Senator Ben Cardin (D-MD) introduced the Progressive Consumption Tax Act last week that would reform the tax code and change the way that tax revenue is collected, introducing a nationwide consumption tax. The additional revenue generated would be used to cut the corporate rate in half and eliminate the income tax for three-quarters of households.
Cardin describes his the bill as a "comprehensive, progressive, pro-growth" proposal. As he explains:
Credible tax reform is critical to America’s economic competitiveness. Every other developed country in the world, including all other Organisation for Economic Cooperation and Development (OECD) countries, have a consumption tax. The Progressive Consumption Tax Act puts this country on a level playing field with other nations by providing for a broad-based progressive consumption tax, or PCT, at a rate of 10 percent. The PCT would generate revenue by taxing goods and services, rather than income.
Cardin's plan would adopt a 10 percent tax on most goods and services. However, both businesses and individuals would pay far less in income taxes, and most individuals would not owe any income tax.
For the individual income tax, a single person earning less than $50,000 or a couple earning less than $100,000 would not owe any taxes. According to the Tax Policy Center, approximately 75 percent of taxpayers had cash income below this threshold in 2013. Above that level, there would be three brackets – 15, 25, and 28 percent – instead of the current seven brackets that max out at 39.6 percent. Taxpayers in the top bracket would see only a small reduction in taxes on income they spend, since the new income tax rate would be 28 percent plus 10 percent on consumption spending. However, any income that goes into savings and investment would not be subject to this additional 10 percent tax.
Many of the deductions and credits currently available to individual taxpayers would be repealed, including the lower rate on capital gains and the alternative minimum tax. Those that the plan would keep – the state & local tax deduction, the mortgage interest deduction, the charitable deduction, and health & retirement benefits – would only be relevant to taxpayers with high enough income to owe tax. The refundable credits, like the Earned Income Tax Credit and Child Tax Credit, would be replaced by larger rebates based on income and family size, which would "practically eliminate the consumption tax burden for lower- and moderate-income families," according to Cardin's office.
Tax reform has been an increasingly common way to pay for infrastructure spending in recent years. Both President Obama and outgoing House Ways and Means Chairman Dave Camp (R-MI) proposed using revenue from business tax reform to fund the Highway Trust Fund (HTF) for a number of years.
Last week, Representative John Delaney (D-MD) proposed a version of this idea as well, but with a twist: he would also set up a deadline for tax reform and a backstop in case it wasn't passed.
Like Chairman Camp's proposal, Delaney's bill would use an 8.75 percent deemed repatriation tax to fund the Highway Trust Fund, in this case for six years. The tax would apply to the approximately $2 trillion of foreign earnings by U.S. companies held outside the country. He would also use the revenue to fund a $50 billion infrastructure bank. Camp's proposal raised $170 billion, $127 billion of which was dedicated to the HTF. It appears that Delaney would dedicate the same amount to infrastructure and use the remainder for the $50 billion bank.
Senator Coburn's office yesterday published the "Tax Decoder", a 300+ page guide describing more than 165 tax expenditures. The report highlights inefficiencies in many of the current tax breaks, drawing attention to areas where these breaks have been abused or provide an over-sized benefit to one specific industry, "allow[ing] Uncle Sam to put a thumb on the scale, placing politicians instead of markets at the center of capital allocation." See the full document here.
The report covers nearly every tax break. It describes attention-grabbing breaks like a tax break for a tuna company, breaks for NASCAR tracks, tax-free financing of stadiums built for private sports teams, and private foundations used by celebrities. It also tackles the largest tax expenditures, providing a serious treatment of large provisions like accelerated depreciation, the child tax credit, and the mortgage interest deduction. As the report says:
This report is meant to help decode the tax code for the public and policymakers alike, exposing special giveaways and surprising tax preferences unknown to many Americans who cannot afford tax lawyers or accountants.
The report "is designed to provide the building blocks of comprehensive tax reform for lawmakers wishing to enact a meaningful overhaul of the tax code in the coming years." It gives plain language summaries of many of the breaks that will come under discussion in tax reform. Many members, including outgoing Ways & Means Chairman Dave Camp (R-MI) and former Senate Finance Chairman Max Baucus (D-MT), started the work of reforming the tax code over the last several years. Hopefully, this report will inform the public and the lawmakers who will continue those discussions in the next Congress.
Republicans and Democrats do not agree on much, but both parties are talking about business tax reform that is "revenue-neutral," raising the same amount of money as the current tax code. But "revenue-neutral" can mean drastically different things, depending on which baseline policymakers choose to use. Discussing budget baselines might put most people to sleep, but the choice could mean an extra trillion dollars added to the debt over the next ten years.
Playing Baseline Games
Much of the disagreement over which baseline to use focuses on tax extenders, a set of mostly business tax breaks that expired in 2013. These breaks expire every year or two, and Congress routinely extends almost all of them. The Senate Finance Committee has a bill that would extend nearly all of them for two years, at a cost of $85 billion. Yet if all those provisions are extended year after year, the total ten-year cost would be almost $700 billion. Although Congress will likely deal with the extenders before the end of the year, their fate could set the parameters for future tax reform efforts.
