Major Tax Issues in the 108th Congress

Major Tax Issues in the 108th Congress

Order Code IB10110
CRS Issue Brief for Congress
Received through the CRS Web
Major Tax Issues
in the 108th Congress
Updated December 2, 2004
David L. Brumbaugh, Coordinator
Government and Finance Division
Congressional Research Service ˜ The Library of Congress

CONTENTS
SUMMARY
MOST RECENT DEVELOPMENTS
BACKGROUND AND ANALYSIS
The Economic Context
The State of the Economy
The Federal Budget
The Federal Tax Burden
Tax Legislation Enacted in 2004
President Bush’s FY2005 Budget Proposal
Working Families Tax Relief Act (H.R. 1308; P.L. 108-311)
The American Jobs Creation Act (H.R. 4520; P.L. 108-357)
Tax Legislation in 2003
The 2003 Tax Cut: The Jobs and Growth Tax Relief Reconciliation Act (JGTRRA)
The Policy Debate
Selected Issues
Expiration of the 2001 Tax Act and its Acceleration by JGTRRA
Deductibility of State and Local Sales Tax
Tax Cuts for Economic Stimulus
International Taxation
Other Tax Issues
Fundamental Tax Reform
Business Taxation
Small Business Taxation
Family Tax Issues
Estate Tax
Individual Alternative Minimum Tax (AMT)
Expiring Tax Provisions
Energy Taxation
Internet Taxation
Charitable Contributions

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Major Tax Issues in the 108th Congress
SUMMARY
In 2004, the congressional tax policy
2010). During the first half of 2004, the
debate continued to focus on several issues
House passed a number of bills that would
Congress considered in 2003. One such focus
extend or make permanent large parts of the
was the broad tax cuts Congress enacted in
EGTRRA and JGTRRA tax cuts, including
May 2003, as the Jobs and Growth Tax Relief
the tax cuts for married couples, the 10% tax
Reconciliation Act (JGTRRA; P.L. 108-27).
bracket, the increased child tax credit, and the
An issue in 2004 has been whether to extend
increased alternative minimum tax exemption.
a number of JGTRRA’s tax reductions that are
In early fall 2004, H.R. 1308, a bill relating to
scheduled to expire at the end of the year. A
refundability of the child tax credit, became a
second prominent issue was the controversy
vehicle for consideration of extending the
over the extraterritorial income (ETI) tax
expiring measures. On September 23, the
benefit for U.S. exports, which was found to
House and Senate approved a conference
be impermissible by the World Trade Organi-
agreement on the bill; the President signed the
zation (WTO); both the House and Senate tax-
measure and it became P.L. 108-311. The
writing committees passed legislation repeal-
measure extended the increased child tax
ing ETI in late 2003. The legislation also
credit, the tax cuts for married couples,
contained broader provisions affecting U.S.
broadening of the 10% tax bracket, and an
and overseas investment, and Congress con-
increased exemption under the AMT..
tinued to debate the bills through the first part
of 2004. Other tax issues that Congress
The ETI controversy is a long-simmering
addressed in 2004 included pension reform
dispute between the European Union (EU) and
legislation, extension of a moratorium on
the United States, with the EU lodging com-
internet taxation, and taxes related to highway
plaints with the WTO about current law’s ETI
funding.
benefit, as well as its statutory predecessors,
the Foreign Sales Corporation (FSC) and
The principal tax cuts contained in
Domestic International Sales Corporation
JGTRRA were actually “accelerations” of
(DISC) provisions. In late spring 2004, the
reductions previously enacted in 2001 with the
House and Senate each passed bills that would
Economic Growth and Tax Relief Reconcilia-
both repeal the contentious ETI provisions and
tion Act (EGTRRA; P.L. 107-16). EGTRRA
implement different mixes of benefits for
provided a gradual phase in of a variety of tax
domestic and foreign investment. In October,
cuts, including reduction of individual income
the House and Senate approved a conference
tax rates and tax cuts for married couples and
committee version of the bill; the President
families. JGTRRA moved the effective date
signed the measure and it became P.L. 108-
of EGTRRA’s gradual tax cuts forward to
357. For its part, the EU received permission
2003. However, several of JGTRRA’s accel-
from the WTO to impose retaliatory tariffs on
erations are scheduled to expire at the end of
imports from the United States and began to
2004, including an increase in the child tax
phase in the tariffs on March 1. With the
credit, tax cuts for married couples, reduction
repeal of ETI, EU officials have indicated they
of the alternative minimum tax, and tax incen-
will suspend their sanctions but will challenge
tives for business. (EGTRRA’s tax cuts are
parts of ETI’s transition rules.
themselves scheduled to expire at the end of
Congressional Research Service ˜ The Library of Congress

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MOST RECENT DEVELOPMENTS
During 2004, one principal focus of the congressional tax policy debate was legislation
addressing the export tax-benefit (ETI) dispute between the United States and the European
Union. Legislation repealing the contentious export benefit was approved by both chambers
in October in a bill containing a number of tax cuts and tax- revenue raising items for
business. The President signed the measure and it became Public Law 108-357. Another
prominent tax topic in 2004 was whether to extend or make permanent large parts of the
2001 and 2003 tax cuts. In September, Congress approved H.R. 1308, containing a number
of tax-cut extensions. The bill became Public Law 108-311.
For primers on subject specific tax legislation in the 108th Congress, see CRS Electronic
Briefing Book, Taxation, at [http://www.congress.gov/brbk/html/ebtxr1.shtml]. For details
on the legislative developments of current tax-related legislation, see CRS Report RS21386,
Fact Sheet on Congressional Tax Proposals in the 108th Congress, by Pamela J. Jackson.
