This week, Senators Ron Wyden (D-OR) and Dan Coats (R-IN) introduced “The Bipartisan Tax Fairness and Simplification Act of 2011.” The plan is an update of the plan Wyden introduced in the last Congress with the retired New Hampshire Republican Senator Judd Gregg.
Senators Wyden and Coats deserve credit for adding another serious proposal to the likes of the so-called Bowles/Simpson report, the President’s Economic Recovery Advisory Board (PERAB) report (the “Volcker Commission”), and Rep. Paul Ryan’s recent budget plan. While the plan is a useful indication of what legislators can produce in a bipartisan effort, it has some very serious weaknesses that should be addressed.
Here is a short summary of what the plan proposes for individual and corporate taxpayers:
For individuals: The plan reduces the current six taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. brackets to three – 15 percent, 25, percent and 35 percent – while eliminating the AMT, tripling the standard deductionThe standard deduction reduces a taxpayer’s taxable income by a set amount determined by the government. It was nearly doubled for all classes of filers by the 2017 Tax Cuts and Jobs Act (TCJA) as an incentive for taxpayers not to itemize deductions when filing their federal income taxes. , keeping most of the most popular tax deductions (i.e. mortgage interest and charitable), and expanding tax-favored savings. The plan also treats gains and dividend income as ordinary income, but offers a 35 percent exclusion for capital gains.
For Businesses: The plan cuts the top corporate tax rate from 35 percent to 24 percent while eliminating the deferral of taxes on active foreign earnings, repealing the domestic manufacturing deduction, eliminating the corporate AMT, and repealing a handful of other tax deductions largely benefiting the oil and gas industry.
The Good Points:
The best part of the Wyden/Coats plan is that it cuts the corporate tax rate to 24 percent. This would instantly make the U.S. more competitive and lower our ranking from 2nd highest among OECD nations to 11th.
The senators should also be given credit for eliminating the individual and corporate AMTs. However, while eliminating the individual AMT, they failed to cut or scale back the tax preferences that put people in the AMT in the first place – such as the state and local tax deductionA tax deduction is a provision that reduces taxable income. A standard deduction is a single deduction at a fixed amount. Itemized deductions are popular among higher-income taxpayers who often have significant deductible expenses, such as state and local taxes paid, mortgage interest, and charitable contributions. .
The plan does break the mold by calling for the elimination of corporate welfare spending to offset the reduction in corporate taxes. Most corporate tax reform proposals are stuck within the limiting framework of “revenue neutrality.” By shifting to a “budget neutral” framework, the Senators broaden the options available to offsetting the corporate rate reductions.
What Needs Fixing:
In contradiction to its title, the plan does too little simplification on the individual side of the code – aside from eliminating three brackets. It fails to take on any of the major individual tax preferences – especially those that are distorting the health care and housing markets – as well as the tax subsidies that benefit state and local governments.
The plan also needs to cut the 35 percent top rate for individuals while it broadens the base. No doubt, the Senators wanted to maintain the progressivity in the code, but progressivity can still be maintained while cutting the top rate if the tax preferences that largely benefit upper-income taxpayers are eliminated at the same time.
Another major problem with keeping the individual rate at 35 percent is that it will be 9 percentage points higher than the 24 percent corporate rate. Wyden and Coats seem unaware that more than 50 percent of all business income is now taxed under the individual code because of the growth in pass-through entities such as LLCs and S-corporations. Creating such a large rate differential is an invitation for those entities to file as corporations and, thus, save themselves 9 percent. Lowering the individual rate to 24 percent would treat c-corps and pass-throughs equally.
The Senators’ plan to increase the tax rates on capital gains and dividend must be seen in a global context. Already, the U.S. has the 4th highest overall dividend tax rate among OECD nations at 49.5 percent. Their plan to tax dividends at the individual rate would, even with the lower corporate rate, make the overall tax rate on dividends 59 percent – tops in the world. The tax rates on capital gains and dividends should be kept at their current levels of 15 percent.
By tripling the standard deduction, the plan likely knocks millions more taxpayers off the tax rolls. Already, some 52 million tax filers – 36 percent of all filers – pay no income taxes because of the generosity of the current credits and deductions. Increasing the percentage of Americans with no skin in the game will only make the tax system less stable and further disconnect taxpayers from the true cost of government. This provision needs to be reconsidered.
For the Dust Bin:
In order to finance the reduction of the corporate rate to 24 percent, Wyden and Coats eliminate the current “deferral” regime for foreign earnings and reinstate the “per-country” system of foreign tax crediting. These provisions will raise taxes on U.S. multinational by nearly $600 billion over ten years. [JCT score here].
While the purported reason for this policy is to eliminate the “subsidy for shipping jobs overseas,” the real effect will be to undermine the competiveness of U.S. firms abroad and make them takeover targets for foreign rivals. The upshot will be fewer domestic jobs and fewer domestic multinationals. The right policy here is to move to a territorial system of taxing foreign income as was suggested by both the Bowles/Simpson report and the Volcker Commission.
Wyden and Coats also include a number of provisions aimed at raising taxes on oil and gas companies. These include eliminating the provisions for intangible drilling costs and percentage depletion, as well as modifying the foreign tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. s for large integrated oil companies which are dual-capacity taxpayers. These repeal provisions are not grounded in any principles of sound tax policy, but are merely gratuitous shots at an unpopular industry. These should end up on the cutting room floor.
Senators Wyden and Coats deserve credit for contributing to the bipartisan discussion over fundamental tax reform. However, their plan has a number of serious weaknesses that need fixing before it can be deemed fundamentally sound, pro-growth tax reform.Share