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Annette Nellen
A Laundry List of Revenue Options

In case members of Congress run out of ideas for tax proposals, the CBO recently issued an analysis of 59 from which to select.

September 10, 2009
by Annette Nellen, CPA/Esq.

Every two years, the Congressional Budget Office (CBO) issues a report to Congress entitled, Budget Options. This lengthy and detailed report lists and explains numerous possible budget changes. While most of the proposals would reduce spending or increase taxes, some increase spending and decrease taxes. The ideas come from members of Congress, the President's budget, congressional and CBO staff, private groups and others. The report is designed to serve as a compendium of possibilities rather than an endorsement or ranking of proposals. Proposals are explained objectively and revenue estimates are provided.

The proposals are categorized using federal budget categories such as defense, international affairs and energy. Examples of spending proposals include:

  • Eliminate the Department of Energy's applied research on fossil fuels
  • Sell some of the assets of the of the Tennessee Valley Authority
  • Eliminate the Presidential Election Campaign Fund

The Budget Options report issued in August 2009 is Volume II (PDF) and includes over 150 proposals. Volume I was issued by the CBO in December 2008 and includes 115 budget options, including tax law changes, related to healthcare.

This article describes the types of tax proposals included in the August 2009 CBO report with details on a sampling of the suggestions.

Tax Proposals

The 59 tax proposals in the August 2009 report cover all types of taxes although almost half of them pertain to the individual income tax. The proposals do not follow any particular theme, such as raising taxes. In fact, some proposals are outright opposites, such as one to reduce the top corporate tax rate to 30 percent and another to make all corporations subject to a flat 35-percent rate. A few proposals would simplify the law by repealing a provision such as the low-income housing tax credit, the §199 manufacturing deduction or telephone excise tax. A different approach to simplification is a proposal to consolidate the tax deductions and credits for education expenses.

Several proposals would modify itemized deductions and the standard deduction. These include:

  • Gradually reducing the mortgage interest deduction to only apply to $500,000 of debt or replacing it with a 15-percent credit limited to a $500,000 mortgage.
  • Either repealing the deduction for state and local taxes or capping the deduction at two percent of adjusted gross income (AGI).
  • Only allowing a charitable contribution deduction for donations in excess of two percent of AGI.
  • Limiting the deduction for charitable gifts of appreciated property to basis (or fair market value (FMV) if lower).
  • Limiting the benefit of itemized deductions to 15 percent.
  • Allowing non-itemizers a limited deduction for charitable contributions.
  • Repealing the additional standard deduction for elderly and blind individuals.

A few proposals would not only raise revenues, but address climate change and air pollution concerns. Options in this area include increasing the motor fuels excise tax, imposing new taxes on emissions of sulfur dioxide and nitrogen oxide and a new "upstream" tax on greenhouse gas emissions. While the proposed taxes on sulfur dioxide and nitrogen oxide would generate about $21 billion over 10 years, the greenhouse gas tax option could generate $882 billion over 10 years. [Report (PDF), pgs. 252-254]

A Sample Look

Following is a brief description of a few selected options, their rationale and revenue effect.

Capital gains tax structure: The current multi-rate capital gains tax structure could be replaced with a deduction equal to 45 percent of net long-term capital gains. The CBO describes this as a simplification proposal. The removal of special capital gain tax rates would make the effective tax rates on capital gains scale to the graduated rate structure for ordinary income (rather than being the same regardless of income level). For example, a 45-percent deduction for long-term capital gains would result in a 13.75 percent rate on capital gains for an individual in the 25 percent tax bracket, but a 19.25-percent rate for someone in the 35 percent bracket. CBO notes that the 45-percent deduction could also apply to qualifying dividends that today are taxed at a 15 percent rate. CBO projects that this proposal would reduce tax collections by almost $48 billion over 10 years; a lower deduction percentage would reduce that revenue loss. [Report (PDF), p. 182]

Replace the state and local bond interest exclusion with a credit: The current exclusion for interest on state and local bonds reduces federal tax collections by about $36 billion annually. The effect of the exclusion is that the federal government is providing a subsidy to state and local governments. This subsidy need not be provided via exclusion, but can instead be provided with a tax credit. This proposal follows a provision in the American Recovery and Reinvestment Act of 2009 (P.L. 111-5; February 17, 2009) for Build America Bonds (IRC §54AA). Under the proposed system, there would be no exclusion, so the bond interest would be included in income. The bondholder would receive a tax credit instead which would also be included in income. CBO explains that an advantage of the credit approach is that it does not result in providing a higher subsidy than needed to entice high bracket taxpayers to buy the bonds. CBO notes though that this approach might cause some state and local governments to have to raise their interest rates on their bonds. This proposal is estimated to raise almost $20 billion over 10 years. [Report (PDF), p. 211]

Corporate integration: Corporate integration techniques are designed to eliminate double taxation of corporate income. The CBO report includes a proposal to integrate using the dividend-exclusion method. Under this approach, individuals exclude dividends and capital gains that arise from taxed corporate earnings arising subsequent to this law change. This approach will cause some recordkeeping complexity. CBO estimates that this proposal would reduce tax revenues by almost $506 billion over 10 years. [Report (PDF), p. 217]

Disallow tax-free conversions of large C corporations into S corporations: For C corporations with assets exceeding $5 million, there would immediate recognition and taxation of the gain on appreciated assets when electing S status. CBO notes that this rule would reduce the influence of tax rules in deciding the entity form for a business. CBO projects that these changes would increase revenues by about $0.5 billion over 10 years. [Report (PDF), p. 223]

Increase the motor fuels excise tax: The CBO options include increasing the motor fuel excise tax from its current 18.4 cents per gallon (24.4 cents for diesel) by either 50 cents or 25 cents. The rationale is to provide greater funding for highway maintenance and to reduce driving which would decrease pollution, congestion and dependence on foreign oil. Reduced driving or use of more fuel efficient cars would also reduce greenhouse gas emissions. Increasing this excise tax to 68.4 cents per gallon of gasoline (74.4 cents for diesel) could raise $605 billion over 10 years. [Report (PDF), p. 246]

Looking Forward

As with prior CBO Budget Option reports, the long list of possible spending and tax changes is just a compendium for Congress to use as a reference. While a few of the tax options had already been introduced in Congress, such as H.R. 518 to consolidate the education incentives into a single credit, the majority have not been introduced in the 111th Congress (or even prior Congresses). The list of options provides a ready list though, should lawmakers need to find tax increases to offset proposed tax cuts. The list may also provide lawmakers with new ideas for reducing the deficit or remedying some problem they find in the tax system. The list is also useful to practitioners and taxpayers to provide a sense of tax rules that could come under review and possible change in the future.

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Annette Nellen, CPA/Esq., is a tax professor and Director of the MST Program at San José State University. She is also a fellow with the New America Foundation. Nellen is an active member of the tax sections of the AICPA and ABA. She has several reports on federal and state tax reform and a blog.