When lawmakers discuss tax reform, they often refer to the 1986 overhaul of the tax system (the 1986 Act) enacted under President Ronald Reagan. Lawmakers are currently wrestling with proposals for deficit-neutral tax reform that can live up to that bellwether, and a shelved 2014 plan from former Representative Dave Camp (R-MI) (the Camp plan) is experiencing something of a renaissance.
The 1986 Act enjoyed bipartisan support while implementing substantial tax cuts. It was also designed to be deficit-neutral, a task accomplished by broadening the tax base to offset the lower rates. However, the 1986 Act was also intended to be “distributionally neutral,” a concept that is not often discussed with current tax proposals. The core principal of distributional neutrality is that the share of revenue paid by taxpayers in each income bracket remains the same under new tax legislation. It was this feature that may have provided the final impetus to get the 1986 Act passed in a bipartisan process, and this same feature is prominent in the Camp plan.
Camp’s plan features many provisions that broaden the tax base to offset rate cuts, but its focus on distributional neutrality for individual income taxes makes it a candidate for bipartisan support. The role of distributional neutrality in permanent tax reform legislation could be significant. In previous articles we discussed why Congressional rules favor deficit neutral tax reform, as well as possibilities to pay for tax reform. These possibilities, including a potential border adjustment tax, all focus on deficit neutrality. Distributional neutrality can be seen as a counter to the notion that certain tax cuts only benefit the wealthy.
Distribution Neutrality in the Camp Plan
A glimpse into the tax rate brackets endorsed under the Camp plan provides context on how the distributional aspects of its proposals operate. On the individual side, the Camp plan features three tax brackets set at 10 percent, 25 percent, and 35 percent. If these rates look familiar, they are the same as those in the recently released Tax Outline from President Donald Trump. However, the aspects of distributional neutrality in the Camp Plan would quickly change these dynamics.
To provide against an absolute tax cut for high income earners, the Camp plan contemplates a surtax on top of its 25 percent tax bracket, begetting its 35 percent tax bracket. This 10 percent surtax would be levied on certain types of income above a modified adjusted gross income (MAGI) of $400,000 for single filers, and $450,000 for joint filers. MAGI for this purpose would be AGI minus charitable contributions and qualified domestic manufacturing income, and plus employer provided health benefits, the self-employment health deduction, foreign income, tax exempt interest, untaxed social security benefits, and currently excluded 401(k) contributions. This 10 percent additional surcharge is added to the tax on the income taxed at the 25 percent rate to create the plan’s 35 percent rate bracket.
The Camp plan also provides for other provisions that serve to both broaden the tax base and retain distributional neutrality. Worth noting are three such provisions that can be viewed as compensating for revenue losses that stem from tax rate reductions for high income individuals. The first of these is the curtailing of a deduction for state and local taxes. A recent report by the Tax Foundation estimated that more than 88 percent of the benefit of this deduction is enjoyed by taxpayers with income above $100,000. This proposal also appears in the President’s tax outline, though its purpose there appears to compensate broadly for other revenue losses, rather than to achieve distributional neutrality. Additionally, the state and local tax deduction effectively serves as a subsidy for individuals to afford higher state tax burdens. This has a secondary distributional effect as only higher income individuals are subject to the higher state tax rate.
A second provision of the Camp plan that addresses distributional neutrality is a series of phase-out rules. For instance, the Camp plan provides for a phase-out of the 10 percent bracket for high income individuals. Additionally, the Camp plan provides for a phase-out of the standard deduction and child tax credit (each of which otherwise are at increased levels compared to historical amounts). These phase-outs work sequentially, starting with eligibility for the 10 percent bracket, then the standard deduction (or an equivalent amount of itemized deductions), and ending with the child tax credit. These phase-outs begin at $250,000 for single individuals ($300,000 for joint filers). The loss of the benefit from 10 percent rate bracket may be the most significant for these individuals, effectively causing all of their first $400,000 ($450,000 for joint filers) of income to be taxed at a 25 percent rate. Because the 10 percent rate otherwise applies to the first $36,500 of income for single filers ($71,000 for joint filers), it results in a significant increase in tax liability.
The third significant provision of distributional neutrality endorsed under the Camp plan is a reduction in the amount of eligible debt for a mortgage interest deduction. The limit under the Camp plan would be reduced from $1 million to $500,000 (gradually over a four year period). As with the state and local tax deduction, the Tax Foundation found that this deduction is disproportionately claimed by those with higher incomes. Lowering these thresholds would clearly affect high net-worth individuals, as they are more likely to buy homes that cost more than these limits.
Notwithstanding these three provisions, the Camp plan contains other proposals that could have an effect on the distribution of tax burden. Among these are a series of current provisions that would be eliminated, such as:
- The personal exemption
- The current itemized deduction limits
- The alternative minimum tax (AMT)
- The deduction for student loan interest
- The adoption tax credit
- The deduction for tax preparation fees
- The medical expense deduction
- The moving expense deduction
While these deductions generally are claimed in fewer cases, elimination of the AMT would be more pervasive. It is designed therefore to be offset by the new additional surtax and the 10 percent rate phase-out.
Distributing the Tax Burden
With all of these key ambitions for distributional neutrality summarized, does the Camp plan meet the objective for distributional neutrality; is the relative tax burden the same across all income levels? The short answer is no, there are groups that pay more under the proposal and groups that pay less. Overall, the Camp plan contemplates a $56.3 billion dollar tax cut for individuals earning less than $100,000 annually, according to estimates from the Joint Committee on Taxation (JTC). Nearly half of that tax cut would go to those who earn between $75,000 and $100,000. Conversely, the JCT estimated that taxpayers whose earnings exceed $100,000 would face a collective tax increase of $19.6 billion. While a level of inequality is anticipated with respect to distribution of the tax burden, its dynamic is quite different than that predicted under the House Blueprint or the President’s tax outline. For instance, the Tax Policy Center estimated that the House Blueprint would provide 75 percent of its tax cut benefits to those who are the top 1 percent of earners.
While the Camp plan does not accomplish pure distributional neutrality, it is much closer to that objective than other proposals currently debated by lawmakers. This may form the basis of a potential starting point for permanent bipartisan tax reform if Congressional Republicans do not pass a tax reform package through the budget reconciliation process. The Camp plan’s attractiveness to some lawmakers lies with its broadening of the base to address deficit concerns, while also addressing the notion that tax rate cuts disproportionately benefit the wealthy. And, the Camp plan is further along in the drafting process as it has been written into legislative text. This is in contrast to the House Blueprint, which is more aptly described as a detailed set of principles, and the President’s tax outline which is more of a set of broad policy goals.
The individual income tax provisions are only one component of the Camp plan. The Camp plan’s provisions result in an individual tax cut of about $580 billion that is offset by a corresponding increase in the tax burden for businesses. We will address the provisions that lead to this increase in a future article. If you would like further information about the Camp plan, please contact your local CBIZ tax professional.
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