BACKGROUND AND ANALYSIS
The Economic Context
Tax policy is frequently considered by policymakers as a tool for boosting economic
performance in various ways, and the likely economic effects of tax policy are often hotly
debated. A brief overview of the current economic context is thus a good starting point for
looking at tax issues facing the current Congress. The overview of major tax issues begins
by describing three aspects of the economic context in which the tax policy debate during
2004 is likely to occur: the general state of the U.S. economy; the position of the federal
budget; and the level of taxes in the United States.
The State of the Economy
In the first half of 2004 the economy continued its expansion and recovery from the
2001 recession; real output grew at an average rate of 3.0% in 2003, up from 1.9% in 2002.
Real growth was 4.5% in the first quarter of 2004 and 3.0% in the second quarter. The
favorable economic performance is qualified, however, by relatively slow growth in
employment (leading some to characterize the current situation as a “jobless recovery”), but
most prognosticators expect economic growth to continue in 2004 and beyond.
Although the current economic context of tax policy is thus one of growth, one principal
focus of the tax policy debate in recent years has been the efficacy of tax cuts as an economic
stimulus. The tax cuts of 2001, 2002, and 2003 were enacted, in part, as a means of
stimulating a still-sluggish economy, and although the recession has ended and economic
growth has picked up momentum, the debate over the merits of tax cuts as economic
stimulus continues to resonate. For example, one subject of current debate is the extent to
which tax cuts are responsible for the economy’s rebound and the extent to which factors
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such as monetary policy or the end of the war in Iraq are responsible. It is thus informative
to review the main outlines of economic performance over the past few years.
The economic boom of the 1990s lasted nine consecutive years, but by late 2000, the
economy began to show signs of weakness. President-elect Bush had called for a tax cut
during the election campaign for philosophical reasons and to spur long-term growth, but as
2000 came to an end, he added that a tax cut would now also be advisable as a means of
providing a near-term fiscal stimulus to the sluggish economy. The tax cut he proposed in
January 2001 ultimately became the basis for the large reduction enacted as EGTRRA in
June 2001.
As 2001 progressed, there were increasing signs of economic weakness, and in
November, the National Bureau of Economic Research (NBER; the organization that tracks
business cycles) determined that a recession had begun in March of that year. Economic data
now show that the economy contracted during the first three quarters of 2001 before
registering positive growth again in the fourth quarter of that year. The recession ended in
November 2001, having lasted eight months. The recession was of about average severity
and duration for economic recessions of the post-World War II era.1
Following the recession, the economy registered positive growth in all four quarters of
2002, but still exhibited signs of sluggishness. Business investment spending was weak and
employment continued to decline through 2002. Further, the pattern of growth was uneven,
leading observers to characterize the economy’s performance since the end of the recession
as “choppy” and “sub-par.” Several factors were thought to be placing a drag on the
economy: a long adjustment in capital spending; the “fallout” from revelations of corporate
malfeasance; declines in the stock market; and increased “geopolitical risks,” including the
war in Iraq.
Positive economic growth continued through all four quarters of 2003 and accelerated;
growth continued into 2004. Real gross domestic product (GDP) grew at an annualized rate
of 2.0% in the first quarter of 2003, 3.1% in the second quarter, 8.2% in the third quarter, and
4.0% in the fourth quarter. Real growth was 4.5% in the first quarter of 2004 and 3.0% in
the second. Payroll employment, however, remains below the peak it registered before the
2001 recession. The unemployment rate in 2004 has fluctuated between 5.5% and 5.7%, and
has remained at a generally higher level than those registered during the boom of the 1990s.
For further reading, see CRS Report RL30329, Current Economic Conditions and
Selected Forecasts, by Gail Makinen.
The Federal Budget
In its September 2004 update on the budget and economic outlook, the Congressional
Budget Office (CBO) reported that the federal budget registered a deficit in FY2003
amounting to 3.5% of GDP and estimated that the deficit will increase slightly to 3.6% of
GDP in FY2004, assuming current policies remain in place. A deficit in FY2004 would be
1 CRS Report RL31237, The Current Economic Recession: How Long, How Deep, and How
Different from the Past?, by Marc Labonte and Gail Makinen, p. 29.
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the third year in a row the budget has registered a deficit, with the size of the deficit growing
in each successive year. Beginning with FY2005, however, CBO projects a gradual decline
in the deficit as percentage of GDP, shrinking to a position of near-balance (a deficit of 0.4%
of GDP) by 2012. As described below, however, if the assumption that current policies
remain in place is dropped, the outlook changes — an important consideration given
congressional interest in extending or making permanent the 2001 and 2003 tax cuts.
A broader historical perspective shows several reversals in the federal budget situation
in recent years. The budget was in deficit throughout the 1970s, 1980s, and most of the
1990s before registering a surplus in FY1998, a result of both the booming economy and
legislation designed to enforce budget discipline. The budget surplus grew for the next two
years, reaching a peak of 2.4% of GDP in FY2000 before declining in FY2001 and moving
into deficit in FY2002 and FY2003. The difference between the surplus in FY2000 and the
deficit in FY2003 amounts to 5.9% of GDP. The budget data indicate that the change was
a result of both a growth in outlays and a decline in revenues. The decline in revenues was
more pronounced, however; revenues declined from 20.9% of GDP in FY2000 to 16.5% in
FY2003, a drop of 4.4 percentage points. Outlays declined by only 1.5 percentage points
over the same period. The decline in revenues has two sources: the recession of 2001 and
subsequent sluggish economic growth, and enacted tax cuts.
