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The tax reform plan released last week by Congressman Dave Camp, the Republican chairman of the House Ways and Means Committee, fails to accomplish what should be the three basic goals for comprehensive tax reform: 1) raise revenue from individuals and corporations, 2) make our tax system more progressive than it is now, and 3) tax the offshore profits and domestic profits of our corporations at the same time and at the same rate. (See more details on these three goals.) As explained below, Camp’s plan also manages to restrict state and local governments’ ability to make important public investments.
Our lastest study documenting corporate tax avoidance dispels the myth that corporations need the sort of revenue-neutral tax reform that Rep. Camp proposes. But that is only one of many problems with his plan. Here are some other basic ways in which it fails.
FAILS TO RAISE REVENUE:
Tax reform should result in more revenue collected from both the personal income tax and the corporate income tax.
The United States is the least taxed of all OECD countries besides Chile and Mexico. Neither individuals nor corporations are taxed at high rates. American corporations even pay lower effective tax rates in the United States than they pay in other countries where they do business. At a time when Congress continues to bitterly argue whether we have the resources to fund important public investments that most Americans support like Head Start and medical research, we need to take a critical look at our nation’s tax structure and determine how we can raise more revenue in a way that is fair and just. Rep. Camp’s proposal makes no attempt to raise more revenue from wealthy individuals or profitable corporations.
We have been very critical of both Rep. Camp and President Obama for proposing that business tax reform be revenue-neutral. But Camp’s approach is far worse, proposing that all of tax reform (including changes that affect individuals, as well as changes affecting businesses) be revenue-neutral.
FAILS TO ENHANCE FAIRNESS:
Tax reform should result in a tax system that is more progressive than the one we have now.
When you account for the different federal, state and local taxes that people pay, the tax code is just barely progressive. Camp’s plan fails to address this. Partly this is because Camp’s plan would continue to tax capital gains and stock dividends, which mostly go to the wealthy, at lower rates than income from work.
Under Camp’s plan, the personal income tax would have two regular rates, 10 percent and 25 percent, and then a surcharge (an additional tax) of 10 percent would apply to very high-income people. The rules for the regular tax and the surcharge would be somewhat different. For example, no itemized deductions could be taken against the surcharge, except the charitable deduction. But the combination of the regular tax and the surcharge would be similar to having one tax with rates of 10 percent, 25 percent, and 35 percent.
The plan claims that capital gains and dividends would be taxed at the same rates as other income, but effectively they would be taxed at lower rates because 40 percent of capital gains and dividends would be excluded from taxable income. The top effective personal income tax rate on capital gains and dividends would be 21 percent. This is a one percentage point increase over the current top rate of 20 percent, which is probably enough to cause Grover Norquist to have an aneurism but will not address the fundamental unfairness of taxing income from wealth at lower rates than income from work.
Camp’s plan also reduces the EITC and eliminates personal exemptions while also increasing child tax credits and the standard deduction. Citizens for Tax Justice is currently producing estimates of how the combination of these changes would affect people in different income groups. But we already know that low-income families in certain situations would experience a substantial tax increase.
FAILS TO END OFFSHORE TAX SHELTERS:
Tax reform should result in rules that tax American corporations’ offshore profits and domestic profits at the same time and at the same rate.
This is the only way to end the tax incentives for corporations to shift jobs offshore and make their U.S. profits appear to be earned in offshore tax havens (countries where they are not taxed). Under the current system offshore profits and domestic profits are not taxed at the same time, because American corporations can indefinitely “defer” paying U.S. taxes on profits that are officially “offshore” until they are officially brought to the U.S. Under Camp’s plan, offshore profits and domestic profits would not be taxed at the same rate, and in fact the default rule would be for offshore profits to be taxed at a rate of 1.25 percent.
While Camp claims that various other measures he proposes would prevent corporate tax avoidance, it is impossible to believe that they would work since his overall proposal would dramatically increase rewards for any American corporation that can make its U.S. profits appear to be earned in offshore tax havens.
HURTS STATE AND LOCAL GOVERNMENTS:
Camp’s plan would hurt state and local governments by repealing the most justified deduction in the tax code.
Rep. Camp’s plan would limit and repeal many different tax breaks, but one of the most significant changes would be repeal of the deduction for state and local taxes. As the Institute on Taxation and Economic Policy (ITEP) has argued, this is the one of the most justified of all the deductions in the federal personal income tax.
The deduction for state and local taxes paid is often seen as a subsidy for state and local governments because it effectively transfers the cost of some state and local taxes away from the residents who directly pay them to the federal government. For example, if a state imposes a higher income tax rate on residents who are in the 39.6 percent federal income tax bracket, that means that each dollar of additional state income taxes can reduce federal income taxes on these high-income residents by almost 40 cents. The state government may thus be more willing to enact the tax increase because its high-income residents will really only pay 60.4 percent of the tax increase, while the federal government will effectively pay the remaining 39.6 percent. This is why Rep. Camp and many anti-government lawmakers want to do away with this particular deduction.
But viewed a different way, the deduction for state and local taxes is not a tax expenditure at all, but instead is a way to define the amount of income a taxpayer has available to pay federal income taxes. Another view is that the deduction encourages state and local governments to make public investments that they would otherwise underfund because the benefits spill outside their borders. For example, state and local governments provide roads that, in addition to serving local residents, facilitate interstate commerce. They also provide education to those who may leave the jurisdiction and boost the skill level of the nation as a whole, boosting the productivity of the national economy.
In this light, eliminating the deduction for state and local taxes is not a brave attempt to trim unnecessary breaks out of the tax code, but just one more attempt to restrict our ability to make the public investments that allow America’s economy and people to thrive.