Tax Reform in the 114th Congress: An Overview of Proposals
Released: 2016-03-18T00:00:00

Introduction

Late in the 113 th Congress, former House Ways and Means Committee Chairman Dave Camp introduced a comprehensive tax reform bill, the Tax Reform Act of 2014 ( H.R. 1 ). While no action was taken on H.R. 1 in the 113 th Congress, tax reform remained a key issue of interest early in the 114 th Congress. In January 2015, the Senate Finance Committee established five bipartisan working groups to evaluate tax reform options. The working groups' reports were released in July 2015. Both the Senate Finance Committee and the House Ways and Means Committee have continued to hold hearings on tax reform in the 114 th Congress.

There are various policy options for achieving comprehensive tax reform. One option is to enact a base-broadening reform, maintaining the current system with reduced tax rates, in the spirit of the Tax Reform Act of 2014. A second option is to substantially revise or eliminate the current tax system, instead relying on an alternative tax base for revenues (e.g., taxing consumption rather than income). Tax reform legislation introduced early in the 114 th Congress has tended to take the latter approach, proposing a retail sales tax at the federal level or a flat tax. Either option can be designed to be revenue-neutral or change the revenue outlook, depending on the exact provisions of the reform.

As an alternative to comprehensive tax reform, Congress may choose to consider reforms to certain parts of the code. For example, Congress may choose to consider international tax reform options, or evaluate business-only options. Toward the end of 2015, as part of the Consolidated Appropriations Act, 2016 ( P.L. 114-113 ), certain temporary provisions for individuals and businesses were made permanent. The 114 th Congress may consider other targeted tax changes to the taxation of individuals or businesses, absent comprehensive tax reform.

Tax systems are often evaluated using the criteria of efficiency, equity, and simplicity. One goal of tax reform is to enhance economic efficiency, removing provisions in the code that adversely affect decisionmaking and economic output. Changes in tax policy also have equity implications, with respect to "fairness" of the tax code. The current tax code is widely seen as being overly complex. Thus, tax reform provides the opportunity to simplify the U.S. tax system. Balancing these three objectives often involves trade-offs. Balancing the trade-offs in these objectives is one of the challenges policymakers face in implementing tax reform.

Tax Reform Options

Fundamental or comprehensive tax reform may be achieved either by modifying the existing income tax system or by changing the source of tax revenue (e.g., replacing the current tax system). In modifying the existing tax system, base-broadening could raise additional tax revenues. The additional revenues could either be used to reduce tax rates or for deficit reduction. Similarly, revenues from a new tax (e.g., a consumption tax) could be used to offset reductions in current taxes, or to reduce the deficit. Much of the recent debate has centered around a revenue-neutral tax reform, with lower rates on individual and corporate income. Either base-broadening or an alternative revenue source could be used to pay for lower rates in a revenue-neutral tax reform. How revenue-neutrality is evaluated might also be an issue to be considered, with some suggesting that dynamic scoring be used to evaluate tax reform proposals.

Income Tax Reform: Base-Broadening4

Some Members of Congress have expressed concern about the large number and high cost of tax expenditures. Examples of tax expenditures include the deduction for mortgage interest on owner-occupied residences and the deduction for property taxes on owner-occupied residences. Many tax expenditures are seen as targets to be reduced or eliminated. In evaluating tax expenditures, one issue Congress may want to consider is whether the benefits of a particular tax expenditure exceed the costs of that tax expenditure. Identifying and quantifying the costs and benefits associated with particular tax expenditure provisions, however, can be challenging.

The current tax reform debate generally deals with the issue of broadening the individual and corporate income tax bases, often by scaling back or eliminating tax expenditures. The additional revenues could be used to lower marginal tax rates, reduce the deficit, or achieve some combination of these two options. Both the Tax Reform Act of 2014 and the Fiscal Commission's 2010 tax reform proposal pay for reduced tax rates at least in part by repealing or reforming many major tax expenditures.

The tax expenditures associated with the individual and the corporate tax differ in their size and value, and thus in their scope for potential revenue generation. The potential revenue gain from individual tax expenditures is large as they currently result in roughly $1 trillion of lost revenue annually. While these large amounts suggest a significant scope for base-broadening, most of these tax expenditures arise from a limited number of provisions, many of which are popular and broadly used, are difficult to eliminate in a technical sense, and/or are considered desirable provisions. In 2012, the Joint Committee on Taxation (JCT) found that a revenue-neutral reform that (1) repealed the AMT; (2) repealed all itemized deductions; (3) taxed capital gains and dividends at ordinary rates; and (4) retained the earned income tax credit (EITC), child tax credit, and tax benefits for retirement savings and healthcare could reduce rates by 4%. Thus, the top individual income tax bracket would be reduced from 39.6% to 38.02%.

Corporate tax expenditures are relatively small in value, partially reflecting the smaller corporate tax base. Analysis suggests that eliminating all corporate tax expenditures would allow the statutory corporate tax rate to be reduced from 35% to roughly 28% to 29%. These base-broadening provisions are also concentrated in a few provisions, which may be difficult to change, such as accelerated depreciation. There are, however, some significant potential base-broadening provisions outside of tax expenditures. For example, additional revenues could result from taxing large pass-through entities that currently pay taxes at the individual level as corporations or by restricting interest deductions. Enacting additional base-broadening reforms could be used to reduce the corporate tax rate below what could be achieved through revenue-neutral policy that only eliminated tax expenditures.

