The State of Federal Tax Reform

Am I alone in pondering whether significant tax reform can be accomplished without significant budget reform and bipartisan agreement having some relationship to a bell-curve determined by the moderate center from both major political parties on spending priorities? Merriam-Webster defines a “budget” to be “a plan used to decide the amount of money that can be spent and how it will be spent.” By definition, a budget requires that there be a source of revenue available for the money that is to be spent.

The revenue source for the U.S. budget is comprised mainly from corporate income taxes, individual income taxes and social security taxes. Table 2.1 from the Federal Office of Management and Budget shows that for 2016, there was approximately $3.267 trillion of total receipts as follows:

Individual Income Taxes $1.546 trillion 47.3%
Corporate Income Taxes $0.300 trillion 9.2%
Social Security Taxes $1.115 trillion 34.1%
Excise Taxes and OTher $0.307 trillion 9.4

Spending was $3.853 trillion leaving a budget deficit of $585 billion in 2016.

Democrats don’t often agree with Republicans, while Republicans don’t often agree with other Republicans and/or the Administration, on how to reconfigure a tax system when businesses and individuals are hesitant to give up tax benefits favorably affecting them. In the various tax reform proposals that have been floated, there appears to be clear winners (pay less tax) and losers (pay more tax); the losers then often advocate for the status quo or press for a different proposal, since that is preferable to any potential negative impact. Is it surprising then to observe that efforts by the Republican Party to enact some type of meaningful tax reform might be faltering?

Slicing the revenue pie into source streams is what is driving tax reform. Finding the optimal allocation is extremely difficult, to be sure. However, it is clear according to the above chart that the major source of revenue comes directly from individuals in the form of income taxes and half of Social Security taxes assessed on their salaries and wages. Query then whether that total source of revenue will change significantly in the future (and will politicians ever be brave enough to address social security reform)?

For example, one bold income tax proposal was made in an effort to move the U.S. tax system from an origin based tax system to a more destination based system and is known as the Border Adjustment Tax (BAT); this proposal would result in a higher tax on imported products while exports would be exempt from tax. Proponents argue that this would benefit U.S. based manufacturing. However, large retailers such as Walmart and Target have strongly expressed their view that this tax would hurt consumers (along with themselves). The revenue target of the BAT is that it will raise $1 trillion over 10 years. It’s been estimated that the proposed revenue increase from BAT could offset revenue losses from a proposed reduction in the highest corporate tax rate to 25% from 35% (though President Trump is advocating for a 15% corporate tax rate and House Republicans are advocating for a 20% rate). These two proposed corporate tax law changes when combined are estimated to leave the total revenue raised from corporations unchanged. The rate reduction change might not be able to happen without some form of revenue-generating policy change, such as the BAT, and the status of tax rate reduction proposal that is favored by most parties involved is not clear.

Another idea that appeared to not gain much immediate traction was a proposal to limit the tax-favored status of employer-offered health insurance, which is not taxed to employees; it is a fringe benefit for which an employer obtains a deduction, but the benefit of which accrues to the employee without the imposition of tax. Does this proposal have any realistic possibility of passing if there was reduction in tax rates that, according to some, benefits “only the wealthy?”

Where do you stand on the above issues? What is your neighbor’s view? If it is different than yours, can the difference be resolved? If the differences resulting from various tax reform proposals cannot be resolved, will the status quo be the winner by default? Stay tuned!