Major Tax Issues in the 106th Congress: A Summary

Major Tax Issues in the 106th Congress: A Summary

Order Code IB10013
CRS Issue Brief for Congress
Received through the CRS Web
Major Tax Issues in the 106th Congress:
A Summary
Updated September 21, 2000
Government Finance and Taxation Section
Government and Finance Division
Congressional Research Service ˜ The Library of Congress

CONTENTS
SUMMARY
MOST RECENT DEVELOPMENTS
BACKGROUND AND ANALYSIS
The General Tax Policy Debate
Taxes in 1999
The Debate in 2000
The Economic Context
Federal Tax Burden
Economic Performance
Tax Proposals in 2000
The Death Tax Elimination Act (H.R. 8)
Tax Cuts for Married Couples (H.R. 4810)
Tax Benefits for Education (H.R. 7 and S. 1134)
Taxes and Minimum Wage Legislation (H.R. 3081; S. 625 and H.R. 833)
Proposals in the President’s FY2001 Budget
Legislation in 1999
The Taxpayer Refund and Relief Act of 1999 (H.R. 2488)
A Closer Look at Selected Issues
Marriage Tax Penalties and Bonuses
The Estate Tax
The Alternative Minimum Tax for Individuals
Capital Gains
Tax Treatment of Savings
Tobacco Taxes
Fundamental Tax Reform Proposals (Including Flat Tax Plans)

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Major Tax Issues in the 106th Congress: A Summary
SUMMARY
Taxes have been a major focus of
! H.R. 4865, repealing taxes on
congressional attention during the first half of
Social Security benefits (July
2000. In part, Congress has returned to many
27);
of the issues it addressed last year. In August,
! H.R. 4923, providing tax ben-
1999, Congress passed a set of tax cuts with
efits for economically distres-
the Taxpayer Refund and Relief Act (H.R.
sed communities.
2488; TRRA). However, President Clinton
vetoed the bill, arguing that the cuts were too
For its part, the Senate folded tax cuts
large (an estimated $792 billion over 10 years),
linked to a minimum wage increase into H.R.
would drain funds from Social Security sur-
833, a broad bankruptcy bill. On March 2, the
pluses, and would force reductions in domestic
Senate approved S. 1134, a bill containing a
spending. Early in 2000, Congress signaled its
number of tax benefits for education. On July
intention of revisiting tax cuts with passage on
14, the Senate approved the House-passed
April 13 of a fiscal year (FY) 2001 budget
version of H.R. 8, and on July 17 the Senate
resolution (H.Con.Res. 290) calling for a 5-
approved a tax cut for married couples. On
year tax cut of $175 billion.
September 20, the Senate rejected a confer-
ence report on H.R. 4516, containing repeal of
By the end of August, Congress had
a telephone excise tax and IRS, Treasury, and
addressed many of the same tax cuts that were
legislative branch appropriations.
in the vetoed 1999 omnibus bill, but in a series
of separate bills. The House passed the fol-
On August 5, the President vetoed the
lowing bills:
marriage-penalty bill, maintaining that it is
poorly targeted and too costly. On August 31,
! a tax cut for married couples
the President vetoed H.R. 8, arguing it is
(initially passed February 10;
fiscally irresponsible and not fair. In its own
later included in H.R. 4810);
FY 2001 budget plan, the Administration
! H.R. 3081, a tax cut bill
proposed relatively modest tax cuts targeted at
linked to other legislation
particular areas. The President proposes an
raising the minimum wage
estimated $350 billion of gross tax cuts over
(March 9);
10 years, offset by $182 billion of increases in
! H.R. 4516, repealing the fed-
taxes and fees for a net tax cut of $168 billion
eral tax on telecommunica-
over 10 years. Prominent parts of the pro-
tions (September 14);
posal are a tax benefit for retirement saving,
! H.R. 8, phasing out the estate
expansion of the earned income tax credit,
and gift tax (June 8);
marriage tax penalty relief, child-care tax
! H.R. 1102, a pension reform
incentives, a tax credit for long-term care, tax
bill that includes Individual
benefits for education, and reduction of the
Retirement Account provi-
alternative minimum tax for individuals. The
sions (July 19; later combined
largest single tax increase is an increase in
with debt-reduction measures
tobacco taxes. No action has been taken in
and passed as part of H.R.
Congress on most of the Administration’s
5173);
proposals.
Congressional Research Service ˜ The Library of Congress

MOST RECENT DEVELOPMENTS
During the first part of 2000, Congress has revisited many of the tax cut measures
contained in the Taxpayer Refund and Relief Act of 1999 (H.R. 2488), which Congress
approved in August 1999, but which President Clinton vetoed. The tax cuts, however, have
been considered in a more incremental way, in separate bills more narrow in scope than
H.R. 2488. By mid-July, the House and Senate passed a bill phasing out the estate tax
(H.R. 8), and a measure cutting taxes for married couples (H.R. 4810). However, on August
5 the President vetoed H.R. 4810 and on August 31 he vetoed H.R. 8.
BACKGROUND AND ANALYSIS
The General Tax Policy Debate
Taxes in 1999
Taxes were an important part of the public policy debate in Congress during 1999.
Much of the debate centered on surpluses in the federal budget and on whether or not to use
at least part of the surpluses to finance tax cuts. In 1999, the budget situation was this: there
was an overall surplus in the federal budget for FY1999, but the surplus consisted exclusively
of surpluses in the off-budget accounts – primarily the surplus in the Social Security accounts.