There has been a particular focus, as well, on the tax treatment of foreign source income of multinationals. Under the current system, U.S.-based companies with foreign-source income may be subject to U.S. taxes on that income. However, deferral allows tax payments to be deferred until the income earned abroad is repatriated (returned) to the United States. Some proposals would eliminate the U.S. taxation of income earned abroad by U.S.-based multinationals, which could, depending on the details of the proposal, narrow the tax base. Another option is to increase the taxation of foreign-source income of U.S.-based multinationals, through limiting deferral, for example. Increasing the amount of foreign-source income subject to tax would broaden the tax base. International issues have also been an impetus for lowering the corporate tax rate.

As an additional challenge, corporate tax reform, business tax reform, or individual tax reform in isolation would be difficult to achieve, as the corporate and individual tax systems are highly interconnected. Many of the corporate preferences also benefit unincorporated business, or "pass-throughs." For pass-through entities, business income is subject to the individual income tax.

The Tax Reform Act of 2014 proposed reducing statutory tax rates in both the individual and corporate income tax systems. Under this proposal, there would have been two individual income tax brackets, set at 10% and 25%, with a 10% surtax for certain higher-income taxpayers, for a top individual rate of 35%. Corporate tax rates would have been reduced to 25%, with this reduction phased in over time. The cost of these rate reductions would have been partially offset through base-broadening, and partially through other revenue-raising policies, so as to be revenue-neutral over the 10-year budget window. Additional details on the Tax Reform Act of 2014 are provided in a section later in the report.

A New Tax or Revised Tax Base

Alternative revenue options may be sought for a number of reasons. If the revenues generated through base-broadening do not fully finance desired rate reductions, alternative revenue sources may be sought to fill the gap. Revenue from an add-on tax could allow for the retention of more tax expenditures and smaller reductions in other tax expenditures, or larger tax rate reductions. Further, Congress may choose to seek alternative revenue sources to reduce the budget deficit and national debt. An alternative revenue source or tax base (e.g., consumption) might also be supported as an option for potentially improving economic efficiency.

There are several options for imposing a broad-based consumption tax. These include a value-added tax (VAT), a retail sales tax, and a flat tax. A value-added tax is a tax on the value that a firm adds to a product at each stage of production. The value the firm adds is the difference between a firm's sales and a firm's purchases of inputs from other firms. The VAT is collected by each firm at every stage of production. A retail sales tax is a consumption tax levied only at a single stage of production, the retail stage. The retailer collects a specific percentage markup in the retail price of a good or service, which is then remitted to the government. Both the VAT and the retail sales tax have the potential of a robust revenue yield.

Another option for implementing a broad-based consumption tax would be to levy a so-called "flat tax" (often referred to as a Hall-Rabushka flat tax after the two economists who popularized this proposal). Flat tax proposals generally have two components: a wage tax and a cash-flow tax on businesses. With this form, a flat tax is essentially a modified VAT, with wages and pensions subtracted from the VAT base and taxed at the individual level. Under a standard VAT, a firm would not subtract its wage and pension contributions when calculating its tax base. Under the flat tax, some wage income may not be included in the tax base because of personal exemptions.

Other potentially new revenue sources include environmental taxes or taxes on the financial sector. Environmental taxes have been proposed as an option to simultaneously reduce pollution and raise revenue. The most frequently discussed energy tax is a carbon tax that would be levied on the volume of carbon emitted. Another alternative energy tax option would be higher gasoline taxes. Options for imposing new taxes on the financial sector include a securities transaction tax or taxes on certain types of financial institutions, such as systemically important financial institutions (SIFIs). The Tax Reform Act of 2014 proposed an excise tax be imposed on the consolidated assets of SIFIs in excess of $500 billion.

Framework for Evaluation

In evaluating any change in tax policy, the prevailing economic framework is to analyze the tax policy for equity, efficiency, and simplicity. Tradeoffs may exist between these three objectives. For example, if greater income equality is desired, this may conflict with the goal of economic efficiency.

Equity

Economic theory maintains that it is not possible to make interpersonal comparisons of utility. Hence, whether a change in the distribution of income, with gainers and losers, is an improvement in the national welfare is a value judgment. The effects on different groups, however, can be measured and debated. When considering the fairness of the distribution of tax burdens, the concepts of horizontal and vertical equity are often considered.

Horizontal equity holds that taxpayers with similar incomes should face similar tax burdens. Tax preferences that allow certain taxpayers to claim deductions, credits, or exemptions to reduce tax burdens often result in situations where taxpayers with similar incomes face different tax burdens. Evaluating horizontal equity involves exploring whether taxpayers in similar circumstances pay approximately the same amount of taxes. For example, will the tax burden on two cohabiting single taxpayers be the same as the burden on a similarly situated married couple?

Vertical equity examines the distribution of tax burdens across different income groups. Under an ability-to-pay standard, vertical equity would suggest that taxpayers in higher income groups pay more. How much more is a policy question. Should the after-tax distribution of income be the same as the pre-tax distribution (suggesting taxation should be proportional)? Or should taxpayers with a greater ability to pay have a proportionally higher tax burden (suggesting taxation should be progressive)? In looking at the income of taxpayers, is annual or lifetime income the appropriate ability-to-pay metric? There are also questions as to whether tax reform should seek to be "distributionally neutral," keeping the share of the tax burden borne by different income groups roughly the same.

