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.
With the economy recovering slower than originally anticipated, the government now expects to collect significantly less revenue this decade than it did just two years ago. The most recent budget projections from the Congressional Budget Office (CBO) show the government taking in $1.8 trillion less over a ten-year period than was projected in February 2013.
Growing entitlement spending is the primary source of growth in the federal budget, but this growth would not lead to higher debt if revenues kept pace. Despite the savings from the widely noted $900 billion slowdown in health care spending since March 2011, federal revenues are set even faster, widening the deficit. Over the same 2013-2021 time period, revenue projections have fallen $1.2 trillion since February 2013 and net health care spending has fallen $780 billion since March 2011.
February 2013 was the first budget baseline after the fiscal cliff law, which allowed certain tax cuts for high earners to expire while permanently extending most of the 2001/2003 tax cuts. In that baseline, revenues were expected to climb to 18.5 percent of GDP, both in the immediate future and by the end of the decade. Over the last two years, though, CBO has continually revised these revenue projections downward, particularly in their February baseline of this year. The last month's projections showed revenue staying under 18.2 percent of GDP throughout the period.
Half of the $1.8 trillion is due to decreases in individual income tax revenue. Payroll taxes experienced a similar but smaller decline. Corporate tax revenue is expected to be much lower than expected in the near term – projections for 2016 dropped over 15 percent – but only slightly lower over the long term. Excise taxes are the only exception to the decline, with projections that have slightly increased over the last two years.
Many policymakers have expressed concern about "tax inversions," transactions where American companies move their headquarters overseas in order to pay a lower tax rate. The inversions are estimated to cost about $20 billion in lost corporate tax revenue over the next ten years. Yet even as Congress and the Administration debate whether to stop inversions, there is bipartisan agreement on a series of tax breaks that could cost 35 times more. Reviving the tax extenders continually over the next 10 years will cost about $700 billion (about $400 billion in corporate tax breaks, and about $300 billion for other businesses and individuals).
Since the beginning of the year, at least 14 companies have announced mergers or purchases of overseas companies that would result in an American headquarters moving overseas. Commonly called "tax inversions," these transactions often take place only on paper – no offices or employees move, but the company is considered foreign for tax reasons. By inverting, companies avoid the U.S. corporate tax rate of 35 percent on their overseas earnings, instead paying a much lower (or sometimes zero percent) rate that other countries charge on income outside their borders. This erosion of the corporate tax base is problematic, and there's several ways to address it. One suggestion, by CRFB President Maya MacGuineas, calls for a strategic pause where companies agree not to invert for nine months, paired with a fast-track procedure to encourage comprehensive tax reform.
Inversions are estimated to cost about $20 billion in lost tax revenue over the next 10 years, or about 0.5% of the $4.5 trillion that will be paid in corporate taxes during the same period. Legislation stopping them would raise enough to pay for about one-quarter of the $85 billion cost of continuing the extenders for two years, as the Senate Finance Committee would do. But the extenders have often been extended year-after-year. For example, the current Finance Committee bill continues 52 out of 54 provisions, and expands some tax breaks that were not in the original bill. If the package were continually extended, the provisions would cost $700 billion. (The House, on the other hand, has taken a much more expensive approach, expanding the package to cost over $1 trillion.)
Both the Government Accountability Office (GAO) and Senator Tom Coburn's (R-OK) office have released new reports on a tax credit that rewards banks for investing in low-income communities. Both reports raise questions about whether the money is being used as effectively as it could be. The GAO report raises some concern with the credit's complexity and effectiveness, finding certain cases where investors are receiving many sources of federal money for the same project. Senator Coburn's report goes farther, identifying several places where the credit has been used for questionable purposes and calling for the credit's elimination. As his report explains:
The federal New Markets Tax Credit program was created to steer taxpayers dollars into banks that would in turn funnel financial assistance to businesses and developers in low-income communities to help create jobs. Yet, virtually every neighborhood, from Beverly Hills to the Hamptons, could qualify for the program. The New Markets Tax Credit (NMTC) has subsidized wealthy investors in nearly 4,000 projects, including car washes, bowling [alleys], parking lots and breweries. Many of these are wasteful and not a federal priority – such as an ice skating rink and a car museum - while others are corporations in little need of taxpayers’ handouts – such as chain restaurants like Subway and IHOP.
Since 2000, the New Markets Tax Credit (NMTC) has given investors, mostly large banks and financial institutions, a 39 percent credit for loaning money to businesses in low-income communities. Investors claim the credit over seven years.
GAO notes the financial arrangements used to claim the credit have become much more complex.
Around this time of year, the Social Security Trustees usually issue their report on the status of the program over the next 75 years. In advance of that release, CBO has provided a report to Senate Finance Committee ranking member Orrin Hatch (R-UT) with options for making Social Security solvent over 75 years through payroll tax increases. If no action to address the insolvency is taken, Social Security will see a 23 percent across-the-board benefit cut in the early 2030s. Because CBO's own estimate of Social Security's shortfall is larger than the Trustees', it finds that larger increases would be required to keep Social Security solvent than the Trustees estimate.
Closing the 75-year shortfall through the payroll tax alone would require an immediate 3.54 percentage point increase in the payroll tax rate (to 15.94 percent), compared to the 2.7 percentage point necessary increase projected by the Trustees. CBO also evaluates increases in the cap on income subject to Social Security payroll taxes (the "taxable maximum"), which is currently set at $117,000 for 2014 and increases with average wage growth each year. The cap currently covers 83 percent of wages; raising it to 90 percent would close 30 percent of the funding gap, and eliminating the cap altogether would close 45 percent.
