CRFB's Analysis of the Tax Reform Act
To understand Rep. Dave Camp's (R-MI) tax reform discussion draft, you could read the 194-page section-by-section summary of the bill. Or you could read the 5-page summary that we have just published, detailing the provisions, budgetary impact, and potential economic effects. As a whole, Chairman Camp deserves a lot of credit for producing a reform which makes many hard choices, but we are concerned that the bill could increase deficits over the longer term when reform should be contributing to deficit reduction.
Click here to read our analysis of the Tax Reform Act of 2014.
The paper details the numerous reforms contained in the draft. Individual tax rates are consolidated from seven to three brackets with rates of 10, 25, and 35 percent. The 10 percent bracket is phased out for high earners and the 35 percent bracket is applied to a wider swath of income, effectively limiting the value of tax expenditures like the health and municipal bond exclusions and the mortgage interest deduction to 25 percent. The standard deduction and child tax credits are significantly increased and also phased out for high earners while personal exemptions are eliminated. Capital gains and dividends are taxed as ordinary income but with a 40 percent exclusion, which makes an effective top rate of 21 percent. The state and local tax deduction is eliminated while the mortgage interest deduction and charitable deduction are limited, and a number of other provisions are reformed or eliminated. The Alternative Minimum Tax is also eliminated.
On the corporate side, the top rate is lowered from 35 to 25 percent, and the corporate AMT is eliminated. Preferences like accelerated depreciation, LIFO accounting, and R&E expensing are eliminated. Half of the advertising deduction is required to be written off over ten years. The R&E credit is reformed and permanently extended. The international tax system is transitioned to a territorial system where income is only taxed in the country where it is earned with certain "base erosion" protections to prevent income shifting. The one-time revenue from this transition is dedicated to the Highway Trust Fund.
In addition, the bill repeals the medical device tax and enacts a .035 percent quarterly tax on assets over $500 billion for large financial institutions.
Overall, the legislation increases revenue by $3 billion over ten years, with an almost $25 billion gain in the first five years and a $20 billion loss in the last five years. Judging by the later years of the score, it is possible that the bill would increase deficits over the longer term since there are a number of provisions that provide front-loaded or temporary revenue used to pay for permanent rate cuts. However, there are also a few provisions, such as the Chained CPI, where the revenue would grow over time.
The JCT also evaluated the potential economic benefits of tax reform, finding that it could increase real GDP by between 0.1 to 1.6 percent over ten years, translating to additional revenue gains of between $50 billion and $700 billion. If these gains materialized, the 2023 debt-to-GDP ratio could be lowered by between 0.3 and 4.0 percentage points.
Net Revenue in the Tax Reform Act (Percent of GDP)
Notes: hypothetical revenue with dynamic scoring assumes $375 billion of additional revenue (the mid-point of JCT’s estimates) distributed from 2015 through 2023. Revenue levels compared to pre-reform GDP. Current law with expiring provisions assumes the extension of the normal tax extenders and expiring refundable tax credits. Net revenue refers to revenue minus refundable credits.
Chairman Camp's draft is an impressive piece of legislation, making many hard choices and demonstrating the tradeoffs inherent in tax reform. It can be a good starting point for a bipartisan reform effort. However, the fiscal impact remains a concern; hopefully, a longer-term analysis of the bill can be produced to see if its revenue-neutrality would hold up beyond 10 years. Still, the draft is an important contribution to the tax reform debate and hopefully will help push the conversation forward.
Click here to read our analysis of the bill.