taxes and tax reform in an era of hyper-deficits and gridlock

Taxes and Tax Reform in an Era of Hyper-Deficits

and Gridlockby Jon Forman

Alfred P. Murrah Professor of LawUniversity of Oklahoma

http://www.law.ou.edu/faculty/forman.shtml

Oklahoma CityEconomic Roundtable

March 2, 2011

Overview

The Budget Outlook Short-term Long-term

Taxes The Current Tax System Recent Tax Reform Proposals

Short-Term:Projected Budget Totals

Budget Totals, $billions 2011 2012-2021

Receipts $2,228 $39,084

Outlays $3,708 $46,055

Deficit $1,480 $ 6,971

Budget Totals, % GDP

Receipts 14.8% 19.9%

Outlays 24.7% 23.5%

Deficit 9.8% 3.6%

Public Debt, % GDP 69.4% 75.3%

3Congressional Budget Office, The Budget and Economic Outlook: Fiscal Years 2011 to 2021 (January 2011), http://www.cbo.gov/ftpdocs/120xx/doc12039/01-26_FY2011Outlook.pdf.

10U.S. Department of the Treasury, Financial Management Service, A Citizen’s Guide to the Financial Report of the United States Government (2009).

11Congressional Budget Office, The Long-Term Budgt Outlook (Revised August 2010), at 5, http://www.cbo.gov/ftpdocs/115xx/doc11579/06-30-LTBO.pdf.

Factors Explaining Future Federal Spending on Medicare, Medicaid, and Social Security (percentage of GDP)

Congressional Budget Office, The Long-Term Budget Outlook (June 2009), at 12 (Box 1-2).

Overview of the federal tax system Recent tax reform proposals

14Joint Committee on Taxation, Present Law and Historical Overview of the Federal Tax System (JCX-1-11), January 18, 2011, at 71, www.jct.gov.

Proposed Budget Receipts

Receipts, $billions 2011 2014

Individual income taxes 998 1,671

Corporation income taxes 279 398

Payroll taxes 819 1,092

Excise taxes 73 86

Estate and gift taxes 11 14

Custom duties and other receipts 47 75

Total receipts 2,228 3,442

GDP $15,034 $17,258

Receipts, % GDP 14.8% 19.9%

16Joint Committee on Taxation, Present Law and Historical Overview of the Federal Tax System (JCX-1-11), January 18, 2011, www.jct.gov.Joint Committee on Taxation, Present Law and Historical Overview of the Federal Tax System

(JCX-1-11), January 18, 2011, at 70, www.jct.gov.

U.S. Payroll Tax Rates: Selected Years

1940 1960 1980 2010

Medicare

Social Security

18OECD Tax Database, http://www.oecd.org.

Tax-to-GDP ratio, 2008

19Edward D. Kleinbard, Muddling Through the Budget Crisis (January 6, 2011); OECD Tax Database, http://www.oecd.org.

21Congressional Budget Office, Trends in Federal Tax Revenues and Rates (December 2, 2010), at 10, http://finance.senate.gov/imo/media/doc/120210DEtest.pdf.

Top 10 Income Tax Expenditures, 2012 (Billions)

Health insurance exclusion $184

Mortgage interest deduction 99

401(k) plans 68

Step-up of basis at death 61

Exclusion of net imputed rental income 51

Deductible nonbusiness state and local taxes other than on houses

Employer plans 45

Charitable contrib. (other than health & education) 43

Capital gains (except agriculture, timber, iron, coal) 38

Exclusion of interest on tax-exempt bonds 372012 Federal Budget, Analytical Perspectives, Chapter 17, Tax Expenditures, Table 17-3, http://www.whitehouse.gov/omb/budget/Analytical_Perspectives.

25Office of Management and the Budget, A New Era of Responsibility: Renewing America’s Promise (2009).

Rising Poverty

26U.S. Census Bureau, Income, Poverty, and Health Insurance Coverage in the United States: 2009, (Current Population Report No. P60-238, September 2010), http://www.census.gov.

