1. Alan Cole and Stephen Entin Tax Foundation June 2, 2017
The Economics of Tax Policy and How to Think About Tax Reform Tax Foundation University 2017, Part 1
Alan Cole and Stephen Entin
Tax Foundation
June 2, 2017

2. The Current Tax System

3. U.S. Federal Revenue as a Percentage of GDP (1929-2015)

4. Composition of Federal Revenue (1935-2020, Projected)
Income Taxes Illustrated p. 3

5. The Majority of Companies in the U. S
The Majority of Companies in the U.S. are Pass-Through Businesses Share of Private Business Establishments by Form, 2014
Source: Census County Business Patterns (2014) and Non-Employer Statistics (2014)

6. Pass-Through Businesses Now Earn More Income Than C Corporations Net Income (Less Deficit) of U.S. Businesses, by Form, Thousands of 2015 Dollars
Source: IRS, Statistics of Income, Integrated Business Data

7. Individual Income Tax Key Elements and Structures
Kinds of Income less
Adjustments (certain expenses) =
AGI less
Deductions (itemized or standard) =
Taxable Income times array of
Marginal Tax Rates less
Credits (refundable or non-refundable) =
Tax which may be more or less
Progressive

8. Types of Income

9. Sources of Income

10. Above-the-line Deductions and Adjusted Gross Income

11. Personal Exemption
Reduces taxable income by $4,050 per person claimed in 2017 (indexed).
Phased out between AGIs of $261,500 and $384,000 for single filers;
Between $313,800 and $436,300 for married taxpayers; and
Between $287,650 and $410,150 for heads of household.
Raises marginal tax rates roughly 1.1 percentage point per exemption in phase-out range.

12. Standard Deduction Amounts, 2017 (indexed)
Single filers $ 6,350 Joint filers $12,700 Head of household $ 9,350
Percent of households claiming the standard deduction in 2014: %

13. Itemized Deductions
Mortgage Interest (on up to mortgage balance of $1 million)
State and Local Taxes Paid
Charitable Contributions
Misc. itemized business expenses (over 2% of AGI) and medical expenses (over 10% of AGI)
Raises marginal tax rates roughly 1.1 to 1.3 percentage points in phase-out range.

17. Qualified Capital Gains and Dividends
Top U.S. marginal rate of 23.8 percent at federal level also applies to “qualified dividends” subject to corporate tax.
Lower rate designed to partly mitigate double taxation of corporate earnings compared to pass-through earnings taxed once.

18. Tax Credits
Credits reduce tax burden, dollar for dollar. A $500 tax credit reduces tax burden by $500.
Some credits are “refundable,” which means that they can create a negative tax burden.
The two largest tax credits, both of which are at least partially refundable, are the Earned Income Tax Credit and the Child Tax Credit.

19. Income Tax Progressivity

20. Where Income Tax Revenues Come From

21. Payroll Tax Structure Imposed equally on employers and employees.
6.2 percent for OASDI (up to $127,200 in 2017, indexed by ave. wage growth – up from $118,500 in 2016 and 2015). Combined rate 12.4 percent.
1.45 percent base rate for Medicare, no income cap. Combined rate is 2.9 percent. (Add 0.9 percent surtax on wages > $200,000 single or HoH, $250,000 joint, for a total of 3.8 percent).
Total combined base rate is 15.3 percent (or 19.1 percent with add-on surtax).
Larger than income tax burden for most taxpayers.
Raises 2/3 of the revenue of the individual income tax.

22. Overall Tax Progressivity

23. Estate and Gift Taxes
Lifetime estate and gift tax exemption of $5.49 million (2017) (indexed).
Rate of 40 percent
4th highest in the OECD; 15 of 34 countries in the OECD have no estate or inheritance tax.
Gift tax exempt amount $14,000 per donor per recipient. Excess counts against lifetime exemption.

24. Corporate Income Tax Structure
Revenue minus expenses.
Expenses include employee compensation and business inputs.
Interest paid is deductible, but dividends paid are not.
Capital expenditures are deductible on depreciation schedules (except for modest amounts of small business expensing).
Graduated rates quickly reach 35%.