The outlook, however, may change. As described elsewhere in this issue brief, the tax
cuts enacted in 2001 by EGTRRA expire at the end of calendar year 2010; parts of
JGTRRA’s acceleration of EGTRRA expire at the end of 2004. Extending the tax cuts
would have a substantial impact on the budget, particularly after 2010. To illustrate, the
President’s FY2005 budget proposes extending some, but not all, of the EGTRRA and
JGTRRA tax cut provisions (it would not extend, for example, the increased minimum tax
exemption, an omission that limits the revenue loss from extending the tax cuts). According
to estimates by CBO and the Joint Committee on Taxation, the extension would reduce
revenues by $252 billion in FY2012, the first full fiscal year after EGTRRA’s expiration.
This amounts to 7.8% of revenues that are otherwise estimated to occur and 1.5% of
anticipated GDP.
The longer-term budget situation is a concern to many policymakers, chiefly because
of the combination of rising health care costs and demographic pressures posed by an aging
population that will begin with the retirement of the “baby boom” generation. Under current
law, spending on Social Security, Medicare, and Medicaid is expected to increase
substantially as a share of the economy. The Congressional Budget Office has estimated that
combined spending on the three programs will grow from 8% of GDP in 2004 to over 14%
in 2030 and to almost 18% by 2050.2 According to CBO, either substantial increases in taxes
or cuts in spending will likely be necessary in the future if fiscal stability is to be maintained.3
For additional information, see CRS Report RL31784, The Budget for Fiscal Year 2004,
by Philip D. Winters, CRS Report RL31778, The Size and Scope of Government: Past,
2 U.S. Congressional Budget Office, The Budget and Economic Outlook: Fiscal Years 2005-2014
(Washington: GPO, 2004), p. 8.
3 U.S. Congressional Budget Office, The Long-Term Budget Outlook (Washington: December,
2003), p. 9.
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Present, and Projected Government Revenues and Expenditures, by Don C. Richards, and
CRS Report RS21786, The Federal Budget Deficit: A Discussion of Recent Trends, by Gregg
Esenwein, Marc Labonte, and Philip Winters.
The Federal Tax Burden4
At the outset of the preceding (107th) Congress, some pointed to the historically high
aggregate level of federal taxes compared to the economy as evidence of the desirability of
a tax cut. As a percentage of GDP, federal taxes were at their highest level since the end of
World War II in FY2000, at 20.8%, before falling to 19.8% in FY2001 and 18.0% in
FY2002. These levels are not a dramatic departure from the past; 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. According to CBO, the increased level of tax revenues prior to FY2002
was due to economic growth, an increase in capital gains realizations (for example, from
sales of appreciated stock), and increases in real incomes. The decline in FY2002 revenues
was due to slower economic growth, declines in capital gains realizations, and slower
growth of very high incomes.
Although some fluctuations in the distribution of the federal tax burden have occurred
over the last 20 years, the fluctuations have been concentrated at the opposing ends of the
income spectrum. During the 1980s, the combined burden of all federal taxes 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. Families in the middle-income brackets, however, experienced smaller
changes in their federal tax burdens over this period, despite legislated tax cuts.
While the overall level of federal taxes has been relatively stable, its composition has
shifted. In particular, the share of federal receipts made up by corporate income taxes and
excise taxes has declined, falling from 30% and 18%, respectively, of total receipts in
FY1946 to 10.4% and 3.4% in FY2002. The share of Social Security taxes has increased
over the same years from 7.9% to 36.4%, and is now the second largest source of federal
revenues after individual income taxes.
For further information, see CRS Report RS20087, The Level of Taxes in the United
States, 1940-2002, by David L. Brumbaugh and Don C. Richards.
Tax Legislation Enacted in 2004
President Bush’s FY2005 Budget Proposal
The FY2005 budget that President Bush proposed in February 2004, called for a tax cut
of $1.24 trillion over 10 years and $213 billion over five years. By far the largest component
was a proposal to make EGTRRA’s temporary tax cut permanent (see the discussion below
under “Selected Issues.”) Other elements were more targeted and included revamped and
expanded tax-favored savings accounts, a tax credit for health insurance, a variety of energy-
4 Authored by Gregg A. Esenwein, Specialist in Public Finance, Government and Finance Division.
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related tax cuts, and a charitable-giving deduction for non-itemizers. The plan also contained
a set of revenue-raising items in the general area of tax “loopholes” and compliance; the
largest was more stringent rules for leasing transactions with tax exempt entities. As
described below, Congress ultimately extended (but did not make permanent) the
acceleration of EGTRRA’s tax cuts enacted by JGTRRA. It did not, however, enact the bulk
of the President’s more targeted proposals, although it did adopt restrictions on leasing as
part of P.L. 108-357 (see below).
Working Families Tax Relief Act (H.R. 1308; P.L. 108-311)
The Economic Growth and Tax Relief and Reconciliation Act of 2001 (EGTRRA)
provided a number of substantial tax cuts that were scheduled to be phased in gradually over
the 10 years following EGTRRA’s enactment. As discussed more fully below (see the
section on “Selected Issues”), the tax cuts are generally scheduled to expire at the end of
2010. In 2003, the Jobs and Growth Tax Relief Reconciliation Act (JGTRRA) accelerated
a number of EGTRRA’s phased-in tax cuts, including reduction of individual income tax
rates and tax cuts for married couples and families, making EGTRRA’s cuts fully effective
in 2003. However, JGTRRA’s accelerations were themselves scheduled to expire at the end
of 2004. A principal thrust of the Working Families Tax Relief Act (WFTRA) was to extend
JGTRRA’s tax cuts for varying lengths of time. WFTRA’s provisions:
! extended the increased ($1,000) child tax credit through 2009;
! extended tax cuts for married couples through 2008;
! extended the widened 10% tax-rate bracket through 2010;
! extended the increased alternative minimum tax exclusion through 2005
! accelerated the refundability of the child tax credit to 2004; and
! included combat pay in income that qualifies for the refundable child tax
credit and the earned income tax credit.