Rising Inequality

Shares of Total Business Returns and Net Income, 1980-2007

1980 1990 2000 2007

S Corporations

Returns 4% 8% 11% 12%

Net Income 1% 8% 14% 14%

Partnerships

Returns 11% 8% 8% 10%

Net Income 3% 3% 18% 23%

Sole Proprietorships

Returns 69% 74% 72% 72%

Net Income 17% 26% 15% 10%

C Corporations

Returns 17% 11% 9% 6%

Net Income 80% 62% 53% 53%31

Internal Revenue Service, Statistics of Income, www.irs.gov/taxstats.

Expired Tax Provisions 2010

First-time homebuyer credit Making work pay credit Build America Bonds Estate and gift tax regime for 2010

32Joint Committee on Taxation, List of Expiring Federal Tax Provisions, 2010-2020 (JCX-2-11), January 21, 2011, www.jct.gov.

Expiring Tax Provisions 2011

Tax credit for research and experimentation expenses

Increased AMT exemption amount Increase in expensing to

$500,000/$2,000,000 Above-the-line deduction for qualified

tuition and related expenses Temporary 2% payroll tax cut

Expiring Tax Provisions 2012

Most 2001 and 2003 tax cuts 35% maximum rate 10% minimum rate $1,000 child tax credit 15% capital gain and dividend rates

Expanded earned income tax credit American opportunity tax credit Reduced estate and gift taxes

Recent Tax Reform Proposals President’s Economic Recovery Advisory

Board, The Report on Tax Reform Options: Simplification, Compliance, and Corporate Taxation (August 2010).

National Commission on Fiscal Responsibility and Reform, The Moment of Truth (December 2010).

Bipartisan Policy Center, Restoring America’s Future (November 2010). Co-Chairs: Pete Domenici & Alice Rivlin

Recent Tax Reform Proposals

Bipartisan Tax Fairness and Simplification Act of 2010 (2010). Senators Ron Wyden and Judd Gregg

Rep. Paul Ryan, The Roadmap Plan (2010).

National Taxpayer Advocate, 2010 Annual Report to Congress (December 31, 2010).

President Obama’s FY2012 Budget

Principles of Sound Tax Policy

Simplicity Transparency Neutrality Stability No Retroactivity Broad Bases and Low Rates

37Tax Foundation, The Principles of Sound Tax Policy , http://www.taxfoundation.org/publications/show/25982.html.

More Principles of Sound Tax Policy Distribution matters

A just distribution of economic resources Intergenerational justice/ Deficits

Behavioral consequences matter Encourage work and savings Marriage penalties and bonuses Keep effective rates as low as possible Growth and a stronger dollar

Tax Base

Income Consumption Earnings Wealth

President Obama: Reform Corporate & Individual Tax “I’m asking Democrats and Republicans to

simplify the system. Get rid of the loopholes. Level the playing field. And use the savings to lower the corporate tax rate for the first time in 25 years –- without adding to our deficit. It can be done.”

“In fact, the best thing we could do for all Americans is to simplify the individual tax code. This will be a tough job, but members of both parties have expressed interest in doing this, and I am prepared to join them.”

40Text of President Barack Obama’s State of the Union Address , http://www.politico.com/news/stories/0111/48181.html.

PERAB: Simplification Options

Simplification for Families Consolidate Family Credits and Simplify

Eligibility Rules Simplify and Consolidate Tax Incentives

for Education

42PERAB, The Report on Tax Reform Options: Simplification, Compliance, and Corporate Taxation, at 6, http://www.whitehouse.gov/sites/default/files/microsites/PERAB_Tax_Reform_Report.pdf.

