Analyzing House Republicans' tax reform blueprint
The Congressional Research Service issued a report April 25 summarizing the proposed tax changes in the "Better Way" tax reform blueprint released last summer by congressional Republicans and projecting their economic impact in terms of distributional and equity issues, administrative issues, revenue effects, and other tax-related issues.
The blueprint is likely to be one of several competing tax plans, with the Senate reportedly reviewing proposals made in 2014 by former Ways and Means Committee Chairman Dave Camp, and the White House formulating its own policies.
On June 24, 2016, House Republicans released an installment of their "A Better Way—Our Vision for a Confident America" that contained a number of tax reform proposals.
Individual reforms include:
• Reduce both the top rate (to 33 percent) and the number of brackets (to three)
• Increase the standard deduction (to $12,000 for singles, $18,000 for heads of household, and $24,000 for joint returns), while eliminating personal exemptions and all itemized deductions except the mortgage interest deduction and charitable contribution deduction
• Eliminate the AMT
• Retain, with certain changes, the earned income tax credit and child tax credit
• Tax capital gains, dividends and interest income at 50 percent of ordinary rates (i.e., such that a taxpayer in the highest tax bracket would pay 16.5 percent)
• Repeal the estate tax and generation-skipping transfer tax (no mention is made of the gift tax).
Business reforms include:
• Create a new business rate (maximum rate of 25 percent) for small businesses that are organized as sole proprietorships or pass-through entities instead of taxing them at individual rates
• Reduce the corporate tax rate to 20 percent
• Shift towards a more consumption-based system
• Provide for immediate expensing of the cost of business investments
• Disallow the interest deduction
• Retain the research credit (with modifications)
• Eliminate the domestic production activities deduction
• Allow net operating losses to be carried forward indefinitely
• Shift to a territorial tax system
• Tax accumulated offshore earnings over an eight-year period at 3.5 percent (or 8.75 percent for earnings held in cash or cash equivalents).
CRS analysis of individual provisions
With respect to individuals, CRS found that, while the average marginal tax rates on wages, salaries and self-employment income would be lower under the plan, the effect of broadening the base, particularly with respect to the disallowance of state and local tax deductions, would in many cases offset the rate reduction.
The CRS analyzed the individual income tax changes in terms of vertical equity (i.e., distribution across income classes) and horizontal equity (i.e., the treatment of taxpayers with similar abilities to pay). Citing a distributional analysis performed by the Tax Policy Center and the Tax Foundation, the CRS found that, while there were differences between the two groups' projections, both showed a "general pattern of favoring higher-income individuals."
With respect to horizontal equity, CRS noted the most common way that most taxpayers with the same ability to pay could experience different tax rates is family composition. To this end, CRS concluded the blueprint's treatment of families of different compositions would remain similar to current law. CRS also found the existing marriage penalty or bonus under current law would be largely retained under the blueprint.
Another way taxpayers can differ in their ability to pay is because of circumstances, such as an individual with large medical expenses. CRS noted, under current law, there is an itemized deduction available for extraordinary medical expenses (i.e., those over 10 percent of income), which tends to be concentrated at lower and moderate income levels because such individuals are less likely to have health insurance. This deduction would not be available under the blueprint.
CRS analysis of business provisions
Turning to business taxes, the CRS report, citing a variety of other studies, found that business effective tax rates would decline significantly under the plan. The TPC estimated the overall effective tax rate would fall from 22 to 6.3 percent.
CRS also stated the plan would achieve efficiency gains, particularly in the even treatment of debt and equity finance. The plan would also eliminate many distortions associated with multinational firms, including eliminating the tax treatment that discourages repatriation of foreign source income to the U.S. and the incentive for firms to engage in corporation inversions.
Both the TPC and Tax Foundation estimated the blueprint's revenue effects, with the TPC also taking into account repeal of the Affordable Care Act taxes.
The TPC estimates a revenue loss of $3.1 trillion for the first 10 years and $2.2 trillion for the second 10 years. If the ACA taxes are excluded, the cost is $2.3 trillion in the first 10 years and $796 billion in the second 10 years. Of these, the individual income tax costs are $1.2 trillion in first 10 years and $304 billion in second 10 years.
The Tax Foundation estimated a revenue loss of $2.4 trillion in the first 10 years, with $981 billion from the individual income tax.
According to the CRS, the blueprint would simplify the tax system's administration and compliance by reducing the number of itemizers, eliminating the estate tax, simplifying depreciation, and eliminating the need for most international tax planning to shift profits out of the U.S. However, some new complications would be introduced. These include the need to distinguish between capital income of pass-through businesses (subject to a maximum 25 percent rate) and labor income of their owner-operators (subject to a maximum 33 percent rate) and the implementation of the border adjustment tax.