In addition to the expiring provisions of EGTRRA and JGTRRA, the tax code has long
contained a set of additional temporary tax benefits that are generally designed to promote
various types of investments and activities thought to be beneficial. Prominent examples
include the research and experimentation tax credit, the work opportunities tax credit, and
the welfare to work tax credit. WFTRA extended a number of these so-called “extenders,”
generally through 2005.
According to Joint Tax Committee revenues estimates, WFTRA will reduce revenue
by $132.8 billion over five years and $146.9 over 10 years.
The conference report on WFTRA was passed by both the House and the Senate on
September 23, 2004, and was signed into law on October 4. It became law, P.L. 108-311.
The American Jobs Creation Act (H.R. 4520; P.L. 108-357)
Congress passed the American Jobs Creation Act (AJCA) in October, 2004. The
principal concern of the bill was business taxation. As discussed more fully below (see the
entry under Selected Issues), the bill began as a remedy to a long-running dispute between
the United States and the European Union over the U.S. extraterritorial income exclusion
(ETI) tax benefit for exporters. The scope of the enacted bill, however, was considerably
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broader. In general outline, the act repealed ETI while implementing a mix of tax cuts for
both domestic and multinational U.S. businesses. The act achieved estimated revenue
neutrality with a set of provisions generally in the area of corporate tax compliance.
AJCA provisions are numerous and apply to a broad array of tax code sections. In
general terms however, the act’s most important provisions were:
! A repeal of the ETI export tax benefit;
! A variety of tax cuts generally favoring domestic (as opposed to foreign)
investment. (Chief among these was a new 9% deduction limited to
domestic production.)
! Several tax cuts for multinational firms, including more generous foreign tax
credit rules for the treatment of interest expense and a consolidation of the
several separate foreign tax credit limitations that existed under prior law.
! A set of revenue raisers (in addition to ETI’s repeal) including provisions
aimed at restricting corporate tax shelters, provisions designed to improve
fuel tax compliance, and a provision restricting tax benefits available from
lease transactions involving tax-indifferent entities.
Tax Legislation in 2003
The 2003 Tax Cut: The Jobs and Growth Tax Relief
Reconciliation Act (JGTRRA)
On January 7, 2003, President Bush announced the details of a new tax cut proposal
intended to provide a stimulus to the economy. According to estimates by the Joint
Committee on Taxation, the revenue reduction from the “economic stimulus” elements of
the plan amounted to $726 billion over FY2003-FY2013. The total cost of all the
components of the plan (including not only the stimulus proposals, but also additional tax
cut provisions) was estimated at $1.575 trillion.
A principal part of the President’s tax proposals was acceleration of several tax cuts for
individuals that were enacted by EGTRRA in 2001 but that were scheduled to be phased in
only gradually. The Administration proposed to make the reduction in tax rates fully
effective on January 1, 2003; the rate reductions were scheduled by EGTRRA to be phased
in over the period 2001-2006. The President’s plan proposed to accelerate a broadening of
the 10% rate bracket that was not scheduled to occur until 2008. The plan also proposed to
move up EGTRRA’s scheduled tax cuts for married couples to 2003; the tax cuts were
originally not scheduled to be fully effective until 2009. The President’s plan also proposed
to increase the per-child tax credit to $1,000 from $600 in 2003. The full increase was not
scheduled to occur until 2010 under EGTRRA’s initial provisions.
Another prominent part of the plan was a proposal to move toward “integration” of the
taxation of corporate-source income by eliminating individual income taxes on dividends and
by permitting a “step up in basis” for capital gains resulting from retained earnings. The
Administration also proposed to increase the “expensing” allowance for small business
investment in equipment to $75,000 from current law’s $25,000.
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Each of these proposals was included in the stimulus part of the package the President
outlined in January. Prominent among the additional tax cuts proposed with the budget were
two new tax-favored savings vehicles that would replace Individual Retirement Accounts
(IRAs) and that would have less binding restrictions than current law’s IRAs; a set of new
tax incentives for charitable giving, including a deduction for non-itemizers; a number of tax
benefits related to health care, including a long-term care insurance deduction for non-
itemizers; a set of tax benefits related to energy production and conservation; and permanent
extension of current law’s temporary research and experimentation tax credit.
On May 23, the House and Senate agreed to the conference report for H.R. 2, the Jobs
and Growth Tax Relief and Reconciliation Act (JGTRRA; P.L. 108-27). In broad outline,
the act contained the principal elements of the stimulus part of the President’s tax-cut
proposal. The President signed the bill into law on May 28. While the Senate and House
versions of the bill were similar in broad outline, they did contain some differences that were
reconciled by the conference agreement. The House bill, for example, would have reduced
revenue by $550 billion over approximately 10 years, while the Senate bill proposed a net
tax cut and increases in outlays amounting to $350 billion. The Senate bill also contained
a set of revenue raising proposals not in the House bill.
JGTRRA’s conference agreement contained an estimated $350 billion in reduced
revenues and increased outlays from FY2003 through FY2013, including $320 billion in tax
cuts and $30 billion in outlay increases. In contrast to the Senate provision, which had the
same net cost, the conference package did not include any revenue raising measures acting
as offsets. The principal outlay provisions in the package established a $20 billion fund to
provide fiscal relief to state governments. The principal tax components of JGTRRA were:
! Acceleration to 2003 of the individual income tax cuts enacted and phased
in under EGTRRA. Specifically, income tax rates above 15%, currently
scheduled to decline in 2004 and 2006, were accelerated to their 2006 levels
in 2003. The application of the 10% tax bracket, scheduled by EGTRRA to
increase in 2008, was accelerated to 2003 and 2004.