Unfortunately, House Budget Chairman Paul Ryan (R-WI) is proposing to lower the bar for revenue-neutrality. He recently suggested policymakers should make some of the tax extenders permanent during the lame duck session, arguing that they do not need to be paid for and should add to the debt (which makes their costs disappear from the budget process and from needing to be offset in a revenue-neutral tax reform). If these were made a permanent part of the tax code, a future "revenue-neutral tax reform" would raise $700 billion less than before. Essentially, he is suggesting that this Congress lock in lower revenue levels – and higher debt – to make it easier for the next Congress to pass tax reform that they can claim is revenue-neutral.
Despite partisan differences in Washington, there's actually considerable bipartisan consensus around many elements of tax reform. That's the conclusion of a new report by the Center for American Progress (CAP). The report includes two dozen specific policies to raise $1.4 trillion of revenue over ten years that have been proposed by both Republicans and Democrats, although notably the proposals from Republicans were part of a fundamental tax reform plan that was revenue-neutral overall. Most of the consensus policies come from the President's budget and House Ways and Means Chairman Dave Camp's (R-MI) Tax Reform Act of 2014.
The report outlines a number of reductions in tax expenditures and other policies to raise revenue. On the corporate side, policies include eliminating accelerated depreciation, requiring businesses to write off half of advertising costs over ten years, eliminating last-in first-out accounting, implementing a big bank tax, and restricting earnings stripping and transfer pricing manipulation. The corporate income tax policies raise over $750 billion over ten years.
On the individual side, policies include limiting the benefit of exclusions and deductions for high earners, increasing rates on capital gains and dividends, reducing the mortgage interest deduction, and eliminating the break for "like-kind" exchanges. The report also proposed a few tax cuts through an expanded Earned Income Tax Credit (EITC); in particular, the report would extend the 2009 EITC expansions for married couples and families with three or more children and expand the credit for childless workers. On net, the individual tax policies would raise more than $550 billion, although the report suggests that the EITC expansions could be paired with some of these policies to form a revenue-neutral package.
Treasury Secretary Jacob Lew proposed administrative rules this week that would limit the benefits of tax inversions, where companies move their headquarters overseas for tax reasons. The rules target abusive practices where deals were often structured solely to skirt U.S. tax law. They eliminate some incentive for companies to invert, but many of the basic incentives to invert will remain until fundamental tax reform passes Congress and is signed by the President.
Recent months have seen a wave of actual and proposed corporate "tax inversions," where U.S. companies merge with a foreign corporation to move their headquarters overseas and avoid the high statutory U.S. tax rate on corporate income. Inversions are estimated to cost about $20 billion in lost corporate tax revenue over the next ten years. The Obama Administration had been pushing for legislation to address the issue, but after Congress left town for campaign season without addressing the issue, the Treasury Department moved forward in areas where they believe they have clear legal authority.
While the proposal reduces some benefits to inversions and may cause some companies to rethink their plans, inversions are a small symptom of an outdated tax code.
A new paper suggests that tax cuts that add to the deficit provide little boost to economic growth and may actually hinder it. Last week, the Tax Policy Center (TPC) put out a paper entitled “Effects of Income Tax Changes on Economic Growth,” summarizing the academic literature. According to the authors, Bill Gale from Brookings and Andrew Samwick from Dartmouth, the net economic impact of a deficit-financed income tax cut is either small or negative, with the negative effects of additional debt likely overwhelming the economic benefit of lower rates, particularly over the long term.
Tax cuts have the potential to grow the economy, but their benefit depends on how they are structured and financed. For tax changes to promote growth, changes should encourage work and investment through lower rates, efficiently encourage new economic activity (rather than providing a windfall for previous investments), reduce economic distortions, and create minimal (if any) increases in the budget deficit.
The key question is, how do you pay for tax cuts? If tax cuts are deficit-financed, the negative economic effects of debt will crowd out investment, which can outweigh any positive growth impact from the tax cut. CBO has found that an “Alternative Fiscal Scenario” representing roughly a $2 trillion increase in deficits over ten years would lead to a 7.5 percent smaller economy in 25 years, while a deficit reduction plan of $4 trillion would increase the size of the economy by 2 percent. Increased revenue has been a key part of many bipartisan plans for deficit reduction, including Simpson-Bowles and Domenici-Rivlin.
Importantly, however, the lack of growth from deficit-financed tax cuts is distinct from the effects of either tax reform, which pairs rate reductions with base broadening, or tax cuts that are financed through simultaneous spending reductions to reduce government consumption. Using base broadening to pay for lower rates avoids crowding out other investment, but would likely temper the economic gains because some base broadening can push up effective marginal tax rates on taxpayers who were taking advantage of the closed loopholes.
