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Tax Reform, Part 2

The New York Analysis of Policy and Government concludes its two-part examination of the tax reform debate. 

President Trump’s tax reform proposals may include elements of the Republican tax proposal issued in June 2016. An Americans for Tax Reform analysis of the GOP tax reform concept, proposed last June, provides this summary:

  • According to the Tax Foundation’s Taxes and Growth Model, the plan would significantly reduce marginal tax rates and the cost of capital, which would lead to 9.1 percent higher GDP over the long term, 7.7 percent higher wages, and an additional 1.7 million full-time equivalent jobs.
  • The plan would reduce federal revenue by $2.4 trillion over the first decade on a static basis. However, due to the larger economy and the broader tax base, the plan would reduce revenue by $191 billion over the first decade.
  • Although the plan would reduce federal revenue by $2.4 trillion on a static basis in the first decade, much of the revenue loss is one-time. As a result, the plan will cost much less in subsequent decades.
  • On a static basis, the plan would lead to 0.7 percent higher after-tax income for all taxpayers and 5.3 percent higher after-tax income for the top 1 percent. When accounting for the increased GDP, after-tax incomes of all taxpayers would increase by at least 8.4 percent.”

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  • Increases the standard deduction from $6,300 to $12,000 for singles, from $12,600 to $24,000 for married couples filing jointly, and from $9,300 to $18,000 for heads of household.
  • Eliminates the personal exemption and creates a $500 non-refundable credit for dependents who are not children.
  • Increases the Child Tax Credit to $1,500 per child, limits the refundability of the credit to $1,000, and raises the phaseout threshold for the Child Tax Credit for married households from $110,000 to $150,000.
  • Eliminates all itemized deductions besides the mortgage interest deduction and the charitable contribution deduction.
  • Eliminates the individual alternative minimum tax.
  • Eliminates federal estate and gift taxes.

Changes to Business Income Taxes

  • Reduces the corporate income tax rate from 35 percent to 20 percent.
  • Eliminates the corporate alternative minimum tax.
  • Taxes income derived from pass-through businesses at a maximum rate of 25 percent.
  • Allows the cost of capital investment to be fully and immediately deductible.
  • Eliminates the deductibility of net interest expenses on future loans.
  • Restricts the deduction for net operating losses to 90 percent of net taxable income and allows net operating losses to be carried forward indefinitely, and increased by a factor reflecting inflation and the real return to capital. Does not allow net operating losses to be carried back.
  • Eliminates the domestic production activities deduction (section 199) and all other business credits, except for the research and development credit.
  • Creates a fully territorial tax system, exempting from U.S. tax 100 percent of dividends from foreign subsidiaries.
  • Enacts a deemed repatriation of currently deferred foreign profits, at a tax rate of 8.75 percent for cash and cash-equivalent profits and 3.5 percent on other profits.
  • Modifies all business income taxes to be border-adjustable, disallowing the deduction for purchases from nonresidents and exempting export profits and foreign-derived profits from taxation.

 Impact on the Economy

According to the Tax Foundation’s Taxes and Growth Model, the House Republican tax plan would increase the long-run size of the economy by 9.1 percent (Table 3). The larger economy would result in 7.7 percent higher wages and a 28.3 percent larger capital stock. The plan would also result in 1.7 million more full-time equivalent jobs. The larger economy and higher wages are due chiefly to the significantly lower cost of capital under the proposal, which is due to the lower corporate income tax rate and the full expensing of capital investment.”

A December, 2016 analysis by Mark Bloomfield, writing for The Hill maintained that all the ingredients necessary for tax reform exist, including the desire of major U.S. corporations to repatriate funds orphaned abroad due to current tax law, the need for those funds to be brought stateside to pay for infrastructure, and the desire of the GOP leadership to get it done.

That doesn’t necessarily indicate that the task is certain or easy. Bloomfield notes that “The Republican majority in the House can pass tax reform without any problem. It’s a different story, however, in the Senate, where 60 votes are required to advance even the slightest controversial legislation. However, there is a way around the Senate’s filibuster rules. McConnell confirmed on Dec. 12 that the Senate would pass tax reform using the budget reconciliation process, which is a privileged motion that needs only a simple majority to pass…There are also a number of Red State Democratic senators up for reelection in 2018, who could make tax reform bipartisan. I reckon that there’s a 63 percent chance of tax reform succeeding in 2017. Why? Because it has been that many years since the Internal Revenue Act of 1954, the first comprehensive reform of the federal income tax since its origin in 1913.”

Because tax reform is central to almost every other aspect of governance, fighting will be fierce. However, the impact of a reduced tax on the American economy, particularly for jobs creation and economic revitalization, would be exceptionally significant, and the political gains from a simplified tax code would be substantial.  With a majority in both houses of Congress, and with the precedent set by the Gorsuch nomination rules change, expect the GOP to move forcefully on the issue.