The on-budget accounts remained in deficit in FY1999 but were projected to move into
surplus in FY2000. With its FY2000 budget proposal in February, 1999, the Clinton
Administration proposed to save the surpluses in the Social Security accounts by using them
to pay down the federal debt. At the same time, the President proposed to use the projected
on-budget surpluses to finance a modest tax cut – $327 billion over 10 years – and to provide
added funding for Medicare, defense spending, and a number of other programs.
Congressional Republicans likewise proposed to use the off-budget surpluses to pay
down the federal debt, but proposed using most of the projected on-budget surpluses to
finance a larger tax cut. The congressional budget resolution for FY2000 called for a tax cut
of $792 billion over 10 years. In August, Congress passed the Taxpayer Refund and Relief
Act of 1999 (TRRA; H.R. 2488), which contained the tax cut proposed in the budget
resolution. President Clinton vetoed the bill, stating that the tax cut was too large and
because of its estimated distributional effects.
The Debate in 2000
In 2000, Congress has revisited many of the tax cuts contained in the TRRA, but with
a more incremental approach, passing various parts of the tax cut as stand-alone bills. The
most prominent are a phase-out of the estate and gift tax (H.R. 8, passed by the House on
June 9 and the Senate on July 14) and a tax cut for married couples (H.R. 4810; a conference
report is expected to be considered by the House and Senate on July 20). Other prominent
tax cut bills include:
! a tax cut for small businesses linked to a minimum wage increase (H.R. 3810
in the House, passed on March 9; H.R. 833 in the Senate, passed on
February 1), containing small business tax cuts linked to a minimum wage;
! a pension reform bill that includes provisions that would increase over 3
years annual contribution limits on Individual Retirement Accounts from

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current law’s $2,000 to $5,000 (H.R. 1102, passed by the House on July 19;
later passed again by the House as part of H.R. 5173);
! a measure repealing of the 3% federal telecommunications tax (H.R. 3916;
passed by the House on May 25, approved by the Senate Finance Committee
on June 14. Passed again by the House as part of H.R. 4516, which was
rejected by the Senate on September 20).
Against this background, both the Administration and the Congressional Budget Office
have revised upwards their projections for federal budget surplus expected for both the
current fiscal year and the next 10 years. To a large extent, however, the general debate over
tax policy remains the same as in 1999: how much of the surplus should be used for federal
debt reduction, for spending programs, and for tax cuts? The budget resolution passed by
Congress on April 13 (H.Con.Res. 290) calls for a 5-year tax cut of $175 billion. The
President’s FY2001 budget plan (which has not been adopted) calls for a smaller tax cut of
$168 billion over 10 years. Further, the Administration has objected to many of this year’s
congressional proposals on equity grounds, as well as their cost. The Administration vetoed
both the estate tax bill and the tax cut for married couples, arguing that an insufficient share
of their benefits would accrue to middle- and lower-income persons.

The Economic Context
Many tax issues may concern an interest in reducing the federal tax burden and the desire
to enact tax incentives to promote increased economic growth and savings.
Federal Tax Burden
As a percent of gross domestic product (GDP), federal taxes are at their highest level
since the end of World War II: 20.0%, in fiscal year 1999. This is not a dramatic departure
from past levels; since the mid 1950s, federal taxes as a percentage of GDP have remained
within a range of between 17% and just below 20% of GDP. Growth in the economy
combined with federal legislation to reduce the budget deficit (tax increases in 1990 and
1993) have produced a slight increase in federal revenues as a percentage of GDP over the
last several years. In FY1990, federal taxes accounted for only 18.0% of GDP. Over the
same period, however, the federal budget has improved from a deficit of 3.9% of GDP in
FY1990 to a surplus of 1.4% of GDP in FY1999.
While there have been some fluctuations in the distribution of the federal tax burden over
the last 20 years, the fluctuations have been concentrated at the ends of the income spectrum.
During the 1980s the federal tax burden increased for lower-income families and decreased
for upper income families. This trend was reversed in the 1990s with tax reductions at the
lower end of the income spectrum and tax increases at the upper end of the income spectrum.
Families in the middle income brackets, however, experienced very little change in their
federal tax burdens over this period, despite legislated tax cuts. Some of the benefits of the
tax changes contained in the 1997 Act will not necessarily accrue to middle-income families.
The $500 child tax credit will likely reduce federal taxes for middle income families, but only
those families with qualifying children. The benefits of reductions in the tax on capital gains,
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expanded IRAs, and other savings and investment incentives will tend to accrue to families
at the upper-end of the income spectrum.
For further information, see CRS Report RS20059, The Federal Tax Burden, and CRS
Report RS20087, The Level of Taxes in the United States, 1941-1998.
Economic Performance
Many of the tax proposals being considered in the 106th Congress are intended to boost
long-term growth by increasing private saving and investment, thereby expanding the nation’s
capital stock. It is the impact of these various proposals on saving that is perhaps the most
prominent economic performance issue the proposals present. First, can tax incentives for
saving or tax benefits for investment actually boost the nation’s rate of private saving and
investment? Second, total national saving consists of private saving minus government
borrowing. Thus, is any expansion the proposals may cause in private saving larger than any
increase they also cause in the federal budget deficit (or decrease in the federal budget
surplus)? If provisions actually cause an increase in total national saving, the nation’s capital
stock expands, resulting in higher economic growth. Yet economic analysis is not clear on
whether and by how much private savings responds to tax incentives.
A number of the tax provisions that are being considered provide favorable tax treatment
to particular types of economic activity, extending special tax credits, deductions, or
exclusions to certain activities. In these cases, economic theory suggests that favorable
treatment for the specified activities can distort the economy’s ordinary decision making and
channel more resources into the favored activity than would otherwise occur. Since the
economy’s resources are limited, this also means that resources are simultaneously drawn
away from activities that are not tax-favored. The question that economic analysis pursues
is whether a specific intervention in resource allocation actually improves overall economic
performance.
