The Tax Reform Framework

The Tax Reform Framework

October 2, 2017
The Tax Reform Framework
The proposed tax reform “Unified Framework for Fixing
blueprint, although the blueprint had a top rate of 33%.
Our Broken Tax Code” was released on September 27,
Bracket widths were specified, along with the increase in
2017. The Framework, agreed to by the majority party
the child credit ($500) and treatment of head-of-household
leaders of the House and Senate and the chairmen of the
returns (heads of households would now use the singles
Ways and Means Committee and Senate Finance
rate schedule and have a standard deduction of $18,000,
Committee, along with representatives of the
compared to $9,350 under current law). In the “Better
Administration, contains many elements of the House tax
Way” plan, capital gains, dividends, and interest would be
reform blueprint, the “Better Way,” released in 2016. The
taxed at 50% of ordinary rates; currently, capital gains and
“Better Way” blueprint is analyzed in CRS Report R44823,
dividends are subject to a top rate of 20% and interest is
The “Better Way” House Tax Plan: An Economic Analysis,
taxed at ordinary rates.
by Jane G. Gravelle.
Tax Provisions Affecting Businesses
Many of the details of a potential tax reform are not
The Framework would reduce the corporate tax rate from
outlined in the Framework, but remain to be determined in
35% to 20% and provide for a maximum 25% tax rate for
the legislative process.
small and family-owned businesses that are taxed under the
individual income tax as pass-throughs. Pass-throughs are
Individual Tax Revisions
organized as proprietorships, partnerships, or Subchapter S
For the individual income tax, the plan would broaden the
corporations (corporations that have a small number of
base by disallowing most itemized deductions except for
shareholders and elect to be taxed at individual rates). The
mortgage interest and charitable contributions deductions. It
language in the Framework suggests that this rate would
would replace the current seven rate brackets (ranging from
apply to all income from business, whether labor or capital
10% to 39.6%) with three brackets, with tax rates of 12%,
income. It does not define small business.
25%, and 35% (with the possibility of another higher rate
for the highest-income taxpayers). The rate brackets widths
The “Better Way” blueprint had the same rate; it applied the
are not specified. It would alter some of the elements
25% rate to all pass-through businesses but only to capital
related to family size and structure by eliminating personal
income. The treatment in the Framework is more consistent
exemptions, allowing a larger standard deduction ($24,000
with the proposals released by the President as a candidate.
for joint returns and $12,000 for singles), increasing the
child credit by an unspecified amount, and adding a $500
The Framework provides that investment in equipment (but
credit for non-child dependents. (The current personal
not structures) that is currently recovered, in part, over a
exemption is $4,050 and the current standard deductions are
period of years, be expensed (deducted immediately) for at
$12,700 for joint returns and $6,350 for single returns.) The
least five years. Deductions for interest for corporations
current $1,000 child credit would not be altered except
would be partially limited, and interest deductions for pass-
through a higher income phase-out range, but only that part
throughs would be considered by committees. A much
of the child credit would be refundable. The alternative
more sweeping change was proposed in the “Better Way”
minimum tax would be repealed.
plan, where both equipment and structures were to be
expensed as permanent provisions and interest deductions
The current earned income credit is not mentioned. There is
disallowed.
no discussion of the tax treatment of capital gains and
dividends. Special provisions for education and retirement
The Framework would repeal the production activity
would be retained but might be modified.
deduction, other unspecified deductions, and most credits,
but explicitly retain the research credit and the low-income
The Framework also envisions a measure of inflation that
housing credit. The “Better Way” plan also had unspecified
the proposal’s sponsors deem more accurate to index rate
changes, repealed the production activity deduction, and
brackets and other parameters such as the standard
retained the research credit.
deduction. While the Framework does not specify this
measure, it likely refers to the chained CPI which adjusts
International Business Tax Provisions
the ordinary consumer price index to recognize the
Under current law, worldwide income of U.S.
substitution of goods when relative prices change. While
multinationals is taxed, but the tax on earnings of foreign
many economists believe this measure is a better measure
subsidiaries is delayed until the income is repatriated (paid
of inflation, using it would have the effect of raising taxes
as dividends to the U.S. parent). Firms may take a credit
compared to using the regular CPI.
against U.S. tax for taxes paid to foreign jurisdictions. U.S.
firms have accumulated a large amount of untaxed earnings
Many of these elements (although not changing the
abroad, including a significant share held in cash and cash-
inflation measure) were present in the “Better Way”
like assets.
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The Tax Reform Framework
The Framework moves to a territorial tax (where foreign