Evaluating the fairness of tax policy, from an economic perspective, may also involve asking several other questions. For example, what will be the effect on taxpayers in different age groups? Will there be distributional effects by region of the country? Another consideration might be how minority groups could be affected.

Efficiency

Tax policy should promote economic efficiency; that is, tax policy should be as neutral as possible by minimizing economic distortions. Low marginal tax rates tend to lessen distortions. Taxes that are applied to a broad base, with few exclusions or exemptions, also tend t o be more economically efficient.

Many efficiency questions concern household decisions, specifically those related to savings and labor choices. In the long run, savings used for investment promote economic growth. Increased labor supply can also positively contribute to GDP. Thus, in evaluating economic efficiency, the following types of questions might be asked. What will be the effect of a tax change on households' decisions to save versus consume? Will household decisions about the composition of goods and services consumed be affected? Will households' choices of leisure versus work be affected?

Other efficiency questions concern firms' decisions. What will be the effect on firms' decisions concerning the method of financing (debt or equity), choice among inputs, type of business organization (corporation, partnership, or sole proprietorship), and composition of output?

Simplicity

The greater the simplicity of the tax system, the lower will be the administrative and compliance costs. Tax compliance tends to increase with simplicity such that simplifying the tax system could help reduce the tax gap. Thus, tax policy should eliminate any unnecessary complexity and promote transparency. Numerous questions concerning simplicity arise; among them are the following: How will a tax change affect federal administrative costs? Will the administrative costs of state and local governments change? How will compliance costs of households be affected? Will business compliance costs change?

Tax Reform in the 114th Congress

Tax reform options continue to be actively debated in the 114 th Congress. While there has been sustained congressional interest in tax reform, it is not clear what form reform might take. Comprehensive tax reform, similar to what was proposed in the Tax Reform Act of 2014, remains an option. It is also possible that tax reform efforts proceed but target a specific sector of the economy, through a business-only tax reform or a reform of international tax law.

Committee on Ways and Means and Committee on Finance

In the first session of the 114 th Congress, the Committee on Ways and Means considered legislation to make permanent a number of temporary tax provisions. Permanent extensions of a number of temporary tax provisions were enacted as part of the Consolidated Appropriations Act, 2016 ( P.L. 114-113 ) in December 2015. The Ways and Means Committee has continued to hold tax reform hearings in the 114 th Congress.

Early in the 114 th Congress, Senate Finance Committee Chairman Orrin Hatch and Ranking Member Ron Wyden announced the creation of "tax reform working groups," with the goal of providing tax reform recommendations. The working groups were to provide recommendations for tax reform in five areas: (1) individual income tax; (2) business income tax; (3) savings and investment; (4) international tax; and (5) community development and infrastructure. In March 2015, the committee announced it would be seeking input from stakeholders on how to make the tax code "simpler, fairer, and more efficient." Stakeholder submissions were posted on the Finance Committee's website in April 2015. The working groups' reports were released in July 2015. The committee has also held a number of hearings on tax reform in the 114 th Congress.

Legislative Proposals

Reform the Income Tax System

As of the date of this report, legislation that would provide a comprehensive reform of the individual and corporate income tax systems has not been introduced. Comprehensive tax reform legislation was introduced in December 2014 as the Tax Reform Act of 2014 ( H.R. 1 ), and is discussed below in the section " Tax Reform in the 113th Congress ."

Reforming the Current Tax System Through Base-Broadening: Economic Analysis

Proposals that broaden the tax base and reduce statutory tax rates are widely believed to promote economic growth. The degree to which a specific set of policies is likely to affect growth, however, depends on changes in the effective marginal tax rates. It is possible for base-broadening to increase effective marginal tax rates, potentially offsetting any growth benefits that would be expected from statutory rate reductions.

The Joint Committee on Taxation (JCT) prepared a macroeconomic analysis of the Tax Reform Act of 2014, which was released along with the discussion draft. The JCT's analysis found that the Tax Reform Act of 2014 would have been expected to reduce effective marginal tax rates on labor, creating an incentive to work, and increased the after-tax income of individuals, increasing demand for goods and services. Both of these effects would be expected to stimulate the economy. On the corporate side, even though statutory tax rates would have been reduced, base-broadening provisions, including repeal of accelerated depreciation, would have led to higher effective tax rates on some capital investments. Overall, the JCT estimated that the increased cost of capital for domestic firms would lead to reduced investment in domestic capital stock. On net, the JCT estimates suggest that the provisions proposed in the Tax Reform Act of 2014 would increase economic output.

Replace the Income Tax System

Several proposals to replace the income tax system have been introduced in the 114 th Congress. The Fair Tax Act of 2015 ( H.R. 25 / S. 155 ), the Flat Tax Act ( H.R. 1040 ), and the Simplified, Manageable, and Responsible Tax (SMART) Act ( H.R. 1824 / S. 929 ) have all been introduced in previous Congresses. The Fair Tax Act of 2015 would replace the current income tax system with a national retail sales tax. Both the Flat Tax Act and the SMART Act would impose a flat tax system that is structurally similar to the Hall-Rabushka flat tax proposal, taxing wages and business taxable income.