An important aspect of any tax proposal is its effect on federal revenues and the federal
budget deficit or surplus. Deficit reduction has been a primary focus of budget debates over
the past several years. The effects on federal revenue of several elements of the various tax
proposals have been questioned. For instance, as noted earlier, economic analysis does not
provide clear-cut answers about the extent to which economic activity might increase in
response to tax incentives. As a result, the ultimate revenue effects of broad-based tax cuts
or tax incentives for saving are unclear. In addition, several changes — notably, those
involving IRAs, depreciation, and capital gains — would likely register a much larger revenue
impact a number of years in the future rather than in the near term. Thus, revenue estimates
confined to these proposals’ first few years do not show the potential long-run magnitude of
their revenue loss. Their supporters, however, generally argue that the measures would
stimulate economic growth that would shrink any revenue loss.
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Tax Proposals in 2000
The Death Tax Elimination Act (H.R. 8)
H.R. 8 would phase down, then completely repeal the federal estate and gift tax. The
phase-down would gradually reduce the tax rates currently applicable to estates over the
period 2001-09. Full repeal would become effective in 2010.
In 2010 the bill would also repeal current law’s “step up in basis” available for inherited
assets that have appreciated in value over a decedent’s lifetime. Under current law, when a
person inherits an asset and subsequently sells it, the “basis” of the asset – the amount that
can be deducted from the sales price in calculating capital gains under the income tax – is its
value at the time of death. With two exceptions, H.R. 8 replaces this step up in basis with a
“carryover basis.” That is, when an inherited asset is sold, its basis in the hands of the
beneficiary is the basis it had in the hands of the decedent. The step up in basis is retained for
a decedent’s property up to $1.3 million and to property transferred to a spouse up to $3
million.
H.R. 8 was approved by the House on June 9 and by the Senate on July 14. The
President vetoed the measure on August 31, arguing that it is fiscally irresponsible and not
fair. On September 7, a House vote failed to override the veto. The Joint Committee on
Taxation has estimated the 5-year revenue cost of the bill at $28 billion.
For further information, see CRS Report RS20592: Estate Tax Legislation: A Description
of H.R. 8; and CRS Report RL30600, Estate and gift taxes: economic issues.
Tax Cuts for Married Couples (H.R. 4810)
Congress’s incremental approach to tax cuts in 2000 began with the Marriage Tax
Penalty Relief Act (H.R. 6), a bill whose scope is principally confined to a tax cut for married
couples. H.R. 6 was approved by the full House on February 10. The same bill was again
passed by the House on July 12 as H.R. 4810, the first of two reconciliation bills required by
the FY2001 budget resolution (H.Con.Res. 290)
The House bill takes the same approach to taxes paid by married couples as did the
TRRA. The proposal makes four changes: it provides a standard deduction for married
couples that is twice that of singles; it increases the beginning and end-points of the earned
income tax credit’s phaseout range; and it phases in over 6 years a doubling for married
couples of the width of the lowest (15%) tax bracket; and it repeals restrictions on refundable
personal tax credits under the alternative minimum tax . According to Joint Tax Committee
estimates, the proposal would result in a revenue loss of $182.3 billion over 10 years. (By
comparison, the total net revenue loss estimated for the TRRA was $792 billion over 10
years; President Clinton’s proposal for married couples would reduce revenues by $45
billion.)
On March 30, the Senate Finance Committee approved a bill reducing the marriage
penalty that is estimated to reduce revenues by $247.8 billion over 10 years. The bill contains
the same basic provisions as H.R. 6, but with two additions. The bill would double the width
of the 28% tax bracket for couples, not just the 15% bracket. The bill also would make
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permanent the full creditability of nonrefundable credits against the Alternative Minimum Tax
(AMT) and provides that refundable credits would not be reduced by the AMT. The bill was
approved by the full Senate on July 17 as an amended version of H.R. 4810.
A conference committee version of the bill was approved by the House on July 20 and
the Senate on July 21. As with both the House and Senate bills, the conference bill doubles
the standard deduction for couples; as in the House bill, it increases the beginning and end
points of the Earned Income Tax Credit’s phase-out by $2,000. Both provisions would be
retroactive to January 1, 2000. As with the House bill, the conference measure doubles the
width of the 15% rate bracket for couples, but not that of the 28% bracket. The widening
is phased in over the period 2000-04. The bill also permits nonrefundable credits to offset the
AMT, and, beginning in 2002, provides that the refundable child credit earned income tax
credit are not reduced by the AMT.
On August 5 the President vetoed H.R. 4810, arguing that its revenue cost is too large
and that too large a share of the tax cut would accrue to couples currently receiving a
marriage tax bonus rather than a marriage tax penalty (BNA Daily Tax Report, August 8,
2000, p. G-2).
For further information, see CRS Report RL30419, The Marriage Tax Penalty: An
Overview of the Issues; CRS Report RL30420, Marriage Tax Penalties: Legislative
Proposals in the 106th Congress.
Tax Benefits for Education (H.R. 7 and S. 1134)
On March 2, the Senate approved S. 1134, a bill containing a number of tax benefits for
education. On March 22, the House Committee on Ways and Means approved H.R. 7.
According to news reports, however, consideration of the bill by the full House has been
postponed (BNA Daily Tax Report, March 31, 2000, p. G-9).