Earlier in the week, we highlighted a portion of CBO Director Doug Elmendorf's presentation at Cornell University highlighting the increased resources going to health care, Social Security, and interest spending to the detriment of the rest of the budget. In addition, the slideshow contained other helpful charts showing how the federal budget could change over the next decade, the choices policymakers face to alter the trajectory of debt, and a further look at the impacts of the Affordable Care Act. Here are some of the more interesting charts from that presentation.
Putting Debt on a Sustainable Path Requires Significant Changes
With debt set to continue to rise as a percent of GDP, simply maintaining the status quo will require significant changes. Keeping debt stable at its current elevated level of 74 percent of GDP for the next 25 years would require $2 trillion of savings over ten years, twice as much as the savings in the President's budget. Getting debt close to its historical average of 40 percent of GDP in 25 years will require $4 trillion in ten-year savings.
Individual Income Tax Revenue is the Only Growing Revenue Stream
CBO's ten-year projections show only a modest rise in revenue as a share of GDP over the next decade, from 17.5 percent to 18.2 percent, and in fact from 2015 to 2024 revenue will remain roughly flat.
House Republicans plan to vote this week on a jobs package combining bills that would "build a robust economy and foster job creation." While promoting economic growth should be a top priority after a lackluster jobs report and a slow recovery, policymakers should also be fiscally responsible. Unfortunately, the House Republican approach would make the debt much worse. We've compiled the cost estimates for the various bills, and the package would cost more than $570 billion over ten years, before interest.
The package includes a combination of tax, spending, and regulatory changes, many of which could help to spur short or long-term economic growth. The majority of the costs in the legislation come from permanently extending and expanding a few expired tax provisions which focus on promoting research and investment. Unfortunately, the legislation would include over $570 billion of costs, but only $400 million worth of savings. Without offsets, the package will add substantially to the debt.
This increase in debt isn’t only bad for the fiscal situation; it also works against the exact purpose of the bill. As CBO has noted, a high national debt creates drag on economic growth by crowding out private investment, reducing output, and increasing interest rates. The package's care-free attitude towards increasing the debt will dampen any economic growth that would occur from the legislation.
As we've argued many times, if something is worth having, it is worth paying for. The fact that a package has the potential to promote growth does not mean we should allow it to add to the debt over the long run. In the past, we’ve suggested numerous offsets to pay for unemployment insurance, highway spending, extending tax provisions, veterans health care, or the Medicare "doc fix." Any of those, or any number of others, could be attached to this package to make it more fiscally responsible.
|Provisions in the September 2014 House Jobs Package
|Policy||Ten-Year Costs, 2015-2024
|Expand and make permanent bonus depreciation||$269 billion|
|Expand and make permanent the research & experimentation tax credit||$156 billion|
|Expand and make permanent 2013 levels of small business expensing (Section 179)||$73 billion|
|Change the definition of full-time employment from 30 to 40 hours/week||$46 billion|
|Repeal medical device tax||$26 billion|
|Make permanent two expired tax breaks relating to S Corporations||$2 billion|
|Exempt from the employer mandate servicemembers and veterans who already have health insurance||$1 billion|
|Codify standards for regulations that create private mandates||< $0.1 billion|
|Require agencies to submit a monthly report of proposed and final regulations||< $0.1 billion|
|Require major regulations to get Congressional approval||"significant"|
|Exempt most private equity financial advisors from SEC registration||negligible|
|Exempt certain merger & acquisition brokers from SEC registration||negligible|
|Streamline the process to obtain permits to extract critical and strategic minerals from public land||negligible|
|Permanently ban states and localities from imposing taxes on internet access||$0|
|Increase timber production on federal lands||- $0.4 billion [savings]|
|Total, House Republicans Jobs Package||$572 billion*|
Senators Chuck Schumer (D-NY) and Dick Durbin (D-IL) have introduced legislation that would reduce the benefits to companies that choose to "invert," or move their headquarters overseas for tax reasons. The bill is very similar to a proposal included in last year's President's Budget, which would save about $3 billion over ten years by limiting tax deductions. It targets "earnings stripping," when companies with large amounts of cash borrow purely for tax reasons.
Recent months have seen a wave of corporate "tax inversions," where U.S. companies merge with a foreign corporation to move their headquarters overseas and avoid the high statutory U.S. tax rate on corporate income. Inversions are estimated to cost about $20 billion in lost corporate tax revenue over the next ten years.
Schumer and Durbin's proposal targets what they call “one of the most egregious practices of corporate inversions,” known as earnings stripping. This practice involves a foreign parent company lending to its U.S. subsidiary. Then, the U.S. subsidiary can send its profits to the parent company as interest. While this paper transaction doesn't change the company's overall financial position – it has the same income and debt levels as before – the loan provides two tax benefits. First, the U.S. subsidiary will have greater interest payments, which can be deducted as a business expense. Second, more of the company's income is "booked" outside the United States, where companies do not have to pay U.S. tax unless they repatriate the funds back to the U.S.