Simplify Savings and Retirement Incentives Consolidate Retirement Accounts Integrate IRA and 401(k)-type

Contribution Limits and Disallow Nondeductible Contributions

Consolidate Non-Retirement Savings Reduce Retirement Account Leakage Simplify Taxation of Social Security

Simplify Taxation of Capital Gains Harmonize Rules and Tax Rates for Long-

Term Capital Gains Simplify Capital Gains Tax Rate Structure Limit or Repeal Section 1031 Like-Kind

Exchanges Capital Gains on Principal Residences

Simplify Tax Filing The Simple Return Data Retrieval Raise the Standard Deduction and

Reduce the Benefit of Itemized Deductions

Simplification for Small Business The Alternative Minimum Tax

PERAB: Compliance Options

Dedicate More Resources to Enforcement and Enhance Enforcement Tools

Increase Information Reporting and Source Withholding

Clarify the Definition of a Contractor

PERAB: Corporate Tax Reform

Reduce Marginal Corporate Rates Broaden the Corporate Tax Base Eliminate or Reduce Tax Expenditures

Eliminate the Domestic Production Deduction

Eliminate or Reduce Accelerated Depreciation

Eliminate Other Tax Expenditures

PERAB: International Corporate Tax Issues

Option 1: Move to a Territorial System Option 2: Move to a Worldwide

System with a Lower Corporate Tax Rate

Option 3: Limit or End Deferral with the Current Corporate Tax Rate

Option 4: Retain the Current System but Lower the Corporate Tax Rate

President’s Fiscal Commission

Co-chairs: Alan Simpson & Erskine Bowles Designed to raise 21% of GDP Individual tax rates of 12, 22, and 28% Eliminate the AMT Eliminate the phase-out of personal

exemptions & limits on itemized deductions Eliminate itemized deductions but retain

standard deduction & personal exemptions Tax capital gains & dividends as ordinary

income49The National Commission on Fiscal Responsibility and Reform, The Moment of Truth (December

2010), http://www.fiscalcommission.gov; Tax Policy Center, http://www.taxpolicycenter.org.

Eliminate tax expenditures except: child credit and earned income tax credit mortgage interest deduction—replace

with 12% credit; $500,000 mortgage cap cap and phase out the exclusion for

employer-sponsored health care charitable giving deduction—replace with

12% credit for contributions over 2% AGI

50The National Commission on Fiscal Responsibility and Reform, The Moment of Truth (December 2010), http://www.fiscalcommission.gov.

Eliminate tax expenditures except: exclusion of interest on state and

municipal bonds—tax interest only on newly-issued bonds

retirement savings—maintain basic preferences, but consolidate retirement accounts and cap annual tax-preferred contributions at lower of $20,000 or 20 percent of income; expand savers’ credit

defined benefit pensions51The National Commission on Fiscal Responsibility and Reform, The Moment of Truth (December

2010), http://www.fiscalcommission.gov.

Eliminate corporate tax expenditures & reduce corporate tax rate to 28%

Territorial tax system for active foreign-source income

Increase Social Security taxable wage base to 90% of wages, by 2050

Increase the gasoline excise tax on gasoline by 15¢ per gallon

52The National Commission on Fiscal Responsibility and Reform, The Moment of Truth (December 2010), http://www.fiscalcommission.gov.

Bipartisan Policy Center

Co-Chairs: Pete Domenici & Alice Rivlin

one-year payroll tax holiday in 2011 to help stimulate economic recovery

individual tax rates: 15% on the 1st $50,000 of taxable income ($100,000 for married couples, 27% on excess

eliminate the AMT

53Bipartisan Policy Center, Restoring America’s Future (November 2010), http://bipartisanpolicy.org/sites/default/files/FINAL%20DRTF%20REPORT%2011.16.10.pdf.

Eliminate tax expenditures: exclusion from tax of the inside buildup

of life insurance and deferred annuities credits and deductions for higher

education expenses credit for child & dependent care exclusion from income of benefits under

Section 125 cafeteria plans foreign earned income exclusion

Exempt the first $1,000 of net long-term gains from taxation (indexed for inflation) tax any additional long-term gains and

all qualified dividends as ordinary income include in income unrealized capital

gains at death

Cap and phase out the exclusion for employer-sponsored health care

Eliminate deduction for state and local taxes

Replace charitable contributions and mortgage interest deductions with 15% refundable credits