The report also shows that getting to 75-year solvency would require a 2.3 percentage point payroll tax increase in combination with the 90 percent option and a 1.6 percentage point payroll tax increase for the elimination option. There are a number of permutations of these options included in the report, which you can see below.
The House Ways and Means Committee just published its plan for a short-term fix to the Highway Trust Fund, which needs an additional $8 billion to fund highway construction through the end of the year. Unfortunately, it relies on a known gimmick called "pension smoothing," which technically raises revenue on net over 10 years but may cost money in future years. Lawmakers should not be using any gimmick, let alone a "pay-for" that may increase future deficits.
Since lawmakers have less than a month before disruptions occur, they may need to rely on a short-term patch while a long-term highway bill is being negotiated. To help, we published a list of options to offset a transfer of general revenue into the highway fund, which intentionally left off pension smoothing, even though it was used to "fund" the last highway bill, because it is a gimmick.
The Ways & Means plan raises $10.9 billion for the Highway Trust Fund: $6.4 billion from the pension smoothing gimmick, $3.5 billion from extending customs fees through 2024, and $1 billion transferred from an over-funded trust fund for leaking underground oil tanks. However, the pension smoothing money is entirely a timing shift that raises money upfront and transfers the costs beyond the 10-year budget window.
Citizens for Tax Justice released a new report detailing options to raise revenue, which could help lawmakers in their pursuit of tax reform to lower the debt. The revenue-raisers in the report are divided into three categories – those that raise money from high-income individuals, businesses, and multinational corporations. Within those categories, the report distinguishes between options that would only be considered in the context of tax reform and less significant changes that could be enacted on their own. Finally, the report helpfully separates the permanent and temporary impacts for provisions that raise greater revenue upfront.
Our recent paper Trust or Bust: Fixing the Highway Trust Fund called on lawmakers to identify a long-term fix to the funding gap in the Highway Trust Fund (HTF). Unfortunately, it appears unlikely that there is sufficient time to enact a fix before funds fall too low and disrupt construction this summer. A short-term patch can be enacted by transferring funds from general government revenue. To be fiscally responsible, however, this transfer should be fully offset elsewhere in the budget.
Previously, we discussed long-term options to restore highway solvency by cutting spending, raising more from current highway taxes, and raising new taxes. Below are tax, spending, and other options that could pay for upfront general revenue transfers to shore up the HTF in the short-term, although they leave the HTF's chronic imbalance in place. These options can buy time, but they do not replace the need to identify a long-term solution to bring dedicated revenue and spending in line.
|Options To Offset a Transfer of General Revenue|
|Policy||Ten-Year Savings||Trust Fund Extension|
|Dedicate one-time "deemed repatriation" tax to the HTF||$125 billion||8 years|
|Dedicate temporary transition revenue from repealing LIFO to the HTF||$90 billion||6 years|
|Repeal certain oil and gas tax preferences^||$35 billion||30 months|
|Eliminate tax exclusion for new private activity bonds||$30 billion||24 months|
|Require filers to have a SSN to file for a refundable child tax credit||$20 billion||16 months|
|Eliminate Amtrak subsidies*||$15 billion||12 months|
|Eliminate "Capital Investment Grants" for the rail system*||$15 billion||12 months|
|Reduce farm subsidies||$15 billion||12 months|
|Close Section 179 "luxury SUV loophole"||$10 billion||8 months|
|Reduce Strategic Petroleum Reserve by 15 percent||$10 billion||8 months|
|Increase sequestration by $1 billion/year||$10 billion||8 months|
|Repeal tax deduction for moving expenses||$10 billion||8 months|
|Clarify worker classification||$5 billion||4 months|
|Prevent "double dipping" between unemployment & Social Security Disability||$5 billion||4 months|
|Allow drilling in ANWR and the Outer Continental Shelf||$5 billion||4 months|
|Reduce federal research funding for fossil fuels and nuclear energy*||$5 billion||4 months|
|Repeal or phase-out tax credit for plug-in electric vehicles||$1.5 - $5 billion||1 - 4 months|
|Require inherited IRAs to be paid out within 5 years||$4 - $5 billion||3 - 4 months|
|Extend current Fannie/Freddie fees through 2021||$4 billion/year||3 months|
|Extend customs fees through 2024||$4 billion||3 months|
|Deny biofuels credit for black liquor (retroactively)||$3 billion||3 months|
|Increased mortgage reporting||$2 billion||~2 months|
|Require the IRS to hire private debt collectors||$2 billion||~2 months|
|Enact federal oil and gas management reforms in the President's Budget||$2 billion||~2 months|
|Devote mandatory aviation security fee to deficit reduction through 2024||$1.5 billion||~1 month|
|Make coal excise tax permanent||$1.5 billion||~1 month|
|Make Travel Promotion Surcharge permanent||$1.5 billion||~1 month|
|Clarification of statute of limitations on overstatement of basis||$1.5 billion||~1 month|
|Close the "gas guzzler" loophole||$1 billion||~1 month|
|Revoke passports for seriously delinquent taxpayers||< $0.5 billion||<1 month|
Sources: CBO, OMB, JCT, and CRFB calculations
All numbers are rounded and calculated by CRFB based on a variety of sources.
*These discretionary changes would need to be accompanied by reductions in the discretionary spending caps.
^Includes expensing for exploration and development as well as the “percentage depletion allowance”
Without a fix soon, the Highway Trust Fund (HTF) will run out of money this summer, slowing down infrastructure projects across the nation.