introduction
As the United States rebuilds its economy after the pandemic, policymakers are considering various tax reforms that would increase revenue, reduce inequality, and minimize avoidance and evasion. In this blog, we highlight a selection of policy proposals from The Hamilton Project 2020 book, Tackling the Tax Code: Efficient and Equitable Ways to Raise Revenue. These proposed reforms address several large areas of our tax code, including transfers and gifts, individual income, multinational corporate income, and tax enforcement.
Compensation of the playing field between inherited income and earned income through an inheritance tax by Lily Batchelder
In the past few decades, economic inequality – whether measured by income or wealth – has increased in the United States. In addition, the United States has comparatively less economic mobility between generations among high-income countries, and some aspects of the country’s tax laws play a key role in perpetuating this trend. For example, inherited income is a key factor in a child’s economic future, but is taxed at less than a seventh of the average tax rate on income from work and savings. To counteract these differences, Lily Batchelder (New York University) proposes several reforms of the current taxation of bequests and gifts.
In particular, Batchelder proposes repealing the current inheritance and gift taxes and instead taxing inheritance received by an inheritance that exceeds a lifelong allowance as regular income; the proposal shows estimates for allowances of $ 500,000 to $ 2.5 million per inheritance. In addition, if the gift or legacy contains assets that reflect capital gains, Batchelder will propose taxes on any accrued gains in excess of an allowance. In contrast, under applicable law, both the donor and the heir can avoid taxes on the capital gains made at the time of the transfer. The property is essentially treated as new (a tax rule known as the top-up base) and the transfer is subject only to inheritance tax, which has decreased significantly in size over the past few decades and only applies to the portion of a testator’s total estate (if all) that exceed very high thresholds.
By only taxing individuals who receive inheritances in excess of very high allowances, the proposal would both increase revenue and lead to a more equitable distribution of taxes. In addition, by reducing unproductive tax planning and reducing distortions in labor markets and capital allocation, the proposal also promotes efficiency and economic growth. In 2019, the Urban-Brookings Tax Policy Center estimated that the proposal would gross $ 1.4 trillion over the next decade if the lifetime exemption was set to $ 500,000 and $ 340 billion at $ 2.5 million US dollars would be priced.
Taxing Multinational Corporations in the 21st Century by Kimberly Clausing
Current tax laws result in low corporate tax revenues and create incentives for multinational corporations to legally evade paying US taxes on their profits. Public Law Amendments 115-97, enacted in 2017, commonly known as the Tax Cuts and Jobs Act (TCJA), lowered the corporate tax rate to 21 percent and essentially left loopholes in tax law that allow companies to transfer their profits to other countries . The result was hundreds of billions of dollars in lost corporate tax revenue. Kimberly Clausing (now Deputy Assistant Secretary of Tax Analysis at the Treasury Department, previously at the University of California, Los Angeles) proposes several changes that would increase corporate tax revenues and limit the ability of businesses to move profits overseas while maintaining US competitiveness. Based on pre-pandemic economic projections, these reforms would generate an estimated $ 1.4 trillion in tax revenue from 2021 to 2030.
First, Clausing’s proposal would raise the corporate tax rate from 21 percent to 28 percent. This change would generate significant revenue but keep the US an attractive place to invest. As evidence of this, Clausing points out that in 2017, when the corporate tax rate was 35 percent higher, the largest companies worldwide were disproportionately based in the USA.
Second, Clausing’s proposal would make several changes to increase taxes on profits that companies wanted to relocate overseas under current law. The proposal would move to taxing foreign profits at a higher minimum tax by applying the global minimum tax on intangible low taxed income (GILTI) per country at a rate of 21 percent. GILTI is taxed worldwide according to current law. That means multinational corporations can minimize their tax burden by mixing streams of low-taxed foreign income with streams of higher-taxed foreign income that offer tax credits, with the entire foreign amount then taxed at a 50 percent discount on corporate income earned in the US is taxed. In addition, the proposal would remove the provision in current law that allows the first 10 percent of the return on foreign assets to be tax-exempt. The result would greatly reduce profit shifting and increase significant revenue. As an alternative to the country base, Clausing offers another option to raise the GILTI tax rate to the domestic corporate tax rate.
The third proposal removes the deduction for foreign intangible income that was used as a tax advantage on profits from export sales. Under current law, this deduction, coupled with the GILTI, creates an incentive to offshoring and does little to encourage multinational corporations to move assets to the US
Tax reform for progressiveness: a pragmatic approach by Natasha Sarin, Lawrence Summers, and Joe Kupferberg
Federal spending needs will increase due to government policies and underlying economic forces such as an aging population, the rising cost of certain government-funded services such as health care, and inequality. To meet these needs, authors suggest Natasha Sarin (now Deputy Assistant Secretary for Economic Policy at the Treasury Department, previously at the University of Pennsylvania), Lawrence Summers (Harvard University) and Joe Kupferberg (Harvard University and University of Pennsylvania) Two approaches to increasing revenue progressively and pragmatically: 1) preventing illegal tax evasion and 2) reducing legal tax avoidance by broadening the tax base and closing loopholes that enable many of the wealthiest individuals to reduce their tax debts.
To prevent illegal tax evasion, Sarin, Summers, and Kupferberg suggest higher investments in the Internal Revenue Service (IRS) to be used for better tax compliance. Specifically, they propose: Providing more resources to increase and better target tax auditing efforts, especially towards the very wealthy; Investing in IT infrastructure so the IRS can better spot erroneous returns; and encourage greater bipartisan reporting to ensure that all income is reported and tax liabilities are appropriately valued. Given that tax violations are more common among the wealthiest applicants (because their sources of income, such as investment income, are the most opaque and therefore less likely to be reported and taxed honestly, especially when compared to wages and salaries), simply improve upon the IRS Efficiency would have a progressive impact on taxation.
To expand the tax base and close loopholes that allow the rich to reduce their tax debts, the authors propose a number of reforms, including: eliminating certain corporate tax evasions and discouraging companies from relocating profits abroad; Closure of individual tax havens such as the wage tax loop that allows S company owners to reduce or avoid wage tax liability by categorizing income as “corporate profits” rather than “wage income”; Raising tax rates on capital gains and dividends to the level of ordinary income; Change in tax on capital gains in bequests as proposed by Batchelder above; and limiting tax deductions for the rich.
Overall, these reforms would effectively increase taxes for the wealthiest and create a more efficient and progressive tax system. Using pre-pandemic economic projections, the authors estimated their proposal would raise more than $ 4 trillion by 2020 to 2029, including $ 1 trillion more revenue from improved tax compliance.
Conclusion
Given the growing wealth inequality exacerbated by the COVID-19 pandemic and various unmet needs, policymakers need to find ways to generate more revenue both fairly and efficiently. For more revenue-boosting suggestions on wealth, financial transactions, business, and consumption taxation – and more information on the suggestions discussed here – see the Hamilton Project’s March 2020 book Tackling the Tax Code: Efficient and Equitable Ways to Raise Revenue.