House Ways and Means Chairman Dave Camp (R-MI) released his comprehensive tax reform plan yesterday. It has been a long time since a sitting member of Congress was bold enough to propose a plan that includes enough detail to be scored by the Joint Committee on Taxation. We applaud Chairman Camp for doing so and hope that this is only the beginning of a discussion that includes more proposals at this level of detail from both sides of the aisle.
BPC’s Domenici-Rivlin Debt Reduction Task Force released a proposal for comprehensive tax reform as part of their budget proposal. Like the Camp plan, Domenici-Rivlin focused on lowering the corporate and individual tax rates and broadening the base by eliminating loopholes and tax expenditures. Unlike Camp’s plan, which raises no new revenue over the ten year window, the Domenici-Rivlin proposal raised significant new revenues.1 The task force believed that raising more revenue from a streamlined and simplified tax code was an important part of putting the country on a sustainable, pro-growth economic path for the future. As the proposal runs over 900 pages, this short blog post will not provide a complete accounting of provisions in the plan. Instead, we will attempt to summarize the broad outlines of the plan and to point out similarities to BPC recommendations in the Domenici-Rivlin plan.
Brackets and Rates
The Camp tax reform, like the Domenici-Rivlin plan, flattens the tax code by reducing the number of brackets and removing loopholes. The Camp plan has only three brackets on the individual side and one on the corporate side – compared to seven and four now and would get rid of the Alternative Minimum Tax. It also lowers the top rates from 39.6 percent on the individual side and 35 percent on the corporate side to 35 percent for certain types of income on the personal side and to 25 percent for corporations. The Camp tax plan would be slightly more progressive than the present tax code. Those towards the top of the income spectrum (with income from $500,000 to $1,000,000) would see increases in aggregate tax collection in 2023, while the very highest of earners (with income above $1,000,000) and those with income below $500,000 would see taxes that remain the same or would be lower than under the current code.
Like the recommendations of the Domenici-Rivlin Task Force, the new plan would index parameters in the tax code (such as the income thresholds for tax brackets and the value of certain deductions, credits, and exclusions) to the chained CPI, rather than the currently-used CPI-U. The chained CPI is a better measure of inflation than the CPI-U. Switching to chained CPI also increases revenue because more income falls into brackets with higher rates when the thresholds grow more slowly.
Deductions and Exclusions
The plan would drastically reduce the number of people who would itemize deductions (from about 33 percent to 5 percent of filers) by increasing the value of the standard deduction. Fewer individuals itemizing deductions would decrease the value of many popular deductions, including the mortgage interest deduction, which would be further limited by halving the amount of principal to $500,000 that would be eligible for deductibility of interest. The plan would also eliminate the popular state and local tax deduction, which was also a recommendation of the Domenici-Rivlin Debt Reduction Task Force. For individuals in the 35 percent income-tax bracket, the value of itemized deductions and exclusions, including the exclusion for employer-sponsored health insurance (ESI), would be limited to 25 percent.
The plan would increase the value of both the refundable and non-refundable parts of the child tax credit and index the enhanced credit to inflation. However, the boon to low-income Americans would be largely offset by cuts to the Earned Income Tax Credit that would fall particularly hard on childless workers.
Additionally, the plan simplifies the morass of tax credits for higher education and replaces most of them with an expanded American Opportunity Tax Credit. This portion of the bill is very similar to last year’s bipartisan proposal from Reps. Diane Black (R-Tenn.) and Danny Davis (D-Ill.).
The main retirement provisions in the plan are to eliminate traditional Individual Retirement Accounts (IRAs) and the related deduction, remove income limits on contributions to Roth IRAs, and require that any employee contributions to 401(k)s in excess of half of the limit ($17,500 for employees under age 50 in 2014) are made to Roth accounts. (In a Roth account, contributions are made from after-tax dollars, and withdrawals are free of income tax.) Only the last of these has a significant impact on revenue over ten years. Unfortunately, the increase in revenue will eventually dwindle because the switch from pre-tax to post-tax contributions will decrease tax collections in the future when those funds – including investment earnings – are withdrawn.
Reforms to Taxation of Business
The taxation of business income is very complicated. Some businesses pay the U.S. corporation income tax; other businesses are taxed on individual returns (the familiar Form 1040). Camp proposes some reforms that are exclusive to corporation tax and other reforms that would impact business that file on individual returns as well.
Corporation Tax Reforms
On the corporate side, Camp’s plan includes a dramatic overhaul. The top rate would be brought down from its current 35 percent (the highest in the developed world) to 25 percent. Camp would also make significant changes to the taxation of foreign income. Today, income earned by a U.S. corporation overseas is subject to U.S. corporation income tax, but payment of tax is deferred until profits are brought back to the United States. Camp would transition to what is known as a “territorial system,” in which foreign profits of U.S. corporations are not taxed at all, and he would also implement a variety of provisions that would make it harder for companies to shift income to low-tax countries. As part of this transition, corporations would be required to pay a tax on income deferred under the previous system, whether or not the profits are ultimately returned to the U.S. Camp would broaden the base of the corporate tax by eliminating or revising a variety of deductions and credits, some of which are exclusive to the corporation tax and some that affect business filing as corporations or as part of an individual return.
BPC’s Domenici-Rivlin plan called for a similar reduction in the corporate rate (to 28 percent) and broadening of the base, but proposed retaining the current “worldwide system” for international taxation.
General Business Tax Reforms
Camp’s proposal includes major changes that would affect taxation of business income on both corporation and individual tax returns. First, he significantly curtails a set of tax breaks known collectively as “accelerated depreciation.” When a business makes certain kinds of investments, such as buying equipment that will be used over many years, it cannot claim the entire purchase as an expense in one year; it must spread the expense over several years in its financial statements. This principle of expensing investments over several years is called “depreciation.” The current tax code allows businesses to claim depreciation expenses much earlier for tax purposes than they report on their financial statements. The effect is to reduce net income, and the associated tax owed, in the near term. Camp’s reforms would make businesses account for depreciation expense on their tax forms in a similar fashion to how they account for this expense on their financial statements. Additionally, Camp’s proposal would end the ability for businesses to use certain inventory accounting methods that usually reduce tax liability.
For more on the economic rationale behind tax reform, please see our primer.
Alex Gold contributed to this post.
1 When scored on a static basis. When scored on a dynamic basis, which incorporates the impact of tax changes into future growth and future revenues, the plan raises between $50 billion and $700 billion over 10 years depending on the exact modeling assumptions.