Another proposal would replace the corporate income tax with a cash flow tax on business income. The American Business Competitiveness Act ( H.R. 4377 ) proposes a top rate of 25% on net business income, whether that income was earned by a corporation or a business in a non-corporate form. Most business tax credits and deductions would be repealed. The current system of depreciation would also be repealed (with provisions allowing for depreciation deductions accrued before enactment to be claimed as scheduled), and businesses would expense capital purchases. Interest would no longer be deductible as a business expense, and interest income for individuals would be taxed at the same rate as capital gains and dividends. Net operating losses could be carried back five years, and carried forward indefinitely. All businesses would be required to use the cash method of accounting. The alternative minimum tax (AMT) would be repealed for business income. The proposal would also convert to a territorial system for taxing overseas income. A cash flow tax, similar to what is proposed in H.R. 4377 , is essentially the business component of a flat tax.

Replacing the Current Tax System with a Consumption Tax: Economic Considerations38

Relative to the current system, it is often asserted that a flat tax (or consumption tax) would increase economic efficiency. This type of tax is imposed on a broad definition of wage income (or consumption), and there are limited deductions, exemptions, and credits to reduce tax liability. Lower tax rates on a broader tax base tend to promote economic efficiency. If the flat tax (consumption tax) is not applied to capital income or corporate income, the flat tax may contribute to additional capital accumulation and investment. A cash flow tax might also encourage additional investment, as allowing business expensing exempts the normal (or marginal) return on capital from tax. A flat tax (or consumption tax) system, however, is likely to be less progressive than the current tax system, particularly at the top of the income distribution. Thus, efficiency gains achieved by moving to a flat tax (or consumption tax) system would come at the cost of reduced equity, as higher-income groups would tend to see tax burdens decline while lower-income groups would tend to see increased tax burdens.

Another potential benefit of a flat tax system is simplicity. A flat tax system would impose one tax rate, and eliminate most of the tax deductions and tax credits currently in the tax code. A cash flow system that eliminates most credits and deductions and provides that most business expenses are expensed rather than depreciated over time, coupled with cash accounting, might also contribute to tax simplicity. However, much of the complexity in the current tax system is related to the definition of income, rather than the income tax rates. If the tax were applied only to wage income, this would create an incentive for non-wage compensation (e.g., benefits), as is the case in the current tax system with the exclusion for employer-provided healthcare. Further, if the flat tax system were to run parallel to the current income tax system, as proposed in H.R. 1040 , the flat tax could create additional complexity for taxpayers trying to decide whether to elect flat tax treatment. There would also be horizontal inequities, as taxpayers with identical incomes and tax circumstances would have different tax liabilities under the flat tax and income tax systems.

While reduced tax rates, particularly reduced corporate tax rates, could yield economic benefits, there are revenue considerations to be taken into account. The Joint Committee on Taxation has not publicly released revenue estimates for any of the tax reform proposals discussed in this section. If a tax reform proposal contributed to increased deficits, meaning the reform was ultimately financed with government debt, increased interest rates could crowd out economic benefits associated with the reform.

Other Tax Reform Proposals

Legislation introduced in the 114 th Congress would eliminate the current tax code, leaving it to Congress to design a new tax code. The Tax Code Termination Act ( H.R. 27 ) would terminate the Internal Revenue Code, and declares that any new tax system should be a simple and fair system that (1) applies a low rate to all Americans; (2) provides tax relief for working Americans; (3) protects the rights of taxpayers and reduces tax collection abuses; (4) eliminates the bias against savings and investment; (5) promotes economic growth and job creation; and (6) does not penalize marriage or families.

Fiscal Reform in Budget Proposals

Budget Resolution for FY2017

The House and Senate have not yet agreed to a budget resolution for FY2017.

Budget Resolution for FY201646

After going to a conference in April 2015, the House and Senate agreed on a budget resolution ( S.Con.Res. 11 ) for FY2016. As is required of a budget resolution, S.Con.Res. 11 includes enforceable aggregate levels of revenue for FY2016. Additionally, the budget resolution demonstrates some support for congressional action on tax reform. Specifically, the resolution includes:

A deficit-neutral reserve fund in the Senate for legislation related to tax reform. Congress frequently includes "reserve funds" in the budget resolution. Such provisions provide the chairs of the House or Senate Budget Committees the authority to adjust the budgetary allocations, aggregates, and levels included in the budget resolution in the future if certain conditions are met. Typically these conditions consist of legislation dealing with a particular policy being reported by the appropriate committee or an amendment dealing with that policy being offered on the floor. Generally, the goal of such a reserve fund or adjustment is to allow certain policies to be considered on the floor without triggering a point of order for violating levels in the budget resolution. Two policy statements expressing support in the House for tax reform. The first policy statement communicates support for fundamental tax reform that will foster economic growth and job creation, and the second states that tax reform should be enacted that (1) simplifies the tax code; (2) substantially lowers tax rates for individuals and consolidates the current seven individual income tax brackets into a fewer number; (3) repeals the Alternative Minimum Tax; (4) reduces the corporate tax rate; and (5) transitions the tax code to a more competitive system of international taxation.

