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Annette Nellen

Pathway to tax reform

Congress considers plan for pursuing comprehensive tax reform in 2013.

August 9, 2012
By Annette Nellen, Esq., CPA

To date, the tax committees of the 112th Congress have held more than 30 hearings on various aspects of tax reform. Topics included taxation of business entities; incentives for innovation; tax treatment of debt and equity; and incentives for education, charitable giving, and home ownership.

The hearings raised many questions and produced some answers. What the discussion did not produce, though, was a plan for making tax reform happen. House Rules Committee Chairman David Dreier, R-Calif., addressed this missing piece on July 24 via H.R. 6169, the Pathway to Job Creation Through a Simpler, Fairer Tax Code Act of 2012. The bill moved quickly, passing in the House on Aug. 2 (232–189). H.R. 6169 provides reasons for comprehensive tax reform, lays out broad elements of a reformed tax system, and includes a plan of action. This article summarizes H.R. 6169, describes the concerns of opposing members, and notes some obstacles.

Problems warranting reform

H.R. 6169 lists 19 problems with the Internal Revenue Code. They are arranged below according to key themes. The number in parentheses refers to how the item is numbered in H.R. 6169.

Inequities:

  • The Code is “unfair” due to hundreds of special rules that “only benefit certain special interests.” (1)
  • The Code treats similarly situated families differently, thereby violating “equal justice.” (2)

Economic inefficiencies:

  • Tax expenditures cost more than $1 trillion, which is about equal to the amount generated annually by the federal income tax. H.R. 6169 states that some of these “tax subsidies” are “similar to government spending” and can be a “drag on economic growth and job creation.” (3)
  • Too many temporary provisions in the law create “economic uncertainty.” (4)
  • About 50% of profits of small businesses are taxed at the current top two rates for individuals. (9)
  • Under current law, tax revenues will increase to 21.2% of GDP, higher than they have been in the past. (Generally they average 18% to 19% of GDP.) (10)
  • The top current individual tax rate of 35% is “highly punitive” and will increase to more than 40% in 2013. (11)
  • Double taxation of corporate income causes the United States to have one of the highest tax rates on capital. (18)

 

Complexity:

  • About 4,500 changes have been made to the law since 2001. (5)
  • Almost 90% of individuals either hire a preparer or purchase tax preparation software. (6)
  • Taxpayers spend more than 6 billion hours and more than $160 billion annually to comply with the Code. (7)
  • Small businesses spend about $74 per hour on compliance. (8)
  • The “flawed” alternative minimum tax (AMT) affects almost 30 million individuals, far more than originally intended. (12)

 

International noncompetitiveness:

  • The combined federal and state corporate tax rate of 39.2% is highest among developed countries. (13)
  • A corporate tax rate that is more than 50% higher than the average for Organisation for Economic Co-operation and Development (OECD) countries discourages companies from locating or investing in the United States. (14)
  • The United States is one of the few countries using a worldwide tax system (generally taxing income of resident individuals and corporations no matter where earned) and has not “substantially reformed” its tax system from what it was 50 years ago when the United States accounted for a much larger portion of the global economy. (15)
  • A high corporate tax rate and a worldwide tax system leads to double taxation for U.S. firms when they compete in foreign markets and reinvest earnings in the United States. (16)
  • The tax law is a contributing factor behind the fact that in 2010 six of the world’s 20 largest companies were based in the United States, compared with 17 in 1960. (17)
  • Only four of the 38 countries in the OECD and the BRICs (Brazil, Russia, India, and China) have a higher tax rate on capital. (19)

 

Elements of comprehensive tax reform

H.R. 6169 calls for “enactment of comprehensive tax reform” in 2013. Elements of a reformed system include the following:

  • A two-tier individual tax structure of 10% and top rate of no more than 25%.
  • A top corporate tax rate of no more than 25%.
  • A broader base that eliminates “special interest loopholes” and generates revenues of 18% to 19% of GDP.
  • Greater simplicity.
  • No AMT.
  • “Modern levels of progressivity.”
  • Enables savings.
  • More similar tax treatment of business entities.
  • Encourages innovation and job creation.
  • A stable and predictable set of rules.
  • Low taxes on small businesses.
  • Transition to a territorial tax system.
  • Reduced impact of double taxation of investment and capital.

 

Plan for action

H.R. 6169 calls for the chair of the House Ways and Means Committee to introduce a tax reform bill by April 30, 2013. An expedited review procedure is spelled out with respect to deadlines for committee consideration and minutes of debate.

Dissenting view

H.R. Rep’t 112-629 by the House Committee on Rules includes the dissenters’ concerns. This group agrees with the need for comprehensive tax reform, but objects to the plan and some of the principles. For example, they prefer a “rate structure that distributes the tax burden in a more progressive manner.” They also want to be sure time is given to proper vetting of proposals. The report closes with the following statement that indicates that the political parties have differing views on the tax system problems and possible solutions: “Because the hard-nosed partisanship of H.R. 6169 cannot possibly form the foundation for a successful bipartisan tax reform effort, we must dissent.”

Obstacles

Many of the terms and suggestions in H.R. 6169 are vague. For example, it does not specify which “tax subsidies” or “loopholes” should be eliminated as part of base broadening. Calls for promoting innovation and keeping taxes on small businesses low may lead to continuation of some “tax subsidies” or spending, or perhaps creation of new ones, causing tension with the goal of base broadening.

Several of the suggestions will lead to political debate with a need for compromise to obtain the bipartisan support most likely needed for comprehensive tax reform. For example, given that President Barack Obama and many members of Congress want to let the 2001 and 2003 tax cuts expire for upper-income individuals, it will be difficult to “maintain modern levels of progressivity.”

Today’s low rates exist in a system that produces large deficits. Achieving even lower rates while lowering the deficit will require significant increases to the tax base (“base broadening”). This will likely require changes to the largest tax expenditures, such as the exclusion for employer-provided health insurance and the mortgage-interest deduction, which will be challenging. (See Joint Committee on Taxation, Background Information on Tax Expenditure Analysis and Historical Survey of Tax Expenditure Estimates (JCX-15-11), p. 25 (3/9/11).)

Looking forward

There is broad consensus that our current tax system suffers from many flaws and comprehensive reform is needed. However, many views exist on what the flaws are (such as whether a 15% rate on capital gains is too high or too low) and what a reformed system would look like (e.g., two rates or more). Because of this lack of agreement, H.R. 6169 may go nowhere (as of this writing, it was reported that the Senate may not even consider the bill).

The results of the November election are unlikely to change the status quo for achieving tax reform. Instead, the results may change which party gets to pass a plan. The major task of comprehensive tax reform and its economic and societal impacts is something unlikely to occur and be successful without comprehensive, bipartisan support.

For a complete list of the hearings with hyperlinks, see the author’s website for “Tax Reform Hearings of the 112th Congress.”


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Annette Nellen, Esq., CPA, is a tax professor and director of the MST Program at San José State University. She is an active member of the tax sections of the AICPA, ABA, and California State Bar. She chairs the AICPA's Individual Taxation Technical Resource Panel. She has several reports on tax policy and reform and a blog.