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Tax Reform and America’s Financial Death Spiral

The New York Analysis of Policy and Government takes a two-part look at the tax reform debate.

Tax reform is about to be debated in Washington—and not a moment too soon.

America’s finances are in a death spiral. Similar to a heroin addict that has reached the point where ever-larger doses are necessary to get a desired “high,” federal tax rates are at a point that discourages businesses from investing in job-producing activities in America, and penalizes individuals who seek to grow their income.   Continuing the current system and rates (or increasing them) to address the near-$20 trillion national debt and the annual deficits that add to it won’t cure the problem; it will kill the patient.

Washington is certainly collecting a great deal of revenue. The U.S. Treasury  has disclosed that during the first six months of the current fiscal year, it has pulled in a record haul of $695,391,000,000 in individual income taxes. This was in addition to $547,491,000,000 in Social Security and other payroll taxes.  The Tax Foundation  gave a bad mark to the United States in individual income taxes, ranking it behind 24 other developed nations in ease of burden of this type of levy.

The Congressional Budget Office describes how the current tax system discourages incentive:

“When workers’ earnings rise but their after-tax income rises less—because of increases in their income and payroll taxes or declines in their benefits from government programs—their incentive to work typically declines.”

Despite the record intake from individual income taxes, the federal government still ran a $526,855,000,000 deficit. Even with that vast intake from the Individual Income Tax and all that deficit spending, crucial needs, including an underfunded national defense, a crumbling infrastructure, and a social security system headed for insolvency all remained unresolved.

In fact, total federal tax collections declined because of lower returns from the corporate income tax. America’s uncompetitive corporate tax rates discourage business survival, growth and job creation within the nations’ borders.

The Tax Foundation notes that The United States has the third highest general top marginal corporate income tax rate in the world, at 38.92 percent. The U.S. rate is exceeded only by the United Arab Emirates and Puerto Rico. The worldwide average top corporate income tax rate, across 188 countries and tax jurisdictions, is 22.5 percent. Forbes  found that America has the highest statutory corporate income tax rate of any Organization for Economic Cooperation and Development (OECD) nation.

The OECD also reports that the tax-to-GDP ratio in the United States increased by 0.5 percentage points, from 25.9% in 2014 to 26.4% in 2015. The corresponding figures for the OECD average were an increase of 0.1 percentage point from 34.2% to 34.3% over the same period.

High rates, combined with an extraordinarily complex code, serves as a significant drag on the national economy. Americans for Tax Reform  notes that “…the U.S. has one of the most complex, internationally uncompetitive tax codes and double taxes income earned abroad. As a result, this money is unable to be reinvested back into the [U.S.] economy.”

Former NY lt. Governor Betsy McCaughey, writing in the NY Post   has suggested cutting corporate tax rates to 20%, and candidate Donald Trump had suggested reducing the rate to 15%.

Lowering taxes was a major plank in President Trump’s campaign platform.

President Trump is promising “the biggest tax cut in history,” in a bid to jump-start the sluggish American economy, improve a weak job market, and restore stability to the nation’s middle class.

Specifics appear to include reducing business taxes, currently the highest in the developed world, to 15%, doubling the individual income standard tax deduction and simplifying individual tax returns.

Additional details were not available at the time this report was prepared.

The GOP plan prepared by a “Tax Reform Task Force” began to take shape last June. It established its’ central logic:

“The United States stands at a pivotal moment. Today’s policy decisions will have a lasting effect on future generations – for better or worse. If we stay within the bounds of the current tax discussion, we have only three choices for the path forward:

  • We can do nothing, leaving our children with the responsibility to clean up the tax code and its ruinous effects.
  • We can raise taxes under the existing system, which would levy harsher penalties on hard work, savings, and entrepreneurship.
  • We can tinker around with little tax changes while the sun sinks ever lower on the age of American excellence.

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“The Tax Reform Task Force rejects these false choices and believes it is time to go in a completely new direction. Today we have a once-in-a-generation opportunity to move forward with bold, pro-growth tax reform. As the Task Force worked to develop smart reforms, we asked ourselves two questions about each policy or provision: ‘Will this policy reform grow our economy?’ and ‘Is it worth raising taxes on everyone else to include this provision?’ We are committed to growing our economy without increasing the deficit – taking into account the increased Federal revenues that result from economic growth.”

In its essence, the GOP plan combines lower rates for both companies and individuals, along with a far simpler tax code—including a goal of making the annual individual income tax filing as simple as filing out a single sheet of paper.

The Report concludes tomorrow