Prominent provisions of both bills are an expansion of education savings account
contribution limits to $2,000 from current law’s $500, along with extension of qualified
withdrawals to include primary and secondary school expenses in addition to current-law’s
college costs. Both bills would also expand current law’s qualified tax-favored tuition
programs to include private as well as State institutions and would exclude distributions from
gross income. Both the Ways and Means and Senate bills would repeal the 60-month limit
on student interest deductions; the Ways and Means bill would increase the related income
thresholds for the provision’s phase-out. Both bills would provide a new 4-year expenditure
schedule for school construction bonds under the tax code’s arbitrage rebate rules.
The major difference between the two bills is the presence in the Senate bill of a
permanent exclusion from gross income for employer- provided undergraduate and graduate
education assistance.
According to Joint Tax Committee estimates, the Senate bill would reduce revenues by
$7.7 billion over 5 years and $21.3 billion over 10 years; the Ways and Means bill would
reduce revenue by an estimated $3.8 billion over 5 years and $11.6 billion over 10 years.
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Taxes and Minimum Wage Legislation (H.R. 3081; S. 625 and H.R. 833)
The full Senate and the House Ways and Means Committee each passed bills on
November 9, 1999, that would increase the minimum hourly wage by $1 over 3 years. Both
bills also contained tax provisions designed to reduce business taxes along with the increase
in the minimum wage. On February 1, 2000, the Senate folded the minimum wage and
associated tax provisions of S. 625 into a broad bill relating to bankruptcy, H.R. 833. The
Senate subsequently approved the measure.
On March 9, the full House passed a tax cut bill linked with other legislation increasing
the minimum wage. The bill is patterned after tax cuts approved in November 1999 by the
Ways and Means Committee and that were contained in an earlier version of the minimum
wage bill. The tax cuts were initially passed as part of H.R. 3832, but were then combined
with House-passed minimum wage legislation as part of H.R. 3081. According to Joint Tax
Committee estimates, the tax cuts would reduce revenues by $45.7 billion over 5 years; it
contains no revenue raising offsets. Prominent provisions of the bill include:

! a reduction in estate and gift tax rates (the largest tax cut in the bill; see also,
however, H.R. 8, which would gradually repeal the estate tax);
! an increase in the expensing tax benefit for small business investment to
$30,000, permitting the immediate deduction of amounts that would
otherwise be depreciated over a number of years;
! rescission of the repeal of the installment method of accounting that was
enacted in 1999 as part of the “extenders” bill (H.R. 1180);
! acceleration of the scheduled phase-in of a 100% deduction for the health
insurance costs of self-employed individuals;
! an increase in the portion of business meals that can be deducted; to 60%
from current law’s 50%;
! an increase in contribution limits for qualified pension plans, with other
pension changes; and
! tax benefits directed at economically distressed areas.

The provisions are similar to measures included in the “small business” and “pension”
portions of the vetoed Taxpayer Refund and Relief Act of 1999 (H.R. 2488).
The Senate-passed tax provisions associated with its minimum wage bill are quite similar
to those of the Ways and Means bill, but with a few differences. The Senate bill contains the
same acceleration of the full deductibility of health insurance for the self employed. However,
it also provides for a phased-in, above-the-line deduction for health and long-term-care
insurance for individuals not covered by employment related plans. The Senate bill would
also increase the investment expanding allowance to $30,000 compared to $25,000 under the
Ways and Means Committee bill and would allow 80% of business meals and entertainment
expenses of small businesses to be deductible. It would make the Work Opportunity Tax
Credit permanent. The Senate measure does not contain the estate tax provisions contained
in H.R. 3081. When it was initially passed, the Senate bill contained several items that would
increase revenues. These items – an increase related to installment sales and one for real
estate investment trusts (REITs) – were later enacted with H.R. 1180. According to recent
estimates by the Joint Committee on Taxation, the Senate-passed tax provisions of H.R. 833
would reduce revenue by $25.7 billion over 5 years.
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According to news reports, procedural issues have delayed consideration of the bill by
a conference committee (BNA Daily Tax Report, July 13, 2000, p. G-7). The issues are
related to the Constitution’s requirement that tax bills originate in the House rather than the
Senate; the House version of the bankruptcy bill contains no tax provisions.
The Administration has stated its opposition to the manner in which the Congressional
bills would implement their $1 increase in the minimum wage; the $1 increase would occur
over 3 years, in 3 annual installments. The Administration favors implementing the $1 over
2 years. In addition, the Administration and some Congressional Democrats have voiced
opposition to the minimum wage bill’s tax cuts, arguing they are risky and favor upper-
income individuals. On August 28, 2000, House Speaker Hastert wrote to President Clinton
offering to support an increase in the minimum wage over years while dropping the bill’s
estate tax and pension tax provisions.
Proposals in the President’s FY2001 Budget
On February 7, 2000, the Clinton Administration published details of the tax and other
budget proposals the President had previously outlined in his state of the Union message. In
broad terms, the President proposes gross tax cuts totaling $350 billion over 10 years
(according to Administration estimates), partly offset by revenue-raising measures of $182
billion; the proposed net tax cut is thus an estimated $168 billion over 10 years. In substance,
the tax proposals are selective, for the most part applying to a variety of narrow areas rather
than in an across-the-board fashion. In general, the tax cuts are aimed at particular goals and
activities favored by the Administration. Prominent areas proposed for tax relief include:
married couples, retirement saving, child care, education, long-term care, and persons covered
by the minimum tax. The largest revenue-raising measure is an increase in tobacco taxes.
Other revenue-raising items are small, narrow, and varied, and include a variety of measures
aimed at what the Administration identifies as “unwarranted” tax benefits and corporate tax
shelters. Congress has not taken action on the majority of the President’s proposals.
