The blueprint for tax reform was released in June 2016 as part of the "A Better Way" initiative from U.S. House Speaker Paul D. Ryan, R-Wis. It was the last of six policy planks requested by Ryan. House Ways and Means Chair Kevin Brady, R-Texas, led the tax task force.
The blueprint would lower the corporate tax rate to 20 percent, reduce the number of individual tax brackets to three (12, 25, and 33 percent), allow 100 percent business expensing, and eliminate the deductibility of interest for business. There would also be a 50 percent deduction for capital gains, and the estate and alternative minimum taxes would be completely repealed. Most business credits would be removed from the code (except for the research credit).
On the international tax side, the U.S. would move to a territorial system and a destination-based cash flow tax.
House Speaker Paul D. Ryan, R-Wis., and Ways and Means Committee Chair Kevin Brady, R-Texas, released the blueprint.
A destination-based cash flow tax can be thought of as two separate components: a cash flow component and a destination-based component. A cash flow tax is a type of consumption tax that uses cash flow accounting principles. The idea behind a cash flow tax is that companies are taxed on the net cash flow received from business activities. Companies take immediate deductions for business purchases. The tax base is measured as the difference between receipts from the sale of goods and services and the purchases of goods and services necessary for production. No distinction is made between capital and income.
The destination principle is commonly seen with most value added taxes and is referred to as a border tax adjustment. This adjustment imposes tax on imports and provides tax credits on exports. The destination-based cash flow tax would allow a deduction for compensation paid to employees, a key point in terms of possible World Trade Organization compliance.
Normally when a taxpayer buys a business asset with a useful life longer than one year, no immediate deduction from income taxes is allowed. Instead, the business may take partial deductions for the cost of the asset over time as the value of the asset depreciates. These deductions lower the basis in the asset that may be recovered tax free should the asset be sold rather than fully expended.
Current law does not track with economic depreciation but allows bonus depreciation of half of an asset's cost in the year of purchase. Bonus depreciation is a temporary provision that has been repeatedly extended.
Expensing of capital expenditures replaces depreciation deductions over time with an immediate deduction for the full price of a business asset without regard to the useful life of the business asset. The blueprint would exclude land from this treatment.
Under the blueprint, businesses are not given a current deduction for net interest expense, although they are allowed to deduct interest expense against interest income and carry forward net interest expense indefinitely. The idea is that a business that borrows to invest in an asset that is deductible should not also be able to deduct the interest paid on the loan.
The blueprint generally eliminates corporate tax deductions and credits, but allows immediate expensing of business investments. No current deduction for net interest expense is allowed under the blueprint.
The blueprint would remove the section 199 domestic production deduction because the corporate tax rate reduction and border adjustment would provide support for domestic manufacturing. The domestic production deduction is based on the amount of income arising from the disposition of products domestically manufactured, produced, grown, or extracted, including qualified films.
The blueprint would retain the credit for incremental research activity under which qualified research expenses above an amount determined in relation to a business's previous research efforts are allowed as a credit against tax liability rather than a deduction from taxable income. Congress made the research credit permanent at the end of 2015.
The last-in, first-out method of accounting is a way of matching the costs of inventory sold with the items of inventory sold in order to determine the profit on the sale. Under LIFO, whenever an item of inventory is sold, the seller deducts the cost of the most recently acquired or produced item of that inventory.
LIFO is an alternative to tracking the individual costs associated with each item of inventory or to the alternative assumptions of the first-in, first-out method of accounting. LIFO is elective and is considered beneficial when prices are rising because the taxpayer can then generally use the highest cost to reduce taxable income.
Under a territorial tax system, income is taxed only if it is earned within a country’s borders. This contrasts with the United States' current worldwide tax system, which taxes income based on legal domicile (for companies) or citizenship (for individuals), regardless of where it is earned.
The U.S. system does defer tax on some income earned abroad until it is repatriated. Many businesses have recently advocated that the U.S. move to a territorial system, arguing that it would align the U.S. better with the world and make domestic companies more competitive.
With a border adjustment to the destination-based cash flow tax, exported goods are exempt from tax while imported goods sold in the U.S. are subject to tax. In essence, the border adjustment imposes tax depending on where a good is consumed (its destination) rather than where it is produced.
The WTO has rules about when border adjustments are permissible. As a member of the WTO, the United States must comply with its rules or risk a dispute and possible retaliation by trading partners. WTO rules allow border adjustments only on indirect taxes, which includes taxes like sales taxes and VATs. The destination-based cash flow tax is similar to a consumption tax, but it has some elements of a tax on corporate income, which is a direct tax. WTO rules require that the tax rate on imports be no higher than the rate on similar domestic products. The blueprint proposes allowing deductions for salaries and wages paid by domestic companies, which would mean a lower rate on domestic goods. Because the WTO has never ruled on a destination-based cash flow tax, there are still questions about whether it would be deemed compliant if challenged.
