A Tax Reform State of Mind

photo of a tax formThe tax code is complex and can create burdens for people and companies. And change does not come often. The last time the tax code was overhauled was in 1986.

So what (if anything) should be done to reform it? Today’s WatchBlog takes a closer look at some of the key issues related to tax reform.

Essential questions

We reported back in 2005 on key questions to consider when it comes to taxpayers and tax reform, which still apply today.

  • What should we tax?  Do we continue with the current system, which taxes the income that individuals and companies earn, or move to something like a national sales tax (which just taxes income when it’s spent)?
  • Who should pay and how much? Should wealthier taxpayers pay more than those that are less well off, or should taxpayers pay based on the benefits they receive?
  • How much tax revenue should be collected? Taxes fund government services, and reforming the tax code could raise or lower taxes—creating a surplus or deficit of revenue collected. If the government collects less revenue than it spends, it will have to borrow the difference and pay interest on that amount.
  • How will taxes affect the decisions taxpayers make?  Will taxpayers save, work, or consume more or less because of the tax?
  • Finally, will taxpayers be able to understand and comply with the tax? Will there be more or fewer taxpayers? And, will the IRS be able to administer the tax?

What about corporate taxes?

When it comes to taxing companies, two further issues frequently come up:

  • What tax rate should corporations pay? The United States taxes the income of corporations using a graduated corporate income tax rate. These tax rates range from 15 percent for corporations that make less than $50,000 to 35 percent for those that make more than about $18 million. However, when you account for the various exemptions, tax credits, and other tax benefits large corporations receive, they (on average) paid a rate of about 25 percent of their pretax net income in taxes from 2008 to 2012.
  • How should the income U.S. corporations earn abroad be taxed (if at all)? The current system taxes all income made by U.S. corporations and their subsidiaries, including income they earn abroad. However, income earned abroad by U.S.-owned subsidiaries is only taxed when it’s brought back to the United States—generally when a foreign subsidiary sends back dividends to the U.S. corporation that owns it. This can distort corporate investment and location decisions—for example, a U.S. corporation may keep money abroad because it is in a country with low taxes instead of putting that money into more productive use in the U.S. (e.g., investing in research).

Figure 1: Example of Deferral under the U.S. Worldwide Corporate Income Tax System(Excerpted from GAO-13-789)

Paying for tax reform

Finally, what if Congress decides that it wants to reduce the tax rate for individuals and companies, while ensuring that tax reforms don’t cause a budget deficit? One way to achieve this would be to eliminate certain special tax provisions that reduce the taxes a person or company must pay. These provisions are known as tax expenditures and, because of them, the federal government forgoes more than $1 trillion in tax revenue each year.

To help evaluate tax expenditures, we issued a guide on how to assess their effectiveness. Also, check out our key issues page to learn more about tax reform.

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