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 circumvention. In this blog, we feature a selection of policy proposals from the Hamilton Project's 2020 book, titled Tackling Tax Law: Efficient and Equitable Ways to Increase Income. These proposed reforms address several broad areas of our tax legislation, including transfers and gifts, individual income, multinational business income and tax enforcement.
Equal conditions of competition between inherited income and income from work 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 sustaining this trend. For example, inherited income is a major determinant of a child's economic future. However, this income is taxed at less than one seventh the average tax rate on income from work and savings. To overcome these differences, Lily Batchelder (New York University) proposes several reforms of the current taxation on estates and gifts.
In particular, Batchelder proposes repealing the current estate and gift taxes and instead taxing the inheritances that an inheritance receives and that exceed a lifelong exemption level as regular income. The proposal includes estimates for exemption levels between $ 500,000 and $ 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 that are above an exemption level. In contrast, current law allows both the donor and the heir to avoid paying taxes on capital gains made at the time of the transfer. The asset is essentially treated as new (a tax rule known as an elevated base) and the transfer is subject solely to estate tax, the level of which has decreased significantly in recent decades, and only applies to the portion of a deceased's entire estate ( if all) that exceed very high thresholds.
By only taxing people who receive inheritances that exceed very high levels of exemption, the proposal would both increase revenue and lead to a more equitable distribution of taxes. The proposal also promotes efficiency and economic growth by limiting unproductive tax planning and reducing distortions in labor markets and capital allocation. In 2019, the Urban-Brookings Tax Policy Center estimated the proposal would raise $ 1.4 trillion over the next decade if the lifetime exemption was set at $ 500,000 and $ 340 billion if the Exemption would be $ 2.5 million.
Taxing Multinational Corporations in the 21st Century by Kimberly Clausing
Current tax law increases too little corporate tax revenue and creates incentives for multinational corporations to legally avoid paying US taxes on their profits. Changes to Public Law 115-97, which took effect in 2017 and are commonly known as the Tax Cuts and Jobs Act (TCJA), have lowered the corporate tax rate to 21 percent, leaving essentially intact loopholes in tax law that allow businesses to shift their profits to other countries. The result was hundreds of billions of dollars in lost corporate tax revenue. Kimberly Clausing (now Assistant Assistant Secretary of Tax Analysis at the Treasury Department, previously at the University of California at Los Angeles) proposes several changes that would increase corporate tax revenues and limit the ability of companies to shift profits overseas while preserving the US Competitiveness. Using 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 increase the corporate rate from 21 percent to 28 percent. This change would generate significant revenue, but would keep the US as an attractive investment location. As evidence of this, Clausing points out that in 2017, when the corporate tax rate was 35 percent higher, the world's largest companies were disproportionately based in the United States.
Second, Clausing's proposal would make several changes to increase taxes on profits that companies under current law have tried to relocate abroad. The proposal would move to taxing foreign profits at a higher minimum tax by applying the global minimum tax on low intangible tax income (GILTI) on a country basis at a rate of 21 percent. According to current law, GILTI is taxed worldwide. This means multinational corporations can minimize their tax burden by mixing flows of low-taxed foreign income with flows of higher-taxed foreign income that offer offsetting tax credits, with the entire foreign amount then taxed at a 50 percent discount on corporate income is earned in the US is taxed. In addition, the proposal would remove the provision under current law that the first 10 percent of the return on foreign assets is tax-free. The result would significantly reduce profit shifting and generate significant revenue. As an alternative to the country base, Clausing offers another option with which the GILTI tax rate can be increased so that it corresponds to the domestic corporate tax rate.
The third proposal removes the deduction for intangible income from abroad, which served as a tax preference for profits from export sales. Under current law, this deduction, coupled with the GILTI, is 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
The need for federal spending will increase due to government policies and underlying economic forces such as the aging of the population, the rising cost of certain government-funded services such as health care, and inequality. To meet these demands, authors 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) suggest two – A multiple approach to incremental and pragmatic revenue growth: 1) preventing illegal tax evasion; and 2) reducing statutory tax avoidance by broadening the tax base and filling the loopholes that enable many of the wealthiest people to reduce their tax liabilities.
To prevent illegal tax evasion, Sarin, Summers, and Kupferberg suggest investing more in the Internal Revenue Service (IRS) to improve tax compliance. In particular, they suggest: allocating more resources to increasing and better targeting tax auditing efforts, especially against the very rich; Investing in information technology infrastructure so the IRS can better spot erroneous returns; and encourage greater bipartisan reporting to verify that all income is reported and that tax liabilities are appropriately valued. Given that tax violations are more common among the wealthiest actors (since 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), only the IRS will improved skills would have a progressive impact on taxation.
To expand the tax base and fill in gaps that allow the rich to reduce their tax liabilities, the authors propose a number of reforms, including: removing certain corporate tax havens and deterring companies from shifting profits overseas; Closing individual tax havens such as the wage tax loophole, which enables S company owners to reduce or avoid wage tax liability by classifying income as “corporate profits” rather than “wage income”; Increase tax rates on capital gains and dividends to the same level as ordinary income; Change in tax on capital gains from estates as proposed by Batchelder above; and limiting tax deductions for the rich.
Overall, these reforms would effectively increase taxes for the richest people and create a more efficient and progressive tax system. Using pre-pandemic economic projections, the authors estimated that their proposal would raise more than $ 4 trillion by 2020 to 2029, including $ 1 trillion in increased revenue from improving tax compliance.
With the rising inequality of wealth exacerbated by the COVID-19 pandemic and various unmet needs, policymakers need to find ways to generate more income fairly and efficiently. For more suggestions on increasing income from wealth, financial transactions, business, and consumption taxation, as well as more information on the suggestions discussed here, see the Hamilton Project's March 2020 book on Combating Tax Law: Efficient and Equitable Ways to Increase Income.