In a widely anticipated move in the tax world, House Ways and Means Chairman Dave Camp (R-MI) has released a comprehensive tax reform discussion draft after both tax-writing committees had released a number of discussion drafts dealing with specific sections of the tax code. There is a lot to analyze in the bill: a quick summary of the bill's major reforms is below, and a more detailed analysis will follow later in the week.
In an editorial published in the Wall Street Journal preceding the discussion draft's release, Camp said: "If Congress doesn't take action, the U.S. risks falling further behind. The tax code should make it easier for American companies to bring back profits earned overseas so they can be invested here. It should not hinder small businesses from growing into large businesses. And the individual income tax needs to be simpler, fairer and flatter for everyone." Chairman Camp addressed both the corporate and individual tax systems in his discussion draft released today.
The reform reduces individual tax rates and consolidates tax brackets from seven to three: 10, 25, and 35 percent. These tax brackets – and other income thresholds – will be indexed to chained CPI. The 10 percent bracket also phases out for higher earners, and the top bracket does not apply to business income.
Meanwhile, personal and dependent exemptions are eliminated in favor of a larger standard deduction and child tax credit, both of which phase out for the highest earners. Capital gains and dividends are taxed as ordinary income with a 40 percent exclusion, leading to effective rates of 6, 15, and 21 percent before counting the 3.8 surtax currently in place.
These changes would be paid for in a number of ways. The state and local tax deduction would be eliminated, the mortgage interest deduction limited to $500,000 of debt (down from $1 million), and the charitable deduction subject to a 2-percent-of-AGI floor. A number of other tax preferences would be reduced or repealed, and many of those remaining – including the employer health exclusion, mortgage interest deduction, and exclusion of municipal bond interest – would be limited in value to the 25 percent bracket.
|Area||Current Law||Tax Reform Act of 2014|
|Individual Income Tax|
|Tax Rates||10% | 15% | 25% | 28% |33% | 35% | 39.6%||10% | 25% | 35%
(10% rate phases out at high incomes)
|Standard Deduction||$6.2k/$12.4k||$11k/$22k (phases out at high income)|
|Personal Exemptions||$3,900, phased out at higher incomes||Eliminated|
|AMT||Alternative tax w/ 26% and 28% rates||Eliminated|
|Child Tax Credit||$1,000/child not indexed for inflation - phased out at higher incomes; more refundable through 2017||Credit increased to $1,500 and indexed for inflation, refundability rate increased; phased out at higher incomes|
|Earned Income Tax Credit||$500-$6,000 credit, phased out at higher incomes; higher for families with 3 children through 2017||Reduced credit rates to $100-$4,000, phase-outs begin at higher income levels; marriage penalties lessened|
|Mortgage Interest Deduction||Available to itemizers for up to $1 million of debt||Available to itemizers up to $500,000 of debt; value limited to 25% bracket|
|Charitable Deduction||Available to all itemizers||Subject to 2% of AGI floor|
|Health Insurance Exclusion||Available w/ 40% tax on high-cost plans||Value limited to 25% bracket; 40% tax on high-cost plans|
|State & Local Tax Deduction||Available to all itemizers||Eliminated|
|Municipal Bond Exclusion||Available for public and private bonds||Value limited to 25% bracket; exclusion eliminated for certain private activity bonds|
|401(k) Retirement Accounts||Up to $17,500 of employee contributions on a tax-deferred or Roth-style basis||Contributions above $8,750 allowed only in Roth-style accounts|
|Capital Gains and Dividends||Taxed at 0%, 15%, 20% with 3.8% surtax for income above $250K||Taxed as ordinary income w/ 40% exclusion (effective rates of 6%, 15%, and 21%); 3.8% surtax retained|
|College Tax Credit||$2,500 American Opportunity Tax Credit through 2017 ($1,000 is refundable); additional tax benefits available||AOTC extended permanently, refundability increased to $1,500, income eligibility range reduced; other benefits eliminated|
|Other Tax Provisions||Various credits, deductions, exclusions, and other preferences available||Dozens of preferences repealed or reformed. Numerous loopholes closed.|
|Corporate Income Tax|
|Rates||Top Rate of 35%||Flat Rate of 25%|
|Accelerated Depreciation||Accelerated Depreciation (MACRS)||Economic depreciation, basis adjusted to account for inflation|
|Advertising Deduction||Costs fully expensed||Half of costs amortized over 10 years|
|Domestic Production Deduction||9% of income deduction generally available||Deduction phased out by 2017|
|Research & Experimentation||Costs fully expensed||Costs amortized over 5 years|
|Inventory Accounting||Last-in-First-Out Accounting allowed||Last-in-First-Out Accounting phased out|
|R&E Credits||4 credits, all expired in 2013||Alternative simplified credit reformed and permanently extended, others repealed|
|International Tax||Worldwide w/ deferral||Territorial w/ base erosion protections and one-time transition tax|
|Other Tax Provisions||Various credits, deductions, exclusions, and other preferences available||Dozens of preferences repealed or reformed.|
|Medical Device Tax||2.3% tax on sale of certain medical devices||Tax repealed|
|Bank Tax||N/A||.035% quarterly tax on assets over $500 billion|
On the business side, the corporate income tax rate would be reduced from 35 to 25 percent. This reduction would be paid for by repealing accelerated depreciation, moving away from Last in First Out (LIFO) accounting, requiring partial amortization of advertising and research and experimentation, phasing out the domestic production activities deduction, and making numerous other changes. The draft also calls for moving to a territorial tax system with base erosion protections and a temporary repatriation tax.