Retain medical deduction

Replace the standard deduction, personal exemptions, head of household filing status, the child tax credit, and the earned income tax credit with two refundable credits: $1,600 for each dependent child an earnings credit equal to 21.3 percent

of the first $20,300 of earnings

Tax all Social Security benefits, eliminate the elderly credit & provide 2 new credits: 7.5% of Social Security benefits 15% of the current standard deduction

for individuals age 65 or older

Increase Social Security taxable wage base to 90% of wages

Impose a 6.5% broad-based consumption tax

Impose an excise tax 1¢/ounce on sugar-sweetened beverages

Raise the excise tax on alcoholic beverages to 25¢/ounce

Estate tax: $3.5 million exemption and 45%

Corporate taxes reduce the corporate rate to 27% eliminate many tax expenditures:

domestic production deduction research and experimentation credit accelerated depreciation for rental housing

retain deferral of income for controlled foreign corporations

Wyden-Gregg Tax Act

Like the Tax Reform Act of 1986 Individuals

top tax rate of 35% standard deduction of $15,000 ($30,000

for couples) repeal AMT 35% exclusion for capital gains and

qualified dividends eliminate lots of tax breaks

61Senators Ron Wyden & Judd Gregg, Bipartisan Tax Fairness and Simplification Act of 2010 (2010), http://wyden.senate.gov/issues/issue/?id=FB5B603A-ED94-48A8-8FF1-C220C1052B3F.

Wyden-Gregg Tax Act

Corporate & business replaces the graduated corporate rate

structure with a flat rate of 24% eliminates many business tax breaks allow unlimited expensing of equipment

and inventories for small businesses

62Senators Ron Wyden & Judd Gregg, Bipartisan Tax Fairness and Simplification Act of 2010 (2010), http://wyden.senate.gov/issues/issue/?id=FB5B603A-ED94-48A8-8FF1-C220C1052B3F.

Rep. Ryan’s Roadmap

Designed to raise 19% of GDP Pay income taxes through existing

law, or Through a highly simplified code with

virtually no tax breaks 10% on the first $50,000 ($100,000 for

couples), 25% on the rest $39,000 standard deduction & personal

exemptions for a family of 4

63Paul Ryan, The Roadmap Plan (2010), http://www.roadmap.republicans.budget.house.gov.

Rep. Ryan’s Roadmap eliminate the AMT eliminate taxes on interest, capital gains,

and dividends

Eliminate the estate tax Replace the corporate income tax

with a border-adjustable business consumption tax of 8.5%

64Paul Ryan, The Roadmap Plan (2010), http://www.roadmap.republicans.budget.house.gov.

National Taxpayer Advocate

Repeal the AMT Consolidate the family tax provisions Improve other provisions relating to

taxation of the family unit Consolidate education savings

incentives Consolidate retirement savings

incentives

65National Taxpayer Advocate, 2010 Annual Report to Congress (December 31, 2010), http://www.taxpayeradvocate.irs.gov/Media-Resources/Annual-Report-To-Congress-Full-Report.

National Taxpayer Advocate

Simplify worker classification determinations

Eliminate (or reduce incentives for lawmakers to enact tax sunsets

Eliminate (or simplify) phase outs Streamline the penalty regime

66National Taxpayer Advocate, 2010 Annual Report to Congress (December 31, 2010), http://www.taxpayeradvocate.irs.gov/Media-Resources/Annual-Report-To-Congress-Full-Report.

President Obama’s 2012 Budget

Extend the Earned Income Credit Expand the Dependent Care Credit Extend American Opportunity Credit Tax Dividends and Net Long-Term

Capital Gains at a 20-Percent Rate for Upper-Income Taxpayers

Reduce the Value of Certain Tax Expenditures for Upper-Income

67U.S. Department of the Treasury, General Explanations of the Administration’s Fiscal Year 2012 Revenue Proposals (February 2011), http://www.treasury.gov/.

Enhance and Make Permanent the Research and Experimentation (R&E) Tax Credit

Reform & Extend Build America Bonds Reform Treatment of Financial

Institutions and Products Reinstate Superfund Taxes Reform U.S. International Tax System

U.S. Department of the Treasury, General Explanations of the Administration’s Fiscal Year 2012 Revenue Proposals (February 2011), http://www.treasury.gov/.