The budget resolution also includes reconciliation instructions to several committees, including the committees with jurisdiction over tax reform, the Senate Finance Committee and the House Ways and Means Committee. These instructions trigger the reconciliation process by directing individual committees to develop and report legislation that would change laws within their jurisdiction to achieve a specified budgetary goal. During the final stages of the reconciliation process, the reported legislation is considered under expedited procedures in both the House and Senate. In responding to their reconciliation instructions, the Senate Finance Committee or the House Ways and Means Committee may choose to include in their reconciliation legislation changes to tax policy constituting tax reform.

President's FY2017 Budget Proposal52

Many of the tax policy changes contained in the President's FY2017 budget proposal have been included in the Administration's previous budget proposals. Specifically, 115 of the proposals are substantially the same as those in the FY2016 budget, 15 are modifications or combinations from FY2016 proposals, 12 reflect policy changes, and six are new. In total, there are nearly 150 revenue proposals contained in the President's FY2017 budget.

The tax proposals in the President's FY2017 budget are divided into two general categories. The first category contains proposals to reform the business tax system. The revenue-raising proposals in the President's budget include reforms to the international tax system, the elimination of a number of fossil fuel tax preferences, reform of the tax treatment of financial and insurance products, and the closure of a variety of items that the Administration views as "loopholes." In the international reforms, the largest two proposed revenue raisers are the imposition of a 19% minimum tax on foreign earnings, which the Administration estimates would raise $350.4 billion between 2017 and 2026, and a 14% one-time tax on previously untaxed foreign income, which it is estimated would raise $299.4 billion. The elimination of tax incentives for fossil fuels would raise $38.2 billion, while the reform of the tax treatment of financial products would raise $34.7 billion, and the closure of various loopholes would raise $153.1 billion.

Presumably some of this revenue would be used for various incentives in the budget proposals that are directed toward research, manufacturing, clean energy, small business, and infrastructure. The proposals for manufacturing, research, and clean energy are collectively estimated (by the Administration) to cost $89 billion over 10 years. The largest single item in this category of incentives is a proposal to modify and permanently extend the renewable electricity production tax credit and investment tax credit at a cost of $24.1 billion over 10 years. The simplification and tax relief for small businesses proposals are estimated to cost $47.5 billion between 2017 and 2026. The proposed incentives for increased investment in infrastructure would be the least expensive of the President's proposed business incentives at an estimated cost of $9.3 billion over 10 years.

The second group of tax proposals in the President's FY2017 budget includes tax proposals affecting middle-class households, health and retirement benefits, higher-income taxpayers, and financial institutions. A variety of other changes to increase compliance and strengthen administration were also included. The most costly proposals in this second group were a new second-earner tax credit for working couples, at $87.0 billion between 2017 and 2026, followed by proposed expansion of the EITC, at $61.4 billion between 2017 and 2026; consolidation, expansion, and simplification of education tax incentives, at $48.7 billion between 2017 and 2026; and reform of the child care tax incentives, at $39.8 billion between 2017 and 2026.

The proposals in this second group of provisions that are estimated to generate the most additional revenue between 2017 and 2026 include capping the value of certain tax expenditures at the 28% tax rate ($645.5 billion); imposing a $10.25 per barrel fee on crude oil ($319.1 billion); coordinating the application of the net investment and Self Employment Contributions Act (SECA) taxes for owners of partnerships and limited liability companies (LLCs) who materially participate in the business ($271.7 billion); increasing the capital gains rate from 20% to 24.2% ($235.2 billion); setting estate and gift tax parameters at 2009 levels ($201.8 billion); imposing a fee on certain financial institutions ($111.4 billion); increasing tobacco taxes ($115.1 billion); and imposing a "Buffett Rule" or "Fair Share Tax" ($37.5 billion).

President's FY2016 Budget Proposal54

The President's FY2016 budget, as previous budgets have, proposed a number of tax changes that largely followed those of years past. The President's FY2016 budget used an adjusted baseline, which assumed that the American Opportunity Tax Credit (AOTC), Earned Income Tax Credit (ETIC), and Child Tax Credit (CTC) expansions that were extended through 2017 as part of the American Taxpayer Relief Act (ATRA; P.L. 112-240 ) would be made permanent. These provisions were made permanent as part of the Consolidated Omnibus Appropriations Act, 2016 ( P.L. 114-113 ).

As with the President's FY2017 budget, the tax proposals in the President's FY2016 budget were divided into two groups. The first group of proposals was to be considered as part of a long-run revenue-neutral business tax reform. The revenue raised from the base-broadening proposals in this section would pay for a reduction in the corporate tax rate to 28%, with an effective rate of 25% for manufacturing. The President's FY2016 budget also provided a one-time $268 billion allowance for transportation infrastructure spending, which would be paid for using unspecified revenues generated through the transition to a reformed business tax system.

The business tax reform proposals in the President's FY2016 budget included incentives for research, manufacturing, clean energy, and small business. The proposed modification and extension of the research and experimentation tax credit would have cost $127.7 billion between 2016 and 2026 according to the Administration's estimates. The President's FY2016 budget also proposed extending the increased expensing allowance for small businesses. Both the research credit and small business expensing provisions were modified and made permanent in P.L. 114-113 . Revenue-raising provisions in the President's business tax reform included changes in the tax treatment of derivatives and insurance products, repeal of certain tax incentives for fossil fuels, and repeal of last-in, first-out inventory accounting methods, among several other changes.