Finally, the legislation calls for repealing the medical device tax and imposing a new .035 percent quarterly tax on assets over $500 billion in large financial institutions.
|Reduce rates to 10%, 25%, and 35%, limit certain tax preferences to 25% bracket, phase out 10% rate, and index brackets to chained CPI||-$232 billion||-$544 billion|
|Tax Capital Gains/Dividends with 40% Exclusion||$15 billion||$45 billion|
|Consolidate, reform, and extend personal exemptions, standard deduction, CTC, and EITC||$18 billion||-$16 billion|
|Modify various itemized deductions||$309 billion||$858 billion|
|Require 401(k) contributions above half of current limit be placed in Roth-style accounts||$56 billion||$144 billion|
|Reform education tax preferences||$27 billion||$19 billion|
|Enact other changes||$76 billion||$237 billion|
|Repeal Alternative Minimum Tax||-$443 billion||-$1,332 billion|
|Subtotal, Individual Reforms*||-$174 billion||-$589 billion|
|Reduce corporate rate to 25% and repeal AMT||-$234 billion||-$791 billion|
|Reform accelerated depreciation schedules||$59 billion||$270 billion|
|Modify net operating loss deduction||$30 billion||$71 billion|
|Amortize R&E and advertising expenses||$152 billion||$362 billion|
|Phase out domestic production deduction||$44 billion||$116 billion|
|Repeal LIFO accounting rules||$6 billion||$79 billion|
|Reform international tax system||$20 billion||$68 billion|
|Enact other changes†||$103 billion||$359 billion|
|Subtotal, Business Reforms*||$180 billion||$533 billion|
|Impose .035% tax on large banks||$30 billion||$86 billion|
|Repeal medical device tax and other changes||-$12 billion||-$28 billion|
|Subtotal, Excise Taxes||$18 billion||$58 billion|
|Total Budgetary Impact||$24 billion||$3 billion|
|Addendum #1: Total impact w/ economic growth||Unknown||$50 to $700 billion|
* For pass-throughs, the rate reductions are captured in individual reforms while base-broadening is captured in business reforms.
† Other corporate tax changes include revenue from tax-exempt entities and tax administration and compliance.
As shown above, Chairman Camp's discussion draft would be roughly revenue neutral over the decade. However, because several of the bill's revenue sources represent one-time gains or revenue shifted from the far future into the near future, we are concerned that the legislation would add to the deficit in future decades. We will continue to analyze the legislation and provide further information in the coming days.
* * *
Overall, Chairman Camp deserves a lot of credit for producing a full tax reform proposal; the first such proposal to come out of a Congressional committee in recent years. The plan identifies the trade-offs needed in order in lower tax rates and broadening the tax base while also bringing in new revenue sources. Making many hard choices, as this plan does, is praiseworthy, and the draft represents a starting point for a bipartisan tax reform deal. However, there is concern that the reform would add to the deficit over the long run, when we will need to raise revenue from tax reform to meet the nation's fiscal challenges. Still, the draft is one that lawmakers can build on and use along with entitlement reform to put debt on a downward path.