Legislation in 1999
The Taxpayer Refund and Relief Act of 1999 (H.R. 2488)
The FY2000 budget resolution Congress passed in April 1999 called for a tax cut of
$792 billion over 10 years. On July 22 the House approved a plan (H.R. 2488) to cut taxes
by the $792 billion specified in the budget; the full Senate approved a tax cut bill on July 30.
Like the House bill, the Senate plan proposed to cut taxes by $792 billion, but differed in its
details. On August 4, a conference committee version of the bill was completed, and both the
House and the Senate approved the measure on August 5. However, President Clinton
vetoed the bill on September 23.
Like the House and Senate bills before it, the conference version of H.R. 2488 contained
a tax cut estimated at $792 billion over its first 10 years. A prominent feature of the
conference bill is that a number of its largest provisions -- for example, the rate reductions and
marriage penalty relief -- expire (“sunset”) after 2008. Also, in a provision taken from the
House bill, the conference bill’s rate reductions are contingent on federal debt reduction.
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The centerpiece of H.R. 2488's tax cuts was an across-the-board reduction in individual
tax rates. It provided for each individual income tax rate to be reduced by one percentage
point on a phased-in basis. Thus, for example, the 15% rate was reduced to 14% in 2003 and
thereafter; the remaining rates were scheduled to be reduced in 2005 and thereafter.
Other prominent provisions of H.R. 2488 included:
! Addressing the marriage tax penalty by making the standard deduction for
couples twice that of singles and by increasing the new 14% bracket for
couples to twice that of the singles’ bracket. The bill also addressed the
effect of marriage on the earned income credit by increasing the income
range over which the credit is phased out for joint returns.
! An increase in the rate of the dependent care tax credit.
! A phased-in above-the-line deduction for health insurance expenditures and
long-term care insurance.
! Expansion of tax-favored education savings accounts, including an increase
in the contribution limit and their extension to primary and secondary
education expenses.
! Reductions in capital gains tax rates: the bill cut the current 20% and 10%
rates to 18% and 8%, respectively. Assets were to be indexed for inflation
occurring after 1999.
! Along with other IRA expansions, an increase in allowable annual IRA
contribution limits to $5,000 from current law’s $2,000.

! Gradual repeal of the individual alternative minimum tax.
! Reduction of the corporate alternative minimum tax by repeal of the 90%
limit on foreign tax credits and net operating losses.
! Gradual repeal of the estate and gift tax.
! Permitting U.S.-based multinationals to use so-called “worldwide allocation”
of interest expense in calculating their foreign tax credits.
! Extending a number of expiring tax benefits for varying periods of time.
In addition to its tax cuts, the bill contained a small number of revenue-raising
provisions. The revenue raisers were generally narrow in scope and small in size. While they
were scattered throughout the tax code, they generally would have applied to business and
investment income.
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A Closer Look at Selected Issues
Marriage Tax Penalties and Bonuses
Defining the married couple as a single tax unit, as does the current federal individual
income tax, conflicts with the principle of marriage neutrality. Marriage neutrality means that
the tax system should not influence the choice of individuals with regard to their marital
status. However, under the current federal income tax system, some married couples pay
more income tax than they would as two unmarried singles (a marriage tax penalty) while
other married couples pay less income tax than they would as two unmarried singles (a
marriage tax bonus). A marriage-neutral income tax is an elusive goal. Marriage neutrality
conflicts with two other concepts of equity: progressivity and equal taxation of couples with
equal incomes. Regardless of how these three concepts of equity are juggled, an income tax
can achieve any two of these goals but cannot simultaneously achieve all three.
A number of bills were introduced in the 106th Congress that tried to mitigate marriage
tax penalties. For instance, H.R. 2488, the Taxpayer Refund and Relief Act of 1999,
contained a provision that would have increased the standard deduction for a married couple
filing a joint return to twice the amount of the standard deduction for a single return, doubled
the width of the lowest income tax bracket for married couples, and raised the phase-out
range of the Earned Income Tax Credit for married persons. The President vetoed H.R.
2488, but on February 10, 2000, the House approved H.R. 6, which contained the same basic
marriage provisions as H.R. 2488. Unlike the vetoed bill, however, the scope of H.R. 6 is
confined to a tax cut for married couples. On March 30, the Senate Finance Committee
approved S. 2346, a tax reduction for married couples that is somewhat broader than that in
H.R. 6.
For further information, see CRS Report RL30419, The Marriage Tax Penalty: An
Overview of the Issues; CRS Report RL30420, Marriage Tax Penalties: Legislative
Proposals in the 106th Congress; and, CRS Report RL30485, The Individual Alternative
Minimum Tax: Interaction with Marriage Penalty Relief and Other Tax Cuts.
The Estate Tax
The estate tax was enacted in 1916 as a revenue source for World War I. As with
wealth taxes before it, and like most other taxes, revenue was the primary rationale for the
tax. Why the estate tax rather than other possible sources of revenue? There were essentially
two reasons: first, the estate tax was viewed as a type of fee for the services by the
government in protecting property during lifetime, as well as a fee to cover part of the cost
of probating the estate at death. Also, the estate tax was chosen over other taxes for reasons
of equity and to reduce the concentration of wealth. In 1997, when the exemption was
$600,000, only 3.9% of decedents (90,006 of 2.3 million decedents) left estates large enough
to file a tax return. Further, less than half of those required to file a return (42,901, or 1.9%
of all estates) owed tax.
