While in past decades tax reform plans have been designed to be revenue-neutral (that is, any revenues gained by eliminating tax loopholes would be plowed back into other tax reductions), that is far more problematic at a time when deficit reduction legislation has initiated ten years of cuts in government programs and investments. Since 2011 Congress has enacted nearly $2.8 trillion in deficit reduction, including interest savings. The ratio of spending cuts to revenue increases has been approximately 3:1.
Many economists and advocates including the Coalition on Human Needs believe that tax reform should result in more revenues and should be at least as progressive as the current system. That is also the view of Senate Majority Leader Harry Reid (D-NV) and others in the Democratic leadership. President Obama’s FY 2014 budget proposed to raise $851 billion in revenue over 10 years from individuals, but has in the past supported corporate tax changes that do not result in increased revenues. In a modest departure from his stance on corporate taxation, the President on July 31 called for investing short-term revenue increases from his corporate plan in job creation initiatives. Most Republicans in Congress either want revenue-neutral tax reform or favor additional tax cuts.
Corporate Tax Reform
In the 1950s and ’60s U.S. corporations’ share of federal revenue collected averaged over 20 percent annually. According to a Citizens for Tax Justice presentation, corporations are projected to contribute only about 10 percent of federal revenues in 2013. This precipitous drop has occurred despite soaring corporate profits but has not prevented complaints by corporations that their tax rate is too high, making them less competitive in the global market. Regarding the U.S. corporate tax rate, the highest statutory rate is 35 percent. However, the effective rate (the amount actually paid as a proportion of income after credits, deductions, and other loopholes are exploited) is significantly less. According to a Government Accounting Office report, in tax year 2010 the average effective rate for profitable U.S. corporations was 12.6 percent, increasing to 16.6 percent when foreign, state and local income taxes are included.
Many large U.S.-based multinational corporations avoid paying taxes by parking their profits offshore in countries known as tax havens (places with very low or no taxes). In so doing they avoid paying taxes until or unless those profits are brought back to the United States. A newly-released report from U.S. PIRG (the federation of state Public Interest Research Groups) documents the extensive use of offshore tax havens by the top 100 U.S. publicly traded companies. They have a total of approximately $1.17 trillion sheltered in foreign countries that are known tax havens. Two-thirds, or $776 billion, is stashed away by 15 companies – General Electric, Apple, Pfizer, Microsoft, Merck, Johnson & Johnson, I.B.M., Exxon Mobil, Citigroup, Cisco Systems, Abbott Laboratories, Procter & Gamble, Hewlett-Packard, Google and Pepsi Co. The companies often set up shell subsidiaries in the haven countries with few employees, if any, and little or no business activity. Of the top 100 companies, 21 reported what they would expect to pay in U.S. taxes if they did not keep the profits offshore. Collectively they would owe over $93 billion in additional federal taxes. Repealing the rule that allows corporations to defer paying taxes on their profits could raise approximately $600 billion over ten years.
There are also significant cross-cutting breaks that apply to both multinational and domestic companies in the tax code. One of the largest is the ability of companies to deduct from their taxable income capital investments (in equipment, software, buildings…) at a rate more quickly than the items wear out. In addition, some sectors of the economy benefit from subsidies particular to that industry. Often mentioned are the subsidies for oil and gas companies. Citizens for Tax Justice has a report outlining policy options to raise more revenue by closing tax loopholes and reducing subsidies that benefit companies.
Individual Tax Reform
In 2001, President Bush proposed and Congress agreed to the Economic Growth and Tax Relief Reconciliation Act, which reduced income tax rates for most taxpayers by a few points and created a new 10 percent bracket. The American Taxpayer Relief Act of 2012 made permanent the rate reductions for every tax bracket except the top rate of 35 percent, which it returned to its pre-2001 level of 39.6 percent. (Income over $450,000 is subject to the highest rate.) The result was estimated as a $600 billion tax increase over 10 years. This represents the first contribution revenues made to deficit reduction during the current economic recovery. By historic standards the top rate is still low; it has been over 60 percent for more than half the time since the income tax was adopted a century ago.
The tax code is filled with tax expenditures (subsidies provided through the tax code). These tax breaks lose approximately the same amount of annual revenue ($1.3 trillion) as is brought into the Treasury through personal income taxes. There are expenditures on both the corporate and individual side of the tax code, but the bulk of them are on the individual side in the form of exclusions (an item not taxed), deductions (a reduction in income not subject to tax) or credits (a sum deducted from the total amount of tax owed). The largest tax expenditures for individual taxpayers include the exclusion of employer-sponsored health insurance, preferential rates on capital gains and dividends, the exclusion of pension contributions and earnings, the exclusion for state and local taxes, and the deduction for mortgage interest. As Congress looks at tax reform, Citizens for Tax Justice suggests that it should evaluate whether the expenditure should be repealed, reformed or preserved based on three criteria: cost, progressivity and effectiveness in achieving policy goals, such as subsidizing home ownership, encouraging charitable giving, or encouraging work.