Also included as revenue-raising provisions were proposed changes to the U.S. international tax system. These changes included such things as a 19% minimum tax on foreign earnings; limitations on corporate inversions; interest deductions restrictions; Subpart F reforms; limits on income shifting using intangible property transfers; and restrictions on hybrid arrangements to create stateless income. The Administration estimated the reforms to the U.S. international tax system would generate $238.3 billion between 2016 and 2025. Overall, the long-run revenue-neutral business tax reform section of the President's FY2016 budget would generate a reserve of $141.5 billion for revenue-neutral tax reform.

The second group of revenue proposals included additional provisions related to manufacturing and clean energy, certain incentives for infrastructure, a proposal to expand the Earned Income Tax Credit (EITC), and other individual-level tax incentives. The most costly proposal in this section was a new second-earner tax credit for working couples, at $89.0 billion between 2016 and 2025, followed by proposed expansion of the EITC, at $59.9 billion between 2016 and 2025.

On net, the revenue proposals that are not related to baseline adjustments or reserved for revenue-neutral business tax reform would have raised $1.5 trillion between 2016 and 2025. The provisions that would have generated the most additional revenue between 2016 and 2025 included capping the value of certain tax expenditures at 28% ($603.2 billion); imposing a 14% one-time tax on untaxed overseas earnings ($268.1 billion); increasing the maximum capital gains rate to 24.2% ($207.9 billion); setting estate and gift tax parameters at 2009 levels ($189.3 billion); imposing a fee on certain financial institutions ($111.8 billion); increasing tobacco taxes ($95.1 billion); conforming Self Employment Contributions Act (SECA) taxes for professional services businesses ($74.6 billion); and imposing a "Buffett Rule" or "Fair Share Tax" ($35.2 billion).

Tax Reform in the 113th Congress

Several major tax reform proposals were put forward by Members in the 113 th Congress. While comprehensive tax reform was not enacted, proposals introduced in the 113 th Congress may continue to inform the debate.

Committee on Ways and Means and Committee on Finance

The House Committee on Ways and Means worked toward comprehensive tax reform in the 113 th Congress. On February 26, 2014, Chairman Camp released the draft Tax Reform Act of 2014. This proposal would have broadened the tax base and restructured statutory tax rates in both the individual and corporate income tax systems, changed the tax treatment of foreign-source income for U.S. multinational corporations, and made dozens of other changes to the federal tax system (additional details can be found in the shaded text box below). This reform built on earlier discussion drafts that had been released by Chairman Camp.

Chairman Camp's first tax reform discussion draft on international tax reform was released during the 112 th Congress. A number of the international tax reform proposals in the Tax Reform Act of 2014 appeared in this earlier discussion draft. Similar to the earlier draft, the Tax Reform Act of 2014 would have allowed a 95% dividends received deduction for foreign business income. As a transition rule, the earlier draft had proposed a 5.25% tax on undistributed foreign earnings. The Tax Reform Act of 2014 also proposed taxing accumulated deferred foreign earnings, with a higher rate of 8.75% for cash, with other earnings held abroad taxed at 3.5%. In an effort to prevent tax base erosion, the Tax Reform Act of 2014 would have taxed foreign income generated by U.S. companies through the use of intangibles.

Other proposals in the Tax Reform Act of 2014 were similar to proposals contained in Camp's previous discussion drafts. Similar to proposals made in Camp's January 24, 2013, financial products discussion draft, the Tax Reform Act of 2014 would have required that derivatives be marked-to-market at year-end, such that taxpayers would recognize income or losses. With respect to small businesses, the Tax Reform Act of 2014 did not include the broader reform option that had appeared in the March 12, 2013, small business discussion draft. Instead, the Tax Reform Act of 2014 proposed a number of changes to existing pass-through and partnership tax rules. Among the many proposals are provisions that would have taxed carried interest as ordinary income, changed rules related to partnership audits and adjustments, and restricted the use of publicly traded partnerships.

Former Committee on Finance Chairman Max Baucus also released several discussion drafts related to tax reform. The former chairman released discussion drafts related to international tax reform, tax administration, cost recovery and accounting, and energy tax policy. The discussion drafts were released in addition to a series of tax reform options papers put forward by the committee earlier in 2013.

Under Senator Baucus's international tax reform proposal, passive and highly mobile forms of foreign-earned income would be taxed at the full U.S. rate, as would income earned from goods ultimately consumed in the United States. Two alternatives were put forth for taxing income earned from products and services sold abroad. "Option Y" would subject all foreign-earned income to a minimum tax, which the draft sets at 80% of the U.S. statutory rate. "Option Z" would tax 60% of foreign active business income at the U.S. rate. Similar to Chairman Camp's international tax proposals, undistributed foreign earnings would be subject to a one-time tax. The Baucus discussion draft sets this rate at 20%.

Reforms to cost recovery and accounting rules have also been put forward by former Chairman Baucus as a discussion draft. Proposed reforms would eliminate the modified accelerated cost recovery system (MACRS), enacting instead a system that uses asset pools and longer lives that more closely approximate economic depreciation. Certain intangibles, including research and experimentation as well as advertising expenditures, would be capitalized and amortized. Last-in, first-out (LIFO) inventory accounting rules would be repealed. Small-business expensing allowances would be increased such that more businesses would be allowed to use cash accounting. A number of similar proposals appear in the Tax Reform Act of 2014, discussed above.