! The child tax credit initially scheduled to be $600 for 2003 and 2004 was
increased to $1,000 for 2003 and 2004 but will revert to the levels scheduled
by EGTRRA for 2005 - 2010 ($700 in 2005 - 2008, $800 in 2009, and
$1,000 in 2010).
! For 2003 and 2004 only, the standard deduction and 15% tax bracket for
married taxpayers will become twice those for singles. Beginning in 2005,
these provisions will revert to EGTRRA’s schedule, which provides for
phased-in increases to the levels of twice those for singles over several
years.
! The alternative minimum tax exemption amount was increased by $9,000
for married couples and $4,500 for singles for 2003 and 2004.
! Maximum expensing benefit for small business investment was temporarily
increased from current law’s $25,000 to $100,000 for 2003, 2004, and 2005.
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The provision’s phase-out threshold was increased from $200,000 to
$400,000 over the same time period.
! The temporary “bonus” depreciation allowance originally passed in March
2002 was increased and extended to allow for a 50% first year deduction (up
from 30%) for the period between May 5, 2003 and December 31, 2004.
! The conference agreement reduced the tax rate on both dividends and capital
gains to 15% for taxpayers in the higher tax brackets and 5% for those in the
lower tax brackets for 2003 through 2008. (The tax rate for those in the
lower tax brackets would be 0% in 2008.) The dividend provision applies
to both domestic and foreign corporations.
The Policy Debate. As the tax-cut measure worked its way through Congress, the
policy debate tended to focus on three broad issues: the bill’s likely revenue cost and impact
on the budget; whether a tax cut would stimulate the economy and/or promote long-run
growth; and how it would affect tax fairness. With respect to cost, opponents of the measure
— and those objecting to tax cuts larger than those ultimately adopted — generally voiced
concern about the impact of a tax cut on the federal budget. As noted above (see the section
on the federal budget), the budget has moved from surplus into deficit in recent years and
also faces long-term pressures posed by the looming retirement of baby boomers and
succeeding generations; these pressures would be accentuated by any sizeable tax cut. In
response, the bill’s supporters generally emphasized the beneficial effect a tax cut might have
on tax receipts if it were successful in stimulating economic growth.
In the area of economic performance, the tax cut’s proponents argued that the particular
measures under consideration would benefit the economy in two ways: by providing a short-
run stimulus that would help overcome the economy’s recent sluggishness; and by increasing
long-run economic growth. Skeptics, however, have pointed out that particular tax-cut
measures most likely to increase long-run growth are not well-suited to providing short-term
stimulus, and have questioned the beneficial impact on the economy of the measure that was
adopted. In the area of tax equity, the tax cut’s impact on the fairness of the tax system has
been criticized by some. Several analyses have indicated that the tax cut that was enacted
will likely benefit upper-income individuals more than others. In addition, the enacted tax
cut benefits some groups, for example, families with children and investors owning corporate
stock and assets producing capital gains, more than others.
For further information, see CRS Report RL31907, The 2003 Tax Cut: Proposals and Issues,
by David L. Brumbaugh and Don C. Richards.
Selected Issues
Expiration of the 2001 Tax Act and its Acceleration by JGTRRA
The Economic Growth and Tax Relief and Reconciliation Act of 2001 (EGTRRA)
provided a substantial tax cut that is scheduled to be phased in over the 10 years following
its enactment. The act’s most prominent provisions were a reduction in individual income
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tax rates, tax cuts for married couples, phase-out of the estate tax, a larger per-child tax
credit, education tax benefits, and tax cuts for Individual Retirement Accounts and pensions.
The estimated size of the scheduled tax cut is $1.35 trillion over FY2001-FY2011.
However, a Senate procedural rule, the “Byrd rule,” provides that a point of order can
be raised against any provision of a budget reconciliation bill that is “extraneous” to the
budget reconciliation legislation. Included among the several types of provisions the Byrd
rule defines as extraneous are those that would increase the budget deficit (or reduce the
budget surplus) for a fiscal year beyond that covered by the reconciliation measure being
considered. To avoid application of the Byrd rule, EGTRRA contained language providing
for the expiration of its provisions at the end of calendar year 2010. The passage of
JGTRRA did not modify the expiration of those provisions scheduled to expire under
EGTRRA. Further, JGTRRA’s acceleration of EGTRRA’s tax cuts was itself temporary.
While JGTRRA moved up the effective dates of a number of EGTRRA’s cuts from those
that would apply under EGTRRA’s slower phase in, JGTRRA’s accelerations themselves
generally expire after 2004, meaning that a number of taxpayers could register a tax increase
in 2005. These expirations include the increased child tax credit, expansion of the 10% tax
bracket, and tax cuts for married couples.
During the first half of 2004, the House passed a number of bills to extend or make
permanent large parts of the EGTRRA and JGTRRA tax cuts. H.R. 4181 would make the
tax cuts for married couple permanent; H.R. 4275 would make permanent the 10% tax
bracket; H.R. 4359 would apply to the child tax credit, and H.R. 4227 would extend the
increased alternative minimum tax exemption through 2005. In September, H.R. 1308, a bill
addressing refundability of the child tax credit, became a vehicle for consideration of the tax
cuts’ extension. A conference committee agreement on the bill was approved by both
chambers on September 23. The President signed the measure and it became P.L. 108-311.
