BEYOND THE NUMBERS
The 2017 Trump tax law — and the Bush-era tax laws before it — slashed the taxes of wealthy people and multinational corporations and lost large sums of revenue. The reconciliation bill passed by the House late last year would do the opposite, raising taxes on high-income individuals and large corporations while generating a reported $1.85 trillion to begin to rebuild the federal revenue base. While the House bill doesn’t literally reverse provisions of the 2017 law, it does reverse a significant portion — though certainly not all — of the revenue loss from those tax cuts by asking high-income households and large multinational corporations to pay a fairer amount of taxes. Moreover, the bill would make many important tax reforms, including those that are urgently needed to advance a global agreement to reduce the flow of profits to tax havens.
Below we examine each of the three main areas of revenue changes in the House bill — high-income individuals, corporations (including large multinational corporations), and the tax gap — and discuss key reforms that the Senate should include in its own reconciliation bill.
The House-passed bill would impose a new 5 percent surtax on households with adjusted gross income (AGI) above $10 million and an extra 3 percent tax (for a combined 8 percent) on those with AGI above $25 million. The surtax, which would raise $228 billion over ten years according to the Joint Committee on Taxation (JCT), would apply to a broad income base, including salaries, pass-through income (income that owners of certain businesses, such as partnerships and S corporations, report on their individual tax returns), and realized capital gains and dividends.
The AGI surtax would reverse much of the effect of the Bush and Trump tax cuts for the richest taxpayers. The 2017 Trump tax law cut the top individual tax rate from 39.6 percent to 37 percent and created a 20 percent deduction for certain pass-through business income, which overwhelmingly flows to very high-income households and was described by the late Edward Kleinbard, who served as JCT chief of staff from 2007-2009, as “Congress’ worst tax idea ever.” These regressive tax cuts compounded the deep Bush-era reductions in the capital gains and dividend tax rates.
While the House package doesn’t directly raise rates on capital gains and dividends, the surtax effectively raises these tax rates for multi-millionaires. One drawback is that the high AGI threshold applies only to a small share of the very highest-income households. But it’s an important first step, and the Senate should include it.
The House-passed bill also includes important reforms that would affect high-income taxpayers. For example, it would close a major loophole that allows some high-income pass-through business owners to avoid paying the 3.8 percent Medicare tax on wages and self-employment income and a parallel 3.8 percent tax on net investment income, raising $250 billion over ten years. This loophole gives high-income professionals, such as lawyers or investment fund managers, a significant incentive to recharacterize their income or to rearrange their business operations to avoid the tax.
Unfortunately, the House-passed bill includes an ill-advised tax cut over the next several years by eliminating the cap on the state and local tax deduction, which largely (but not entirely) benefits high-income households. The Senate should either exclude the provision altogether or modify it so that high-income households don’t benefit.
Corporate and International Taxation
The House-passed bill would raise the effective tax rate (i.e., the total taxes paid as a share of pre-tax profits) for some of the largest multinationals by imposing a new 15 percent minimum tax on the income reported to shareholders, known as “book” income. Book income is often much higher than taxable income reported to the IRS. This minimum tax would raise $325 billion over ten years from companies with financial statement profits above $1 billion.
Though it doesn’t change the statutory rate, this provision would significantly offset the cornerstone of the 2017 Trump tax law: a deep, regressive cut in the corporate tax rate from 35 percent to 21 percent. The 2017 cut in the corporate rate largely benefitted corporate shareholders, of whom the vast majority are wealthy households and foreign investors. The new minimum “book” tax in the House bill raises revenues from corporations — the incidence of this tax increase will largely fall on wealthy corporate shareholders.
The House-passed corporate package also includes important tax reforms, including a new excise tax of 1 percent of the value of repurchased stock of publicly traded U.S. corporations. This provision would raise $125 billion over ten years. Corporations have two basic ways to distribute profits to their shareholders: issue dividends or offer to buy back a certain number of their own shares, which in turn raises the value of remaining stocks held by individuals and institutions.
While these are economically similar from the standpoint of both shareholders and the corporation, they have very different tax implications under current law. Dividends are generally taxable when shareholders receive them, albeit at low rates. In contrast, under a stock buyback, shareholders who sell their shares to the corporation at a gain owe capital gains tax. The shareholders who don’t sell their shares, however — typically the overwhelming proportion — see the value of their shares rise but don’t pay tax on the gain until they sell the shares. Their wealth increases but their taxes don’t. By imposing a 1 percent excise tax on share buybacks, this provision is designed to help correct this tax policy inefficiency.
The House bill’s international tax reforms are its most important corporate tax changes. The bill would make crucial changes to the 2017 law’s international tax framework — including the minimum tax on global intangible low-taxed income, or GILTI — which left significant room for profit shifting. For example, the House bill would strengthen GILTI by raising the tax rate on foreign profits to just over 15 percent (from 10.5 percent today) and would require corporations to calculate the GILTI minimum tax in each country in which they operate instead of on an aggregate basis. These changes would keep companies from avoiding the tax by “blending” taxes and income in low- and high-tax countries.
These changes are especially important because they would more closely conform our international tax laws with the recent, once-in-a-century multilateral agreement to modernize the international tax system. The Biden Administration has strongly pushed for this agreement, which more than 130 countries have agreed to. Once implemented, it would establish a global minimum corporate tax that ensures multinationals are taxed at a 15 percent rate in each country in which they operate, helping to ensure that companies’ decisions on where to locate and book profits are based on economic factors, not on differences in countries’ corporate tax systems.
The international deal marks an important step toward international coordination to end profit shifting, but individual governments, including the U.S., must implement the deal’s terms. The European Union has begun the process of formally adopting the minimum tax. The House-passed package largely conforms with the agreement, but the Senate urgently needs to do its part.
Finally, the House-passed bill includes another much-needed tax policy reversal that would ensure that the IRS collects more legally owed taxes, particularly from wealthy people, who make up the largest source of the $600 billion annual tax gap. (People with more modest incomes tend to earn regular wages and their taxes are deducted from their pay every pay period and, therefore, have very high tax compliance rates.)
The IRS budget was gutted from 2010 to 2020. The audit staff, which handles the most sophisticated tax returns (e.g., those from the wealthiest taxpayers), has been depleted to levels not seen in over a half century, causing audit rates of millionaires to plummet. Meanwhile, the IRS’s computer systems continue to grow more outdated, hampering strong enforcement of the tax code. The House-passed bill would infuse roughly $80 billion in long-term funding to give the IRS budget certainty to rebuild its staff, modernize its systems, improve service, and reduce the large tax gap.
The 2017 tax law showered tax cuts on people and corporations who didn’t need them. And on top of these legal tax cuts, the defunding of tax enforcement efforts meant that they could more easily skirt the law and pay less than they owed without being detected. The House-passed bill begins to reverse these misguided policy priorities.