With the release of the FY 2015 President's budget, the Obama Administration has now presented six annual budget plans (and an additional proposal to the Super Committee). As you can imagine, there are a lot of policies in this year's budget that are holdovers from previous ones, but there are also new ones. This blog will highlight major new policies in this year's proposal. In the coming days, we will also talk about the flip side of the coin – policies not in this year's budget that showed up in previous submissions.
Expanding the Earned Income Tax Credit
Arguably the centerpiece new policy of the budget is the expansion of the Earned Income Tax Credit for workers with no children. As we mentioned in talking about the State of the Union, the credit for workers without children is about an order of magnitude less than the one for workers with children and phases out at a very low level of income, making its value as a work subsidy much diminished for childless workers. The budget proposes to double the phase-in rate of the credit – and consequently double the maximum credit from $500 to $1,000 – and increase the income threshold at which the credit phases out. It would also change the age restrictions on who receives the credit from ages 25-65 to ages 21-67 (as long as the person was not claimed as a dependent on another tax return). The expansion costs $60 billion over ten years and is paid for by closing tax loopholes for high earners.
Reasonable Compensation Loophole
Coincidentally, the largest offset for the expansion of the EITC, raising $38 billion, is also a new policy. Currently, participants in partnerships and S corporation owners can largely set their own salary. They set their own wage income (on which they pay payroll tax) and also get the rest of the income from the business (on which they pay no payroll tax). Certain individuals set their wage income intentionally low to reduce their payroll taxes. This loophole is known as "reasonable compensation" since they are required to pay themselves a reasonable amount for their services, or known as the John Edwards or Newt Gingrich loophole, both notorious users of this loophole. The budget would instead require that limited partners who materially participate in their business and S corporation owners include their share of the business's income for self-employment tax purposes. The Camp discussion draft also included this provision, although it would only tax 70 percent of the taxpayer's combined compensation and business income so it would raise less revenue.
With the Senate having produced an immigration reform bill, this year's budget includes the budgetary effect of immigration reform. The Senate bill produces savings of about $160 billion over ten years, with revenue increases of about $455 billion and spending increases of about $300 billion. It produces savings in the Social Security part of the budget of $210 billion and increases on-budget deficits by $50 billion.
International Tax Changes
The President's budgets have long had changes to the international tax system to prevent multinational companies from shifting income to get tax savings. This year, the budget includes a few new policies designed to further that goal.
When it comes to taxation of foreign-earned income, "active" income earned abroad by U.S. multinationals is taxed upon repatriation, while passive income – financial and other highly mobile and fungible income – is taxed in the year it is earned by Subpart F and other regimes. The additional changes proposed in this year's budget would expand Subpart F to include income from digital sales, further limit U.S. interest deductions, prevent companies from using manufacturing service arrangements to avoid taxes on income from acquired property, and limit the use of inversions of headquarters to avoid U.S. taxation, among other changes.
In total, these new provisions raise $55 billion over ten years. Since the revenue is applied to the account for revenue-neutral business tax reform, it does not raise additional revenue for the budget, but it does provide a greater pool of revenue to offset tax rate reductions or expansions of tax benefits.
Business Tax Reform Raising Revenue for Highway Trust fund
President Obama has proposed business tax reform that would be revenue-neutral over the long term. As we have discussed before, since some corporate base-broadening provisions would produce more revenue upfront, reform would likely need to raise revenue in the short term. This year's budget makes explicit the short-term revenue increase and dedicates $150 billion of this revenue to the Highway Trust Fund (HTF) to keep it fully funded through 2018. It is somewhat more fiscally responsible than the Camp discussion draft because it would deposit net new revenues into the HTF instead of double-counting the revenues deposited in the HTF to also achieve revenue-neutrality. However, using revenues to shore up the HTF still means corporate tax reform would not contribute to deficit reduction. Because the increased revenues from business tax reform are short-term, using these revenues to close the HTF shortfall is only a temporary fix. Eventually, changes must be made to HTF spending programs or the gas tax.
Health Care Workforce Investments
While the budget includes about $400 billion in gross health care savings, it also includes a number of spending increases as well. Things like the extension of the doc fix and Medicaid extenders have been in past budgets. However, this year's budget includes three policies totaling $15 billion that are new to the budget, referred to as health care workforce investments.
The largest policy, costing $5.4 billion, would extend for one year the increase in Medicaid primary care physician payments established in the Affordable Care Act that expires at the end of this year (we talked about the policy here). Another policy would establish a competitive bidding program to award grants for graduate medical education (GME) in needed areas. These grants would cost $5.2 billion and would give back about one-third of the savings the budget otherwise gets from reductions in GME payments. Finally, the budget includes $4 billion for the National Health Services Corps for physician shortages in high-need communities.