Former Chairman Baucus has also released a discussion draft related to tax administration and energy tax reform. This tax administration draft contained several proposals designed to reduce the tax gap, enacting additional data reporting requirements and anti-fraud provisions. The energy tax reform discussion draft proposes clean energy production and investment tax credits designed to replace existing incentives for renewables and other clean electricity resources (e.g., nuclear, carbon capture, and sequestration). These credits would be available for the long term, but are designed to begin phasing out once the annual average greenhouse gas emissions rate falls below a specified threshold. The proposal also contains a new tax credit for clean transportation fuels.

Legislative Proposals

Reform the Income Tax System

The Tax Reform Act of 2014 ( H.R. 1 ) was introduced late in the 113 th Congress. This legislation was preceded by several tax reform discussion drafts, discussed above. Key provisions of this comprehensive legislation are provided in the text box below.

Additional legislative proposals in the 113 th Congress would have reformed the current income tax system. Specifically, the Family Fairness and Opportunity Tax Reform Act ( S. 1616 ) proposed substantive changes to the current income tax. Specifically, S. 1616 would have consolidated the tax brackets, repealed the alternative minimum tax (AMT), provided an additional child tax credit and personal credit, eliminated the standard deduction and most itemized deductions (retaining, with modifications, the deduction for mortgage interest and charitable contributions), in addition to making other changes to the tax code. Other legislation, such as the Flat Tax Rate Act ( H.R. 5882 ), would have imposed a single income tax rate of 15%.

Replace the Income Tax System

Several proposals were introduced in the 113 th Congress that would have replaced the income tax system with some alternative form of taxation at the federal level. The Fair Tax Act of 2013 ( H.R. 25 / S. 122 ) would have repealed the individual income tax, the corporate income tax, all payroll taxes, the self-employment tax, and the estate and gift taxes. These taxes would have effectively been replaced with a national retail sales tax. Thus, under H.R. 25 / S. 122 , the current federal tax system, based on taxing income, would have been replaced with a system that taxes consumption. The Fair Tax Act was reintroduced in the 114 th Congress, and is discussed above.

The Flat Tax Act ( H.R. 1040 ) proposed to allow taxpayers to elect to be subject to a flat tax, as an alternative to the current tax system. Individuals and businesses electing a flat tax would pay a flat rate of 19% for the first two years, and a rate of 17% thereafter. The Simplified, Manageable, And Responsible Tax (SMART) Act ( S. 173 ) also proposed a flat tax of 17% on individuals' wages and business taxable income. The flat tax systems proposed in H.R. 1040 and S. 173 were structurally similar to the Hall-Rabushka flat tax proposal. Both of these proposals were reintroduced in the 114 th Congress, and are discussed above.

The American Growth & Tax Reform Act of 2013 ( H.R. 2393 ) would have required the Secretary of the Treasury to submit to Congress a legislative proposal for a progressive consumption tax. H.R. 2393 would have been designed to eliminate the public debt outstanding. Specifically, the Treasury would have been directed to provide rates and details on a progressive consumption tax to eliminate the public debt under scenarios in which (1) the consumption tax in addition to other taxes; (2) the consumption tax would replace the individual income tax; and (3) the consumption tax would replace the corporate income tax.

The Progressive Consumption Tax Act of 2014 ( S. 3005 ) proposed a 10% consumption tax on most goods and services (structured as a value-added tax (VAT)). While the legislation would not fully replace the income tax system, it would have reduced individual and corporate income tax rates to a maximum rate of 28% and 17%, respectively. The legislation also would have broadened the income tax base, eliminating a number of individual tax expenditures. Further, the legislation would have provided an allowance of $50,000 for single filers ($100,000 for married filing jointly), that would have effectively exempted most taxpayers from the individual income tax. Refundable tax credits for families would effectively be replaced with rebates to offset consumption tax liability for lower-income families.

Other Tax Reform Proposals

Legislation introduced in the 113 th Congress would have eliminated the existing tax code, leaving it to Congress to design a new tax code. The Tax Code Termination Act ( H.R. 352 ) would have terminated the Internal Revenue Code, and declares that any new tax system should be a simple and fair system that met a set of criteria, as noted above.

The End Wasteful Tax Loopholes Act ( S. 8 ) proposes to express the sense of the Senate that Congress should enact legislation to (1) eliminate wasteful tax loopholes; (2) eliminate corporate tax loopholes and wasteful tax breaks for special interests; (3) enhance tax fairness by reforming or eliminating tax breaks that provide excessive benefits to millionaires and billionaires; (4) crack down on tax cheaters and close the tax gap; (5) use the revenue saved by curtailing tax loopholes to reduce the deficit and reform the federal tax code; (6) address provisions in the tax code that make it more profitable for companies to create jobs overseas than in the United States; and (7) reform the tax code in a manner that promotes job creation, competitiveness, and economic growth.

Fiscal Reform in Budget Proposals

General instructions for tax reform were not included in the Bipartisan Budget Act of 2013. Section 114 of the act, did, however, provide several deficit-neutral tax reform-related reserve funds for Senate budget enforcement. The earlier Senate- and House-passed budget resolutions recommend substantial changes in current tax law. The House budget resolution ( H.Con.Res. 25 ) called for revenue-neutral comprehensive tax reform, while the Senate budget resolution ( S.Con.Res. 8 ) instructed the Senate Finance Committee to draft revenue legislation that would reduce the deficit by $975 billion over the 2013 to 2023 budget window.