The federal estate tax is a tax on wealth and as such, it raises some of the same economic
issues as annual wealth taxes, which are economically equivalent to annual capital income
taxes. The accumulation of wealth is, in large part, the result of an individual’s decision to
postpone consumption, to save and accumulate capital during one’s life of work and
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investment, and to take risks. As such the estate tax is a tax on accumulated savings imposed
at the end of one’s life. And the tax is paid out of the economy’s total supply of private
savings — reducing private sector savings and increasing government savings (i.e, tax
revenue). But an important economic question is what is the effect, if any, on the lifetime
savings behavior of individuals? Does the estate tax reduce savings rates? Does the tax
reduce the incentives to accumulate capital? Or do individuals compensate for the tax by
increasing their accumulation of pre-tax wealth such that enough after-tax wealth is
accumulated to bequeath to their heirs? Such might be the case if individuals derive utility
either from the wealth itself, or from their heirs’ (children) welfare, or both. However, there
is no clear answer to these questions.
The estate tax is part of the overall cost of bequeathing wealth to one’s heirs. The
existence of the estate tax is believed to reduce the level of planned bequests. If so, reducing
the estate tax is likely to increase planned bequests, but according to economic theory, the
effect on savings is uncertain. The estate tax does create incentives for lifetime gift giving,
for estate planning, for substantial charitable donations, and for the establishment of trusts.
With federal marginal estate tax rates ranging as high as 55%, significant resources and time
may be expended at minimizing the estate tax burden. And a relatively large estate planning
industry — accountants, lawyers, and financial advisors — is available to wealth holders to
minimize any potential estate tax burden.
One economic effect — the effect on farms and small businesses — has dominated the
recent debate over the estate tax and played a key role in the estate tax cuts enacted as part
of the Taxpayer Relief Act of 1997. The estate tax is imposed on business capital and wealth
— land, equipment, stock, buildings, etc. — in addition to personal wealth. It is argued that
this takes capital out of farms and small businesses, inhibiting their transfer to heirs and
retention in the family; that the tax can cause the break-up or dissolution of family farms and
small business. A sale of the assets to or merger of the enterprise with a large competitor
could reduce market competition and inhibit economic efficiency. These effects were a
principal reason for the 1981 estate tax reductions, and have been a key impetus for most of
the recent proposals to reduce the estate tax. However, the estate tax is only one of many
possible causes for the sale of farm or business assets outside the family at death, and not
always the principal cause.
For further information, see CRS Report RS20592: Estate Tax Legislation: A Description
of H.R. 8; and CRS Report RL30600, Estate and gift taxes: economic issues.
The Alternative Minimum Tax for Individuals
To make sure that every person with significant income pays at least a minimum of taxes
while still preserving the economic and social incentives in the tax code, Congress created,
in 1969, what is now known as the individual alternative minimum tax (AMT). In essence,
the AMT is a tax on the use of tax incentives and preferences and was primarily targeted at
upper-income taxpayers who were thought to overuse these preferences to reduce or
eliminate their regular income tax liabilities. However, since its inception, the value and
effectiveness of the minimum tax has routinely been the subject of congressional debate.
Recently, many analysts have voiced concern over the expected increase in the number of
upper-middle income taxpayers who may be subject to AMT coverage in the near future.
This increase will occur because of the combined effects of inflation and recent legislative
changes to the regular income tax.
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The structural components of the regular income tax are indexed for inflation while the
structural components of the AMT are not. Consequently, the gap between tax liabilities
under the regular income tax and the AMT will shrink over time and many taxpayers could
end up subject to the unindexed AMT or experience reductions in their nonrefundable tax
credits under the regular income tax solely as the result of inflation. The potential problems
of an indexed regular tax and an unindexed AMT have long been recognized by tax analysts.
The Joint Committee on Taxation (JCT) released estimates showing that in 1997,
approximately 605,000 taxpayers were subject to the AMT but that the number of taxpayers
subject to the AMT will increase to around 9.2 million by tax year 2007. These estimates,
however, were made prior to the passage of the Taxpayer Relief Act of 1997. When the
effects of both inflation and the 1997 legislative changes are taken into account, preliminary
estimates indicate that by 2007, the number of taxpayers falling under either the AMT or
AMT limits on their tax credits under the regular income tax will grow to almost 12 million.
In general, nonrefundable personal tax credits under the regular income tax are limited to the
amount by which a taxpayer’s regular income tax liability exceeds his tentative minimum tax.
Hence, even if a taxpayer owes no AMT, the AMT could reduce the value of his
nonrefundable personal tax credits under the regular income tax.
The child tax credit and the HOPE tax credit are the two changes contained in the 1997
act that would have the largest impact in increasing the number of taxpayers subject to the
AMT, either directly or indirectly. Many taxpayers in the upper-middle income ranges likely
will see the value of these two credits reduced or eliminated because of the AMT. The
prospect that the AMT is now going to affect many upper-middle income taxpayers who were
not subject to the tax in the past has prompted some calls in Congress for action to remedy
the situation. Congress did take limited action in 1998 by including a provision in the
Omnibus Consolidated and Emergency Supplemental Appropriations Act (PL. 105-277) that
will mitigate part of the problems with the AMT for tax year 1998. Under this provision,
nonrefundable personal tax credits are fully allowed against a taxpayer’s regular income tax
liability for 1998 even if the credits are in excess of the amount by which the taxpayer’s
regular income tax exceeds the amount of his tentative minimum tax.
In November, 1999, Congress passed H.R. 1180 which extended (along with other
temporary provisions) the full creditability of nonrefundable credits through 2001. As noted
above, the President vetoed H.R. 1180. However, on March 30, 2000, the Senate Finance
Committee passed a bill (S. 2346) that would make permanent the full creditability of
nonrefundable credits against the AMT. The bill would also not reduce refundable credits by
the amount of a taxpayer’s AMT.