25. Excise Taxes and Fees Gasoline Airport passenger taxes
Guns and archery equipment
Tobacco
Alcohol
Misc. (e.g. LUST, phone, waterways fees)

26. Reasons for Reform
The current tax system: Distorts economic activity; Depresses total income and employment; Hides the cost of government; Is complex, expensive to comply with, enforce; Is subject to abuse by tax payers and IRS; Is viewed as "unfair" (definitions vary).

28. A Sense of Urgency LOST OUTPUT:
We are about 17% below trend growth. We will not recover without tax and regulatory reform.
That’s losing the equivalent of 5 years’ total GDP.
A full-blown tax reform could add 9%-10% to potential output, and return labor force participation to normal.
RISKING RECESSION:
The current expansion, as weak as it has been, is getting old. Investment is faltering. We should not engage in short run pump-priming, but permanent reform for the long run would also help stave off short run issues with growth.

29. The Tax Code is Over 10 Million Words Long Number of Words in the Internal Revenue Code and Title 26 of the Code of Regulations
Source: Government Printing Office (2005, 2015); West Publishing Company ( ).

30. OECD Revenues as a Percentage of GDP (2012)

31. US Sources of Revenue Compared to OECD Average
Income Taxes Illustrated p. 36

32. The U.S. Corporate Tax Rate is the Highest in the Developed World Top Statutory Corporate Tax Rate by OECD Country, 2014
Source: OECD Tax Database, Table II.1

33. Corporate Tax Rates Around the World Have Declined, While the U. S
Corporate Tax Rates Around the World Have Declined, While the U.S. Has Stayed the Same
Source: Tax Foundation; Calculations based on data from the World Bank, OECD, KPMG, Deloitte, and PwC.

34. Impact of High U.S. Corporate Tax Rate
High rate discourages capital formation in U.S.
Taxes on capital are largely shifted to labor.
If U.S. taxes on capital force capital abroad, U.S. workers suffer, foreign workers gain.
More likely, U.S. taxes on capital merely reduce capital here; we lose, no one gains.
High rate encourages shifting reported profit abroad to lower-taxed jurisdictions.

35. Global Versus Territorial Taxation
Global: U.S. taxes firms on their domestic income and the earnings of their foreign subsidiaries, then gives a tax credit for foreign taxes paid. But the foreign tax is deferred until the parent repatriates the earnings (deferral of foreign source income). Earnings of U.S. workers abroad above an exempt amount get similar treatment but with no deferral.
Territorial: Almost all other countries tax business activity or workers’ earnings within their borders, and not the earnings of their businesses’ foreign subsidiaries or wages earned abroad. This gives foreign firms a competitive advantage vs. U.S. firms trying to operate internationally.

36. Designing Tax Reform
Selecting the type of tax (deciding on rates, base, other features) with an eye toward
Meeting revenue, growth, distribution goals, facilitated by carefully
Estimating outcomes via static and dynamic analysis and scoring, to facilitate
Navigating the Budget Process while
Explaining it all to the public.

37. Tax Expenditures

38. Individual Tax Expenditures are about Saving, Health, and Housing

39. Budget Rules Reconciliation vs. Normal Order
Byrd rule impediments in the Senate
Sunsetting vs. finding alternative revenues beyond the budget window.
Cutting spending.
Redefining the window.

40. Knowing the Growth and Budget Outcomes of Various Tax Provisions Inside and Outside the Budget Window

41. The Triangle of Tax Reform Tradeoffs

42. Different Tax Cuts Deliver Different “Bang for Your Buck” in Terms of
DYNAMIC REVENUES AND GDP
Billions 2013 Dollars
New $1,000
Child Tax
Credit without phase-out
Cut bottom Federal PIT rate from 10% to 3.5%
Cut top three Federal PIT rates to 29.2%
Cut corporate tax rate from
35% to 24%
Move to Full Expensing
Source: Tax Foundation TAG Model

43. Full Expensing Would Lead to Economic Growth Static and Dynamic Revenue Estimates of Immediate Expensing of Capital Investment
Source: Tax Foundation Taxes and Growth Model (Oct. 2016)

45. A Corporate Rate Cut Would Lift GDP Static and Dynamic Revenue Estimates of a 20% Corporate Tax Rate
Source: Tax Foundation Taxes and Growth Model (Oct. 2016)