Correcting Some Misconceptions About the Camp Plan
In the wake of the release of House Ways and Means Committee Chairman Dave Camp's (R-MI) tax reform discussion draft, some misconceptions have been spread about both its potential benefits and drawbacks. In this post, we will look into four of these misconceptions.
Misconception #1: The draft raises corporate taxes by $500 billion to pay for tax cuts for individuals.
At first glance, the draft seems to reduce individual income tax revenue by almost $600 billion while raising more than $500 billion from corporations and another $85 billion from a bank tax. However, the reality of the split between individuals and businesses is more complicated because of the treatment of pass-throughs -- businesses whose income passes through to the owners/shareholders and is taxed by the individual income tax. Pass-throughs are counted in two separate sections in the JCT revenue estimate: revenue lost from the rate cuts is shown with the individual provisions, while revenue gained from base-broadening is shown with the business provisions. Thus, looking at the revenue impact of each of those sections will overstate the tax cuts given to individuals and the revenue raised from businesses.
The exact extent of pass-through revenue is difficult to determine, although we can make some educated guesses. First, the rate cuts on the individual side also apply to pass-through entities. In 2007, pass-throughs paid about 15 percent of individual tax revenue. If that ratio holds true, 15 percent of the revenue from the rate cuts and Alternative Minimum Tax repeal would account for about nearly half the net revenue reduction in the individual score, which would suggest the net tax increase on businesses is closer to $200 billion than $500 billion.
Looking also at the corporate score, it is clear that a substantial portion of the net revenue comes from pass-throughs. As an example, one section called "Pass-Thru and Certain Other Entities" -- which changes tax laws relating mainly to pass-throughs -- raises $25 billion of revenue; there are other provisions which may only impact pass-through entities outside of that section. In addition, many of the corporate base-broadening measures raise revenue from both C-Corps and pass through entities. For example, previous estimates suggest that about 30 percent of the revenue from repealing accelerated depreciation – the biggest revenue raiser on the corporate side – comes from pass-through entities. A number of other provisions are also likely to include substantial pass-through revenue.
While the Tax Reform Act may indeed shift the tax burden from individuals to corporations, the total shift would likely be much smaller than the $500 billion number in the JCT score.
Misconception #2: The discussion draft reduces marginal tax rates for everyone.
One of the main arguments for pursue comprehensive tax reform has to do with the advantages of reducing marginal tax rates. The bill appears to reduce these marginal rates for everyone by cutting the statutory rates from 10, 15, 25, 28, 33, 35, and 39.6 percent to 10, 25, and 35 percent. Yet there is a difference between the statutory rates that are reflected in a tax bracket percentage and marginal rates, which reflect the amount of additional taxes one pays on an additional dollar of income.
The draft would reduce or maintain statutory rates at all income levels. It will reduce marginal rates for most people and on average, but due to phaseouts and other tax code changes, it will not reduce marginal rates for everyone.
There are a few reasons this is true. First, by indexing the tax code to the more accurate chained CPI in favor of the currently used CPI-U, individuals will move into higher tax brackets slightly faster: by 2023, a small number of individuals would face a marginal tax rate of 25 percent as opposed to 15 percent under current law. In addition, the plan essentially eliminates the head of household filing status, which benefits single people with children and would result in lower marginal rates for some people than would be the case under the draft.
Finally, and perhaps most importantly, the legislation includes a number of phase-outs which have the impact of increasing effective marginal tax rates. For example, the legislation phases out the standard deduction, 10 percent bracket, and child tax credit for higher earners. This effectively creates a set of “bubble rates” whereby some taxpayers in the 25 percent bracket face a marginal rate of 30 percent, and some in the 35 percent bracket face a marginal rate of 40 or 42 percent. Len Burman over at the Tax Policy Center discusses some of these higher effective marginal rates in detail – and also points to other phase-outs (for example, a phase-out of the exclusion of capital gains from home sales) which could further increase effective marginal rates.
To be sure, current law also has a number of phase-outs that raise current law effective marginal rates above the statutory rates. And on the whole, the tax reform draft would significantly reduce marginal rates. However, for some individuals marginal rates could increase.
Misconception #3: The draft makes the tax code less progressive.
Given the rate reductions, one might conclude that the discussion draft favors the rich. However, a number of regressive tax preferences were reduced or eliminated, including the state and local tax deduction, mortgage interest deduction, municipal bond exclusion, and charitable deduction. With these reductions, the plan is close to distributionally neutral overall. By 2023, JCT's distributional analysis shows that those making less than $30,000 and more than $100,000 see changes in their effective tax rate of less than half a percentage point, while those in the middle get an average reduction in their tax rates of close to 1 percentage point.
Misconception #4: The discussion draft will raise $700 billion in new revenue from economic growth.
JCT provided an additional analysis of the economic impact of the plan, finding that increased economic growth could raise up to $700 billion in revenue. This figure, however, is provided on a wide range between $50 and $700 billion as a result of GDP being 0.1 to 1.6 percent higher over ten years. The shaded area in the graph below represents the range of potential revenue the increased economic growth could bring, assuming the gains are distributed proportionally over the decade.
Encouragingly, the bill does not rely on the dynamic revenue for the purposes of making the reform revenue-neutral. This means that whether tax reform raises $50 billion or $700 billion from economic growth, that revenue will be used to help strengthen the fiscal situation.
There has been a lot of discussion of the Tax Reform Act since its release a few weeks ago. We will continue our analysis and fact-checking of the draft and the broader tax debate as they develop.