House and Senate Budget Resolutions

The House budget resolution ( H.Con.Res. 25 ) was passed on March 21, 2013. The accompanying H.Rept. 113-17 stated that H.Con.Res. 25 sought to grow the economy through tax reform. Specifically, tax reform as outlined in H.Con.Res. 25 , would have achieved the following objectives: (1) simplify the tax code to make it fairer to American families and businesses; (2) reduce the amount of time and resources necessary to comply with tax laws; (3) substantially lower tax rates for individuals, with a goal of achieving a top individual rate of 25%; (4) consolidate the current seven individual-income-tax brackets into two brackets with a first bracket of 10%; (5) repeal the Alternative Minimum Tax; (6) reduce the corporate tax rate to 25%; and (7) transition the tax code to a more competitive system of international taxation.

H.Con.Res. 25 stated that revenue-neutral tax reform that meets the objectives listed above should have been reported by the Committee on Ways and Means to the House by December 31, 2013. This would have allowed Congress time to enact comprehensive tax reform during FY2014. The tax reform efforts that were being undertaken at the time by the Committee on Ways and Means are discussed in greater detail elsewhere in this report (see " Committee on Ways and Means " above).

The Senate budget resolution ( S.Con.Res. 8 ) was passed on March 23, 2013. This budget resolution stated that by October 1, 2013, the Senate Committee on Finance was to report revenue legislation that would have raised $975 billion between fiscal years 2013 and 2023. The committee report accompanying S.Con.Res. 8 stated that these additional revenues would result from tax increases on "the wealthiest Americans and biggest corporations." The committee report also noted that S.Con.Res. 8 , as reported, supported the goal of comprehensive tax reform that "simplifies the tax code, increases fairness, generates economic growth, and improves the competitive position of U.S. businesses, if it is done in a way that is consistent with the revenue and progressivity goals" of the budget.

President's FY2015 Budget Proposal71

The President's FY2015 budget proposed a number of changes to current tax policy. Many of these changes were part of previous Obama Administration budget proposals. The President's budget used an adjusted baseline, which assumed that the American Opportunity Tax Credit (AOTC), Earned Income Tax Credit (ETIC), and Child Tax Credit (CTC) expansions that were extended through 2017 as part of the American Taxpayer Relief Act (ATRA; P.L. 112-240 ) are made permanent.

The tax proposals in the President's FY2015 budget were divided into two groups. The first group of proposals was to be considered as part of a revenue-neutral business tax reform. The revenues raised from proposals in this section would have paid for a reduction in the corporate tax rate. The President's FY2015 budget also provided a one-time $150 billion allowance for transportation infrastructure spending, which would have been paid for using unspecified revenues generated through the transition to a reformed business tax system.

The business tax reform proposals in the President's FY2015 budget included incentives for research, manufacturing, clean energy, and small business. The proposed modification and extension of the research and experimentation tax credit would have cost $108.1 billion between 2015 and 2024. The President's FY2015 budget also proposed extending the increased expensing allowance for small businesses. Revenue-raising provisions in the President's business tax reform included proposed changes to the U.S. international tax system, changes in the tax treatment of derivatives and insurance products, repeal of certain tax incentives for fossil fuels, and repeal of last-in, first-out inventory accounting methods, among several other changes. Changes to the U.S. international tax system in this section would have generated $276.3 billion between 2015 and 2024. Overall, this section of the President's FY2015 budget would have generated $248.3 billion for revenue-neutral tax reform.

The second group of revenue proposals included additional provisions related to manufacturing and clean energy, certain incentives for infrastructure, a proposal to expand the EITC, and other individual-level tax incentives. The most costly proposal in this section was the proposed EITC expansion, at $59.7 billion between 2015 and 2024.

On net, the revenue proposals that were related to baseline adjustments or reserved for revenue-neutral business tax reform would have raised $1,048.1 billion between 2015 and 2024. The provisions that would have generated the most additional revenue between 2015 and 2024 included the 28% cap on the value of certain tax expenditures ($598.1 billion); setting estate and gift tax parameters at 2009 levels ($118.3 billion); increased tobacco taxes ($78.2 billion); expansion and indexing of the federal unemployment tax act (FUTA) wage base ($59.0 billion); a financial crisis responsibility fee ($56.0 billion); and imposing a "Buffett Rule" or "Fair Share Tax" ($53.0 billion). Similar revenue-raising proposals appeared in previous Obama Administration budgets. Notably excluded from the President's FY2015 Budget was a proposal which first appeared in the FY2014 Budget to re-index the tax code using chained-CPI.

Concluding Remarks

Tax reform continues to be of interest in the 114 th Congress. One open question is whether Congress will choose to pursue comprehensive tax reform that simultaneously addresses the individual and corporate income tax systems, including multinational corporations. An alternative may be to look at international or business-only reforms. The extent to which such reforms are feasible and would achieve the policy objectives of tax reform remains an open question.

Another open question is whether the federal tax system should continue to rely on taxing income as the primary source of revenue. Several tax reform proposals introduced in the 114 th Congress would tend to shift the tax system away from taxing income, taxing consumption instead.