For description of the bill, see the section above on legislation enacted in 2004.
For further information, see CRS Report RS21863, Recent House Legislation Extending
Selected Provisions of the 2001 and 2003 Tax Cuts, by Gregg Esenwein.
Deductibility of State and Local Sales Tax5
Under current federal tax laws, federal income tax filers who itemize can deduct state
and local income and property taxes when computing federal taxable income, but cannot
deduct state and local sales taxes. Thus, taxpayers in states without an income tax are able
to deduct less state and local taxes. Taxpayers in non-income tax states argue that this
differential tax treatment is inequitable. Several proposals have been made to allow state and
local sales taxes paid by individuals to be deducted from federal income tax. Some of these
bills would allow taxpayers to choose an itemized deduction for state and local general sales
taxes in lieu of the itemized deduction for state and local income taxes. Prominent among
these proposals is H.R. 4520, the omnibus business tax and ETI proposal approved by the
House in June 2004. Other bills would permit those residents who itemize deductions in
states without an income tax to deduct state sales taxes when computing federal income tax
5 Authored by Pamela Jackson, Analyst in Public Sector Economics, and Steven Maguire, Analyst
in Public Finance, Government and Finance Division.
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liability. In October, Congress approved a conference agreement on H.R. 4520 that
contained the sales-tax deductibility option.
For further information see CRS Report RL32455, State and Local Sales Tax
Deductibility: Proposed Legislation, by Pam Jackson and Steve Maguire.
Tax Cuts for Economic Stimulus
The possibility of tax cuts to stimulate the economy has occupied the attention of
policymakers in Congress and elsewhere for several years. In 2001, a sluggish economy was
one reason for enactment of the sizeable tax cut contained in EGTRRA. Economic data now
show that a recession was underway at the time: the economy contracted during the first three
quarters of 2001. Since then, the economy in general has returned to positive economic
growth, but remains sluggish; business spending and employment have remained weak. As
described in the preceding section, economic stimulus was one reason for enactment of P.L.
108-27.
Will the tax cut improve economic performance, as intended? Has it played a role in
the recent pick-up in economic growth? Economic analysis generally approaches such
questions by distinguishing between a tax cut’s possible effects on long-term growth and its
efficacy as a short-term economic stimulus. In the long run, according to economic theory,
tax cuts can conceivably stimulate growth by increasing basic economic elements that
contribute to long-run growth: specifically, labor supply and saving (the supply of capital).
In principle, a cut in the tax rates applicable to labor income and/or saving might encourage
individuals to save more or supply more labor. Economic analysis, however, also suggests
several reasons to be skeptical. To begin, economic theory is uncertain as to whether a tax
cut actually increases private saving or labor supply because of two offsetting effects. In the
case of saving, for example, a tax cut might induce individuals to increase their saving
because the after-tax return it produces is higher; on the other hand, if a saver’s goal is to
accumulate a particular sum, a tax cut will enable him to do so at a lower level of saving.
Theory predicts similar conflicting effects on labor supply. Economic theory, in short, is
agnostic on whether tax cuts increase or reduce saving and labor supply. Given the
ambiguity of theory, a firm conclusion necessarily relies on empirical evidence. Most
evidence does not suggest a large savings response from a tax cut.
But whether a tax cut increases private saving or labor supply may be moot because of
a revenue reduction’s budgetary effects. A tax cut that is not matched by reductions in
government spending increases the government’s budget deficit above what would otherwise
occur, and thus boosts the government’s borrowing requirements. As a consequence, real
interest rates faced by private investors may increase, “crowd out” private investment and
more than offset any increase in investment resulting from an increase in private saving.
Another way of looking at this effect is to recognize that total, national saving consists of
private saving minus government borrowing. Economic theory predicts that a tax cut will
thus probably reduce national saving and may therefore reduce long-run growth.
Shifting to short-run considerations, is a tax cut similar to that enacted likely to
stimulate the economy in the near term? Have the recent tax cuts played a role in the recent
pick-up of economic performance? In recent decades, economists have grown more doubtful
of the efficacy of tax cuts as a short-run stimulative tool, especially compared to monetary
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policy, its counter-cyclical alternative. There are several reasons for this skepticism. First,
the modern world economy has become more open, and — via mechanisms such as capital
flows and exchange rate adjustments — much of the stimulative force of tax cuts is thought
by economists to be dissipated in the larger world economy. Beyond this consideration,
monetary policy is thought to have an advantage over fiscal policy because changes in
monetary policy can be implemented with more alacrity than those of fiscal policy; monetary
authorities can recognize the need for stimulus and implement money-supply changes more
quickly than tax-cut or spending legislation can work its way through Congress.
For further information see CRS Report RS21126, Tax Cuts and Economic Stimulus:
How Effective Are the Alternatives?, by Jane G. Gravelle and CRS Report RL30839, Tax
Cuts, the Business Cycle, and Economic Growth: A Macroeconomic Analysis, by Marc
Labonte and Gail Makinen.
International Taxation
The U.S. economy is increasingly open, in terms of both trade and investment flows;
the openness has helped make international tax issues among the most prominent tax
questions Congress has faced in recent years. Specific international tax issues are numerous
and include whether to reform the U.S. system by moving to a “territorial” system that
exempts foreign-source income from U.S. tax; whether to adopt more incremental tax cuts
for U.S. firms in order to help them compete internationally; how to resolve the export tax
benefit controversy with the European Union (EU) over the U.S. extraterritorial income
(ETI) tax benefit for exports; whether to adopt measures designed to curb corporate
“expatriations” or “inversions” in which firms reincorporate abroad to save taxes; whether
and to what extent to cooperate with foreign governments in reducing international tax
evasion and avoidance; and how the Internal Revenue Service should proceed in reducing
U.S. tax evaders that use offshore tax havens.