For further information, see CRS Report RL30149, The Alternative Minimum Tax for
Individuals and CRS Report RL30485, The Individual Alternative Minimum Tax: Interaction
with Marriage Penalty Relief and Other Tax Cuts.
Capital Gains
Since the enactment of the individual income tax in 1913, the appropriate taxation of
capital gains income has been a perennial topic of debate in Congress. Capital gains income
is often discussed as if it were somehow different from other forms of income. Yet, in
economic terms, capital gains income is essentially no different from any other form of income
from capital, such as interest or dividend income. A capital gain or loss is the result of a sale
or exchange of a capital asset. If the asset is sold for a higher price than its acquisition price,
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then the transaction produces a capital gain. If an asset is sold for a lower price than its
acquisition price, then the transaction produces a capital loss.
Current law’s treatment of capital gains differs from what would occur under a
theoretically pure income tax. Ideally, a tax consistent with a theoretically correct measure
of income would be assessed on real (inflation-adjusted) income when that income accrues
to the taxpayer. Conversely, real losses should be deducted as they accrue to the taxpayer.
In addition, economic theory indicates that any real appreciation in the value of capital assets
given as gifts or bequests should be subject to tax at the time of transfer to the extent it was
not taxed as it accrued. Under the current income tax, however, nominal (non-inflation
adjusted) capital gains income is taxed when it is realized (sold or exchanged) by the taxpayer.
Capital losses (within certain limits) are also deducted on a nominal basis when they are
realized by the taxpayer. Currently, the untaxed appreciation in the value of capital assets
transferred at death is not subject to tax.
Under current law, capital assets are separated into four categories. Assets that have
been held for 12 months or less are considered short-term assets. Assets that have been held
longer than 12 months are considered long-term assets. Collectibles (art work, antiques,
coins, stamps, etc.) are the third category of assets and the fourth category of capital gains
assets includes the portion of gain attributable to previously taken depreciation deductions
on section 1250 property (depreciable real estate). Short-term capital gains are taxed at
regular income tax rates. Long-term capital gains are taxed at a maximum tax rate of 20%.
The tax rate is 10% for long-term gains that would have been taxed at a 15% regular tax rate.
Collectibles held longer than 12 months are taxed at 28%. The un-recaptured section 1250
gain attributable to depreciation deductions is taxed at a maximum tax rate of 25%.
Effective for taxable years beginning in 2001, assets that have been held for at least 5
years and would have been taxed at a 10% tax rate will be taxed at an 8% tax rate. For assets
which are held more than 5 years and whose holding period begins after December 31, 2000,
the maximum tax rate will be 18% rather than 20%. Net capital losses are deductible against
up to $3,000 of ordinary income, that is, non-capital gain income. Any portion of the net loss
in excess of the $3,000 limit can be carried forward and used to offset gains in succeeding tax
years. Excess net losses can be carried forward indefinitely and without limit on the amount
of losses that can be carried forward.
Under current law, taxpayers are allowed to exclude from taxable income up to
$500,000 ($250,000 in the case of single returns) of the gain from the sale of their principal
residences. To qualify the taxpayer must have owned and occupied the residence for at least
2 of the previous 5 years prior to the date of sale. Under current law, capital gains transferred
at time of death are not subject to tax. On transfer at death, the basis of the asset (original
cost plus changes in the value due to improvements or depreciation) is stepped up to the
market value of the asset on the date of death.
For further information, see CRS Report 98-473, Individual Capital Gains Income:
Legislative History; CRS Report 96-769, Capital Gains Taxes: An Overview; and CRS
Report RL30040, Capital Gains Taxes, Innovation and Growth.
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Tax Treatment of Savings
The appropriate tax treatment of saving has been one of the most prominent tax policy
debates in recent decades, continuing into the 106th Congress. It subsumes such topics as
individual retirement accounts (IRAs), capital gains taxes, investment incentives, and
corporate income taxes, to list just a few of its particular incarnations. The issue of savings
has links to both economic performance and equity, which has helped make it controversial.
An increased saving rate generally increases the country’s capital stock, which in turn makes
possible higher economic growth and a higher standard of living in the future. If tax
incentives can boost saving, targeted tax cuts may thus be able to boost economic growth.
On the other hand, income from investments is a higher proportion of income at higher
income levels; tax benefits for saving thus reduce the progressivity of the tax system.
Economics suggests that the efficacy of tax incentives for saving depends heavily on how
responsive individuals’ savings rates are to changes in the rate of return to saving, after taxes.
If individuals respond to tax incentives by increasing their saving, tax benefits may be an
effective tool for increasing economic growth. On the other hand, if saving is unresponsive
to targeted tax cuts, their efficacy is questionable. Unhelpfully, economic theory provides no
clear answer and instead identifies two countervailing effects of tax incentives for saving.
One effect (known as the substitution effect) leads individuals to save more because the
aftertax rate of return has increased; a second effect (the income effect) works in the opposite
direction, because a tax cut enables an individual to reach a given savings target with a lower
savings rate.
The ambiguity of economic theory in this case passes the burden of proof to empirical
evidence, and there have indeed been a plentitude of statistical studies. But taken as a group,
these studies too produce no clear answer; some find a positive and significant relationship
between tax incentives and saving — that is, they find that targeted tax cuts increase saving.