Corporate integration attempts to address the double taxation of corporate income by integrating the corporate and individual tax systems so that income is only taxed once. Currently, corporate income may be subject to two levels of taxation – first when the company earns the income, and then again at the shareholder level if the income is paid out as a dividend.
There are multiple ways corporate integration may be accomplished. The Senate Finance Committee is investigating a dividends paid deduction, which would allow a corporation to deduct from its earnings dividends paid to its shareholders, possibly with an accompanying withholding to the shareholders.
A tariff is a duty imposed on imported goods and services that is used to restrict trade. The tariff drives up the price of imported goods and services and causes demand for them to fall.
In contrast, a border adjustment is a combination of an import tax and an export subsidy, both of which are set at the same rate. An import tax in isolation would discourage trade and an export subsidy in isolation would increase trade, but when imposed in concert, the trade effects cancel each other out.
A border tax might be a reference to tariffs or more targeted taxes on corporate behavior, such as moving factories abroad. The border tax may also be incorrect shorthand for the destination-based cash flow tax in the blueprint, which contains border adjustments.
The border adjustments in the blueprint are intended to make the corporate income tax a destination-based tax so that sales to U.S. customers are taxed and sales to foreign customers are exempt. The intention of the blueprint’s plan is to eliminate “the existing self-imposed export penalty and import subsidy” in current law.
Mandatory deemed repatriation involves taxation, typically at a lower rate, of previously deferred offshore earnings of companies, regardless of whether the earnings are actually brought back domestically by the companies. Proposed rates may vary, but one proposal has advocated for two lower rates depending on how the previously untaxed foreign earnings are held (8.75 percent for cash holdings and 3.5 percent for other holdings).
The lockout effect is the negative consequence of a worldwide tax system with deferral. Since foreign earnings are not taxed until they are repatriated, companies have an incentive to keep earnings offshore, so as not to face a large tax when bringing monies back (currently a 35 percent rate). Because of this potential tax bill, companies will often keep foreign earnings offshore, gaining a smaller rate of return, rather than investing domestically.
Some estimates peg the amount of offshore earnings of U.S. companies facing the lockout effect at $2.5 trillion. Lawmakers often look at the large sum as a sign that the U.S. tax system is broken and as an opportunity for revenue if reform can be achieved.
For tax legislation to be revenue neutral, any changes in the tax law must result in no change in the amount of revenue being collected. Since 1986, most tax reform efforts have tried to be revenue neutral, meaning that they will not increase the deficit. Revenue neutrality is a key concept when designing the pay-fors for tax legislation, particularly bills that seek to lower rates and broaden the tax base.
The staff of the Joint Committee on Taxation generally has the task of revenue scoring, including the cost of tax expenditures. JCT scores are key components of any tax legislation and can often determine whether a bill is successful. JCT scores of individual provisions, particularly those that raise revenue, often play a role in determining the pay-fors for nontax legislation. The Urban-Brookings Tax Policy Center and the Tax Foundation also independently score legislation.
The “score” placed on legislation can affect the overall debate over its passage. Historically, legislation has relied on static scoring. Dynamic scoring is a relatively new concept that takes into account the effects that tax law changes may have on macroeconomic variables like employment, gross domestic product, and interest rates. To determine a dynamic score, a static dynamic score is first prepared for proposed legislation. Various economic models are then used to identify any short- or long-term effects on the overall economy, and any budgetary effects. It is important to remember that because of the inherent uncertainty in this type of work, policy analyses like these almost always present a range of possible answers.
As of 2015, House rules mandate the use of dynamic scoring for the estimates of major legislation, defined as any bill with a gross positive or negative revenue impact in any year in excess of 0.25.
Reconciliation is a legislative tool that was established in the Congressional Budget Act of 1974 as a means of balancing the budget. The process permits Congress to conform tax and spending levels to those set in a budget resolution. And, importantly, tax and spending legislation that advances through reconciliation avoids the filibuster and can be passed with only 51 votes in the Senate. Because reconciliation favors a majority party, it has rarely been used for major tax legislation. That said, it was used by the House and Senate in 2010 to pass parts of the Affordable Care Act.
Under section 170 of the Internal Revenue Code, taxpayers who itemize their deductions may reduce their taxable income by the amount they give to charity, thereby making their contributions nontaxable, though there may be some limits depending on the type of contribution.
Groups representing the philanthropic community, such as the Council on Foundations, believe some proposals in the June 2016 tax reform blueprint could cause charitable giving to decline. For example, proposed changes to marginal tax rates could reduce charitable giving incentives for some taxpayers, in particular those with high incomes, according to the council.
Although the blueprint would retain the charitable deduction, it would eliminate other itemized deductions, which could result in fewer itemizers and thus fewer taxpayers using the charitable deduction when making donations, according to charitable giving organizations that also believe that expanding the standard deduction, another blueprint provision, would have a similar effect.
Also, eliminating the estate tax could mean fewer charitable bequests by high-net-worth taxpayers when they die, charitable giving groups say.