Congressional action on the ETI controversy has been time-sensitive: the EU was
authorized by the World Trade Organization (WTO) to impose retaliatory tariffs on U.S.
products, and began phasing in the tariffs in March, 2004. Thus, resolution of the ETI
dispute was a principal purpose of international tax legislation Congress considered
throughout much of 2004 and that culminated in the approval of H.R. 4520 (Public Law 108-
357). The origins of the ETI controversy stretch back more than 30 years to enactment in
1971 of the Domestic International Sales Corporation (DISC) export tax benefit. European
countries complained that DISC was an export subsidy, and as such, it violated the General
Agreement on Tariffs and Trade (GATT, the WTO’s predecessor). In 1984, the United
States attempted to remedy the situation by replacing DISC with a new export tax benefit,
the Foreign Sales Corporation (FSC) provisions. However, in 1997, the European Union
began proceedings against FSC under the new WTO agreements. Several WTO panel
rulings concluded that FSC, like DISC before it, was a prohibited export subsidy. In 2000,
the United States again attempted to revamp its export tax benefit with a WTO-compatible
provision, in this case, ETI. However, WTO panels again supported the EU position, and
in 2002, the WTO ruled that the EU can impose up to $4 billion in retaliatory tariffs against
U.S. products. EU officials have stated that the tariffs will not be imposed as long as the
United States is seen to be making progress on making its export tax provisions WTO-
compatible.
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In the 107th Congress, Chairman Thomas of the House Ways and Means Committee
introduced H.R. 5095, a broad international tax bill that addressed the ETI controversy by
proposing repeal of the export benefit. The bill also proposed to promote U.S.
competitiveness by cutting taxes on U.S. multinational firms in a variety of other ways.
Congress did not take action on the measure before it adjourned, in part due to opposition
from policymakers who favor attempting to negotiate with the EU. In the 108th Congress,
Representative Crane introduced H.R. 1769 in April 2003. The bill proposed to phase out
ETI while phasing in a tax deduction for firms’ domestic production. On July 25,
Representative Thomas introduced H.R. 2896, a bill similar to H.R. 5095, but with the
addition of several tax benefits restricted to domestic investment; the modified bill thus
contained a mix of domestic and overseas investment to accompany repeal of ETI. On
October 1, the Senate Finance Committee approved S. 1637 (Senator Grassley), containing
a somewhat different mix of domestic and overseas tax benefits. On October 28, the House
Ways and Means Committee approved a modified version of H.R. 2896. Congress did not
take further action on the ETI issues before it adjourned for the year.
Congress resumed work on the matter during the first months of 2004. The full Senate
began debate on S. 1637 in March and approved the bill on May 11. On June 4,
Representative Thomas introduced a revised version of the ETI bill as H.R. 4520. As with
S. 1637 and H.R. 2896, the bill proposed to phase out ETI and replace it with a mix of tax
cuts for domestic and international investment, although the particular mix differs from that
contained in the other bills. The House approved H.R. 4520 on June 17. On July 15, the
Senate made procedural preparations for a conference on the ETI bills by approving a version
of H.R. 4520 that replaced the language of the House-approved bill with that of S. 1637. On
October 6, a conference committee approved a version of the bill containing the essential
elements of the House and Senate bills. The President signed the bill into law as Public Law
108-357. (For additional information on the measure, see the above section on legislation
enacted in 2004.)
For further information, see CRS Report RL32066, Taxes, Exports, and Investment:
ETI/FSC and Domestic Investment Proposals in the 108th Congress, by David L. Brumbaugh
and CRS Report RL31717, U.S. Taxation of Overseas Investment and Income: Background
and Issues in 2003, by David L. Brumbaugh, and CRS Report RL32652, the 2004 Corporate
Tax and FSC/ETI Bill: the American Jobs Creation Act of 2004, by David L. Brumbaugh.
Other Tax Issues
Other tax issues that Congress considered during 2004 included the following items.
Fundamental Tax Reform. Congress actively considered fundamental tax reform
— for example, shifting from an income to a consumption tax — in the mid-1990s, but such
legislation never progressed beyond the committee level. In the past, Administration
officials have indicated they would consider fundamental tax reform as a proposal for long-
run tax policy and a number of bills were introduced in the first session of the 108th Congress
that proposed fundamental tax reform, suggesting continuing congressional interest in the
topic. In September 2004, President Bush announced his intention to appoint a panel to
advise the Secretary of the Treasury on fundamental tax reform, suggesting the topic may be
of interest during 2005. For further information, see CRS Issue Brief IB95060, Flat Tax
Proposals and Fundamental Tax Reform: An Overview, by James Bickley.
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Business Taxation. The tax cut Congress approved in May 2003 included several
tax cuts for business — for example, temporary increases in the expensing benefit for small
business investment and in depreciation allowances. In addition, the tax cut reduced taxes
on dividends and capital gains tax — a move in the direction of what tax professionals term
“tax integration,” which is thought to stimulate the flow of investment to the corporate
sector. During 2004, Congress returned to the topic of business taxation in connection with
legislation to repeal the ETI export tax benefit (see the discussion above). Each of the ETI
bills — and the bill that was ultimately enacted — included tax benefits designed to
encourage domestic production for businesses.
For further information, see CRS Report RL31597, The Taxation of Dividend Income:
An Overview and Economic Analysis of the Issues, by Gregg Esenwein and Jane Gravelle,
and CRS Report RL32103, Comparison of Tax Incentives for Domestic Manufacturing in
Current Legislative Proposals, by Jane Gravelle.