and have mixed effects on taxes across asset types
source income would not be subject to regular U.S. tax).
(equipment investment would be more favored relative to
The Framework also has a deemed repatriation of existing
investment in structures than is already the case, as long as
accumulated income subject to tax at an unspecified rate.
it is expensed, but be brought closer to the treatment of
The rate would be lower on earnings invested in illiquid
intangible investments).
form than on earnings in cash or cash equivalents. A
territorial tax encourages more profit-shifting (artificially
A territorial tax with a minimum tax rate eliminates the
moving profits abroad) and the Framework would impose a
disincentive to repatriate foreign source income, but has the
reduced rate on foreign profits on a global basis to address
possibility of increasing profit shifting, depending on the
this issue. It would also make unspecified changes to
level and design of the minimum rate. The effects on capital
address treatment of foreign-headquartered and U.S.-
inflows from abroad are uncertain in direction, since lower
headquartered firms (possibly to address profit shifting by
rates and expensing reduce the tax on equity capital but also
foreign parents of U.S. firms outside of the United States).
reduce the subsidy for debt, an effect that would be
increased if some interest deductions are disallowed.
While the “Better Way” blueprint moved to a territorial tax
and provided a deemed repatriation of existing untaxed
Assuming a child credit and head-of-household treatment
income accumulated abroad, it had a wholly different, and
the same as in the “Better Way” plan and the same bracket
likely highly effective, method of preventing profit shifting
widths, lower- and middle-income taxpayers would
through a border adjustment. The border adjustment would
generally have either no change in taxes or small tax cuts.
tax imports and exclude exports, making the payment of tax
Higher-income taxpayers were taxed at about the same rates
dependent on the production for consumption in the United
under the “Better Way” blueprint if all of their income were
States. The border adjustment proved to be controversial
from wages or labor income. The Framework might confer
and the formulators of the Framework indicated early on
more benefits on the labor income of higher-income
that it would not be a part of the new proposal.
individuals with businesses because the top rate applies to
labor earnings of businesses. In some activities (such as
The Estate Tax
activities of attorneys and doctors) most of the business
The Framework repeals the estate tax as did the “Better
income is from labor income. Both plans reduce the tax
Way” blueprint. Neither plan mentioned the gift tax, which,
burden on capital income through the reduction in corporate
presumably, would also be eliminated (otherwise the
and business tax rates, with the caveat that the magnitude of
system would discourage inter-vivos giving).
the reduction depends on how interest is treated.
Revenue, Economic, Distributional, and
The Urban-Brookings Tax Policy Center has estimated
Administrative Issues
average increases or decreases in after-tax income for most
With so many details to be determined, it is not possible to
taxpayers of less than one-half of 1% for the bottom 95% of
determine most effects. However, the similarity in many
the income distribution with gains of about 2% for the top
ways to the “Better Way” blueprint may provide some
95%-99% and around 9% for the top 1%. As with revenue
insights.
estimates, these estimates are rough and preliminary; better
estimates would require more detail.
The Committee for a Responsible Federal Budget has
estimated that the elements of the plan that have been
Wealthy individuals may also benefit from the repeal of the
advanced (making some assumptions about parts not
estate tax.
specified, such as bracket widths and tax expenditures to be
repealed) would reduce revenues by $2.2 trillion through
Some parts of the Framework will simplify the tax code.
2027. Including interest costs, the increase in the debt
The share of taxpayers (currently about a third) that itemize
would be $2.7 trillion. The Urban-Brookings Tax Policy
should be reduced dramatically due to the restrictions on
Center has estimated that the proposal would reduce
itemized deductions and the increase in the standard
revenues by $2.4 trillion in the first 10 years and $3.2
deduction. Other changes may lead to additional
trillion in the next 10 years. These estimates are rough and
administrative and compliance complications. The lower
preliminary. Better estimates cannot be provided without
maximum tax rate for pass-throughs could lead to
additional details.
significant complications, most notably the potential for
high-income individuals to convert their wage income to
Studies of the “Better Way” blueprint that allowed for
business income. The Framework indicates that there would
crowding out (increased borrowing to finance the debt takes
be measures to prevent this activity, but such provisions
away funds for private investment) generally found this
might be difficult to craft.
effect outweighed any effect on investment from supply-
side incentives.
Jane G. Gravelle, Senior Specialist in Economic Policy
The Framework would appear to reduce some distortions in
IF10744
the current system, such as that between debt and equity,

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The Tax Reform Framework

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