Other studies find no relationship, and still others find a negative relationship. Thus, the
impact of taxes on saving is unproved. However, even if individuals were to respond
positively to savings incentives, that does not necessarily mean incentives are good economic
policy. First, what matters for economic growth is not simply private saving but national
saving — that is, the private saving rate minus any government dissaving by means of a
budget deficit. Thus, the effect of tax cuts for saving in reducing government tax revenue
may at least partly offset any positive effect they may have on private saving. Second, even
though increased saving produces higher standards of living in the future, a tax-induced
distortion that increases saving may not actually increase economic welfare. Absent market
failures, economic theory suggests a tax is more efficient the less it changes behavior. And
if saving is unresponsive to tax changes, it may be less damaging to economic welfare than
alternative sources of tax revenue. Again, however, evidence on the responsiveness of saving
is conflicting. Indeed, this summarizes what economics has to say about tax incentives for
saving: theory and evidence on the efficacy of savings incentives is ambiguous and conflicting.
Tax benefits for saving in the current tax code are numerous. Among the most
prominent are Individual Retirement Account (IRAs), 401(k) retirement savings plans and
other qualified employer-sponsored retirement plans, life insurance policies and annuities,
qualified state tuition programs, and medical savings accounts (MSAs). In addition, the
favorable tax treatment of owner-occupied housing can be thought of as a saving incentive,
as can the reduced tax rates for capital gains under the individual income tax.
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For further information, see CRS Report RL30255. Individual Retirement Accounts
(IRAs): Issues, Proposed Expansion and Universal Savings Accounts (USAs)
Tobacco Taxes
The Balanced Budget Act of 1997 (the BBA; PL. 105-33) provided a substantial
increase in the federal excise tax on tobacco products. Beginning in 2000, the BBA provided
a 10-cent per pack increase in the federal excise tax on cigarettes, thus raising the tax from
prior law’s 24 cents per pack to 34 cents; the act increased taxes on other tobacco products
— for example, cigars, chewing tobacco, snuff, and pipe tobacco — by the same proportion.
Effective in 2002, the BBA scheduled an increase in the tax by an additional 5 cents per pack,
and a proportional increase in the other tobacco taxes.
A tentative tobacco settlement plan negotiated between the states and the tobacco
industry, which would provide limits on future lawsuits in exchange for payments and other
restrictions on the industry, led to a number of legislative proposals in the 105th Congress,
including implementation of a tobacco settlement under federal law with a per pack fee similar
to an excise tax. The Administration also proposed to raise $65.5 billion in revenue over 5
years (without specifying the exact collection method), amounting to about 54 cents per pack.
The tobacco bill was not adopted. On November 17, 1998, the tobacco companies reached
an independent agreement with most states for payments that amount to about 35 cents per
pack. President Clinton proposed a substantial increase in the cigarette tax in both his
FY2000 and FY2001 budgets. The proposal has not been adopted.
For further information, see CRS Report 98-84, Tax Deductibility and the Proposed
Tobacco Settlement.
Fundamental Tax Reform Proposals (Including Flat Tax Plans)
The idea of replacing our current income tax system with a “flat-rate tax” is receiving
renewed congressional interest. Although often referred to as “flat-rate taxes,” many of the
current proposals (introduced in the 104th, 105th, or 106th Congresses) go much further than
merely adopting a flat-rate tax structure. Some involve significant income tax base-
broadening while others entail changing the tax base from income to consumption. Most of
the recent tax reform proposals (the Armey, Shelby, Domenici/Nunn, English, Specter,
Lugar, Tauzin, Linder, Souder, Gramm, Faircloth, and Largent/Hutchinson plans) would
change the tax base from income to consumption. Others are not consumption tax proposals.
Representative Gephardt would keep income as the tax base but broaden the base and lower
the tax rates. Representative Crane’s proposal would levy a tax on the earned income of each
individual as a replacement for the current individual income tax, corporate income tax, and
estate and gift taxes. Former Representative Snowbarger’s proposal would permit each
taxpayer to choose between the current individual income tax return and an alternative
individual tax return with a flat rate. Senator Dorgan’s proposal would allow most taxpayers
to choose between the current individual tax system and his “shortcut” tax plan under which
taxes withheld would equal the employee’s tax liability.
The flat tax controversy has focused on shifting from the present system, which is
predominantly an income tax system, to a consumption tax system as a way to raise the
savings rate, improve economic efficiency, and simplify the tax system. There is, however,
no conclusive empirical evidence that a consumption tax will or will not increase the personal
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savings rate and consequently the level of national savings. Highly stylized life-cycle models
show that a consumption tax would cause a substantial increase in the savings rate, but these
models are controversial because of their idealized assumptions. To raise the same amount
of tax revenue, a consumption-based tax would require higher marginal tax rates than would
an income tax (since consumption is smaller than income). Distortions caused by these higher
marginal rates could offset (or even exceed) other advantages of the consumption tax. Hence,
whether an income tax system or a consumption tax system is more efficient is unknown.
Proponents of some flat tax proposals argue that integration of the current corporate and
individual income taxes as well as simple returns would result from a consumption tax. The
current income tax system is complex. The federal tax code and the federal tax regulations
are lengthy and continue to expand. However, in tax year 1996, approximately 70% of
individual taxpayers took the standard deduction, which made complexity less relevant.
Finally, some argue that it is unfair to compare the current income tax system with an
uncomplicated, “pure” consumption tax that could become complicated by the time it is
enacted.
It has been argued that some flat tax proposals would reduce the balance-of-trade deficit
since imports would be taxed but the tax would be rebatable on exports. Economic theory,
however, suggests that border tax adjustments have no effect on the balance-of-trade because
the balance-of-trade is a function of international capital flows; border tax adjustments would
be offset by exchange rate adjustments.
The United States is the only developed country without a broad-based consumption tax
at the national level. Other developed nations have adopted broad-based consumption taxes,
but as adjuncts rather than as replacements for their income based taxes.
For further information, see CRS Issue Brief IB95060, Flat Tax Proposals: An Overview.
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