Eliminate Oil and Gas Preferences Eliminate Coal Preferences Expand Information Reporting Improve Compliance by Businesses

Require Greater Electronic Filing Worker Classification

Strengthen Tax Administration Expand Penalties

Consumption Tax Options

Progressive Personal Consumption Tax

Subtraction method Value Added Tax Treasury Department proposal for

Business Activity Tax (BAT) Credit-method (European) VAT National retail sales tax (RST)

70Charles E. McClure, Jr., Why the United States Needs a Value Added Tax (2009), http://www.taxadmin.org/Fta/meet/09am/papers/McClure.pdf.

Earlier Tax Reform Proposals

President’s Advisory Panel on Tax Reform, Final Report (November 1, 2005), http://govinfo.library.unt.edu/taxreformpanel.

David Bradford and the U.S. Treasury Tax Policy Staff. Blueprints for Tax Reform (Arlington, VA: Tax Analysts. 2nd ed. 1984).

Conclusion President needs 60 votes in the

Senate and Cooperation in the House The whole tax system is in play

And will be in play for years Lobbyists will be tripping over each other

Change is almost always incremental Boil the frog slowly

Sources The President’s Economic Recovery Advisory Board, The

Report on Tax Reform Options: Simplification, Compliance, and Corporate Taxation (August 2010), http://www.whitehouse.gov.

The National Commission on Fiscal Responsibility and Reform, The Moment of Truth (December 2010), http://www.fiscalcommission.gov.

The Bipartisan Policy Center Debt Reduction Task Force, Restoring America’s Future: Reviving the Economy, Cutting Spending and Debt, and Creating a Simple, Pro-Growth Tax System (November 2010), http://bipartisanpolicy.org.

Sources Senators Ron Wyden & Judd Gregg, Bipartisan Tax

Fairness and Simplification Act of 2010 (2010), http://wyden.senate.gov/issues/issue/?id=FB5B603A-ED94-48A8-8FF1-C220C1052B3F.

Representative Paul Ryan, The Roadmap Plan (2010), http://www.roadmap.republicans.budget.house.gov.

National Taxpayer Advocate, 2010 Annual Report to Congress (December 31, 2010), http://www.taxpayeradvocate.irs.gov/Media-Resources/Annual-Report-To-Congress-Full-Report.

Joint Committee on Taxation, Present Law and Historical Overview of the Federal Tax System (JCX-1-11), January 18, 2011, www.jct.gov.

Sources Joint Committee on Taxation, List of Expiring Federal Tax

Provisions, 2010-2020 (JCX-2-11), January 21, 2011, www.jct.gov.

The Tax Policy Center, Deficit Reduction Proposals, http://www.taxpolicycenter.org/taxtopics/Deficit-Reduction-Proposals.cfm.

Joshua Rosenberg, The U.S. Fiscal Trajectory: Causes and Consequences (January 21, 2011), http://www.abanet.org/tax/MID11/papers/Rosenberg-slidesABA-Boca-Rosenberg.pdf.

Office of Management and Budget, 2012 Federal Budget, http://www.whitehouse.gov/omb/budget.

About the Author Jonathan Barry Forman (“Jon”) is

the Alfred P. Murrah Professor of Law at the OU College of Law, teaching tax and pension law;

a member of the board of trustees of the Oklahoma Public Employees Retirement System (OPERS)

a member of the State of Oklahoma Incentive Review Committee;

a member of the State of Oklahoma Task Force on Comprehensive Tax Reform; and

the author of Making America Work (Washington, DC: Urban Institute Press, 2006).

Jon was the Professor in Residence at the Internal Revenue Service Office of Chief Counsel, Washington, DC, for the 2009-2010 academic year.

Jon can be reached at jforman@ou.edu, 405-325-4779, www.law.ou.edu/faculty/forman.shtml.

taxes and tax reform in an era of hyper-deficits and gridlock

budget receipts

budget crisis

billions2012 federal

longterm budget outlook

federal tax system jcx

federal tax revenues

projected budget totals

income tax expenditures

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