Small Business Taxation. Taxation of small business is a continuing concern to
Congress, and it remained so in 2004. The broad business tax bill Congress approved in
October (P.L. 108-357; described above) included more generous rules Subchapter S rules
for taxing closely-held businesses, and investment incentives such as an increased expensing
benefit for equipment.
Family Tax Issues. Several family tax issues were debated in 2004. For example,
the earned income tax credit for low-income families has been suggested as a focus of
simplification efforts and the individual alternative minimum tax’s impact on families has
been a focus of concern. In addition, several prominent family-oriented tax provisions were
part of EGTRRA’s tax cut and of JGTRRA’s acceleration of EGTRRA’s phase-ins,
including benefits for married couples and the child tax credit. These elements were an
important part of the debate on P.L. 108-311 (described above).. For further information, see
CRS Report RS20988, The Child Tax Credit After the Economic Growth and Tax Relief
Reconciliation Act of 2001, by Gregg Esenwein.
Estate Tax. One of the largest and most debated aspects of EGTRRA was its phase-
out and repeal of the estate tax. In 2003, the House approved H.R. 8, which would make
EGTRRA’s repeal of the estate tax permanent, although the Senate did not take action.
Estate tax issues were a less prominent part of the congressional tax debate in 2004.
However, given the liveliness of the estate tax debate in 2003, and in view of its place (albeit
a small one) as a fundamental part of the tax structure, the estate tax may become a
prominent part of the 2005 tax policy debate. For further information, see CRS Report
RL30600, Estate and Gift Taxes: Economic Issues, by Jane Gravelle.
Individual Alternative Minimum Tax (AMT). Under current law, an individual
pays either the regular tax or AMT, whichever is larger. (The two will ordinarily differ
because the AMT has lower rates but fewer and smaller tax benefits than the regular tax.)
The AMT presents a looming tax issue because key provisions of the AMT are not indexed
for inflation, and an increasing number of individuals will find themselves subject to the
AMT. In addition, tax benefits enacted by EGTRRA and other acts have placed an increased
number of persons at or near AMT status. Congress addressed the AMT in 2004 with the
one-year extension of the increased AMT exemption in P.L. 108-311. Given the temporary
nature of the provision, the AMT may continue to pose an issue in 2005.
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Expiring Tax Provisions. Expiring tax provisions were on the 2004 congressional
tax agenda in several different ways. First, a number of tax cuts enacted by JGTRRA were
scheduled to expire at the end of 2004 (see the discussion in the “Selected Issues” section.)
Further, the EGTRRA tax cuts themselves are scheduled to expire at the end of 2010.
Second, apart from the EGTRRA and JGTRRA tax cuts, the tax code contains a number of
tax benefits that have been temporary since their inception, that have been scheduled to
expire at particular points in time, but that have generally been extended for varying lengths
of time on a number of occasions. Several of the most prominent measures — for example,
the AMT treatment of personal tax credits (see the AMT issue described above), the work
incentive tax credit, the welfare to work credit — were scheduled to expire at the end of
2003. In September, 2004, Congress included an extension (generally through 2005) of
numerous of these items in P.L. 108-311.
Energy Taxation. In 2002, both the House and Senate passed legislation (H.R. 4)
containing tax benefits related to energy, including tax benefits for particular categories of
energy producers and consumers. Although a conference committee convened, the 107th
Congress adjourned without acting on the bill. Both the House and Senate returned to the
issue of energy taxation in the 108th Congress. A conference committee completed work on
an energy bill in November. The House approved the agreement, but the Senate did not act
on the measure before Congress adjourned for the year. Congress considered a set of energy
tax measures in conjunction with the 2004 corporate tax bill (P.L. 108-357). A package of
energy measures was contained in the Senate, but not the House, version of the measure.
Some, but not all, of the provisions were included in the final act. For further information,
see CRS Issue Brief IB10054, Energy Tax Policy, by Salvatore Lazzari.
Internet Taxation. The growth of the Internet has placed pressure on the states’ sales
and use tax systems, raising questions such as how use of the Internet and commerce
conducted via the Internet should be taxed. The federal government has a role in regulating
Internet taxation by virtue of the Constitution’s Commerce Clause, and in 2001, a temporary
moratorium was enacted prohibiting new taxes on Internet access and multiple or
discriminatory taxes on Internet commerce (P.L. 107-75). The moratorium expired on
November 1, 2003. The House passed legislation (H.R. 49) that would make the moratorium
permanent in September, 2003; the Senate passed an extension in April, 2004. Both the
House and Senate approved a conference agreement in November and the President is
expected to sign the bill (S. 150). For further information, see CRS Report RL31177,
Extending the Internet Tax Moratorium and Related Issues, by Nonna Noto.
Charitable Contributions. Bills providing tax benefits for charitable contributions
passed both the House (H.R. 7) and Senate (S. 476) in 2003. Both bills would temporarily
extend the deductibility of donations to non-itemizers and allow tax-free treatment of
charitable distributions from IRAs. The bills, however, contain a number of significant
differences; a prominent difference is the inclusion of revenue-raising “offsets” in the Senate
bill but not the House bill. It does not appear likely the differences between the bills will be
reconciled before the 108th Congress adjourns. In the meantime, a number of revenue-raising
items were included in the final version of the 2004 corporate tax bill (P.L. 108-357),
including new restrictions on automobile donations. For further information, see the CRS
Electronic Briefing Book, Taxation, “Charitable Contributions,” by Jane G. Gravelle,
available online only from the CRS website at [http://www.congress.gov/brbk/html/
ebtxr80.html].
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