Advocates believe that one of the expenditures hardest to justify and most expensive (a predicted $161 billion in lost revenue in 2013) is the lower tax rate on capital gains (profits made from selling assets above their purchase price) and dividends. The richest one percent of taxpayers receives 68 percent of the benefit from this expenditure and the richest five percent receive 82 percent of the benefit. While the maximum tax rate for earnings is 39.6 percent, the tax rate for capital gains and dividends is capped at 20 percent.
For more detail on reforming individual income tax expenditures see the Citizens for Tax Justice report.
Low-Income Tax Credits
Top priorities for advocates in tax reform is preserving the refundable Earned Income Tax Credit (EITC), the Child Tax Credit (CTC), and the American Opportunity Tax Credit. A refundable tax credit is one that results in a “refund check” payment even if the credit exceeds what a person or family owes in taxes. The EITC is calculated on a sliding scale, with the maximum credit of $5,372 available for a family with two children in 2013 with earnings up to approximately $18,000; the credit then gradually decreases as earnings rise, and phases out for married couples at a little over $48,000. The EITC is considered the most beneficial anti-poverty program in the federal government, lifting millions out of poverty. The CTC is partially refundable for low-income working families up to the maximum of $1,000 per child. The American Opportunity Tax Credit helps students and their families pay for college, and is also refundable.
After multiple Finance Committee hearings, bipartisan meetings with members and staff, and numerous option papers over the last few years, Chairman Max Baucus (D-MT) and Ranking Member Orrin Hatch (R-UT) sent a letter to all members on June 27 asking for their feedback starting with a “blank slate” approach – that is, a tax code without all of the tax expenditures – asking them to make the case for retaining, eliminating, or changing them in the code. Most important to advocates is that the letter calls for “maintaining the current level of progressivity” in the tax code. A footnote in the letter says, “The current level of progressivity means the level of progressivity in 2017. Certain tax expenditures are excluded from the analysis where doing so is necessary to maintain the current level of progressivity.” This is especially important because it essentially assumes that improvements to the refundable credits including EITC and CTC which were extended through 2017 will continue in any tax reform plan.
The letter has been met with mixed reviews. Some members have responded by the July 26 deadline with letters to the chairman and ranking member that talk mostly about principles that should be adhered to in tax reform. Others discuss specific provisions in the code that should be retained. Initially some members expressed concern about whether the letters would remain secret. Some decided to make their letters public themselves.
Leader Harry Reid (D-NV) has said that ‘significant’ revenue must be generated from both the corporate and individual sides of the tax code, and has questioned the value of tax reform plans that do not start with an agreed-upon goal of increased revenue. The third ranking Democratic leader, Senator Charles Schumer (D- NY), and other Democrats say that the process should result in $975 billion in net revenue over 10 years, the amount they voted for in the Senate-passed budget resolution earlier this year. Chairman Baucus voted against that budget resolution. Senator Hatch and many Republicans say tax reform must be budget-neutral.
Similar to the Senate, the House Ways and Means Committee has been working on a bipartisan basis to discuss and analyze proposals to reform the corporate and individual tax codes. Ways and Means Chairman David Camp (R-MI) says that the end result should not raise more revenue. In a recent meeting with members of the Committee, the Chairman said he plans to bring a bill to the Committee this fall that follows the framework of the tax plan in this year’s House-passed budget. The plan would reduce the 7 brackets in the individual code to two – 10 and 25 percent – and would drop the top corporate rate from 35 to 25 percent. In July 30 letters to Ways and Means Ranking Member Sander Levin (D-MI), the Joint Committee on Taxation (JCT) scored the 10-year cost of lowering the rates to 25 percent at a cost of $5 trillion in lost revenue over 10 years. Chairman Camp will press JCT to use a scoring method speculates about the impact on the economy of lowering the rates. This so-called ‘dynamic’ scoring method has not been used to make such projections because it is not possible to reliably estimate the effect that the changes would have. Although the House budget plan claimed to be revenue-neutral, an analysis of a similar plan by the Brookings-Urban Institute Tax Policy Center found that the only way that could be achieved would be by shifting the tax burden massively from upper-income to low- and middle-class taxpayers.
The President, in a July 31 speech in Tennessee attempting to re-focus the nation and Congress on job creation, called for a corporate tax plan that would lower the corporate tax rate to 28 percent, while closing loopholes and creating one-time savings that he proposed to invest in a short-term job creation package. His proposal does not spell out enough offsets on the corporate side of the ledger to pay for the rate reduction. Advocates are concerned that support for lowering corporate tax rates without any agreement in Congress for a plan to raise revenues and to invest in job creation will ultimately make revenue losses more likely.
During his presidential run, former Governor Mitt Romney revealed that his federal tax liability was less than 14 percent. More recently a much-publicized Senate investigation exposed the techniques Apple uses to pay little in taxes by sheltering $102 billion in tax havens. Small businesses and moderate-income individuals who pay a higher effective tax rate than many wealthy individuals and large corporations resent the fact that the tax burden falls more heavily on them. Their resentment seems to be shifting the debate in Washington about changes that should be made to make the tax system fairer.
Given the insistence of many Republicans that tax reform not increase revenue, and the stance of many Democrats that such a position is a non-starter, it is hard to see comprehensive tax reform becoming a reality anytime soon.