Tax Reform: Examining the Taxation of Business Entities

Comments for the Record

Senate Finance Committee

Tax Reform: Examining the Taxation of Business Entities

Wednesday, August 1, 2012, 10:30 AM

By Michael G. Bindner

Center for Fiscal Equity

Chairman Baucus and Ranking Member Hatch, thank you for the opportunity to submit these comments for the record to the Senate Finance Committee.  As always, our comments are in the context of our four part tax reform plan.

• A Value Added Tax (VAT) to fund domestic military spending and domestic discretionary spending with a rate between 10% and 13%, which makes sure every American pays something.
• Personal income surtaxes on joint and widowed filers with net annual incomes of $100,000 and single filers earning $50,000 per year to fund net interest payments, debt retirement and overseas and strategic military spending and other international spending, with graduated rates between 5% and 25% in either 5% or 10% increments.  Heirs would also pay taxes on distributions from estates, but not the assets themselves, with distributions from sales to a qualified ESOP continuing to be exempt.
• Employee contributions to Old Age and Survivors Insurance (OASI) with a lower income cap, which allows for lower payment levels to wealthier retirees without making bend points more progressive.
•  A VAT-like Net Business Receipts Tax (NBRT), which is essentially a subtraction VAT with additional tax expenditures for family support,  health care and the private delivery of governmental services, to fund entitlement spending and replace income tax filing for most people (including people who file without paying), the corporate income tax, business tax filing through individual income taxes and the employer contribution to OASI, all payroll taxes for hospital insurance, disability insurance, unemployment insurance and survivors under age 60.

We refer Senators, staff and the public to our prior testimony before the committee for a more detailed presentation of these proposals, which are also available on our blog at http://fiscalequity.blogspot.com.  We are also available for detailed briefings of our proposal.

Our proposals would regularize the taxation of business entities.  Currently, how taxation occurs depends upon the form of ownership of the business.  This will no longer be the case.  Both the value added tax and the VAT-like net business receipts tax will be assessed on all value added, with the chief differences the two being that the VAT will be entirely border adjustable and have only one offset (excess NBRT offsets) while the NBRT will have offsets for various social purposes – from guaranteeing family income to providing health care and education for employees, future employees and retirees with no border adjustability unless a tax in excess of tax expenditures is actually collected (however tax benefits must first be fully  utilized for this to be allowed.  

Personal income taxes will only be filed for the highest quintile of taxpayers, with graduated rates so that middle class taxpayers pay less than those with the highest incomes.  Much, if not all, of the complexity currently endemic to personal income taxation will be moved to business taxes, which will also be greatly simplified.  The only possible personal income surtax deductions will be for sales of assets to a qualified Employee Stock Ownership Program and for charitable contributions – and even these may be forgone to achieve lower rates.  The ESOP exclusion could ended if the NBRT includes an offset for creation of insured personal retirement accounts holding employer voting stock, as a tax incentive will no longer be required in such a case to bring about more such ownership.

The vast majority of taxpayers will no longer be required to file personal income taxes, provided that employer provided disclosures of Child Tax Credit benefits match those reported to the Internal Revenue Service, which will also provide a report of deductions paid.  Filing will only be required if there is a difference between the two filings or if excess credits were granted by the employers of both spouses.  This filing will require no more effort for employers than the current tax system, while greatly reducing the amount of effort required to process tax returns.  Larger employers will likely be able to file all forms automatically and electronically as many firms do now.

Consideration was given to abandoning personal income taxation entirely, as proposed as a possibility by Lawrence B. Lindsey.  We considered and abandoned this approach in our 2005 submission to the Presidents Task Force on Tax Reform because it would have some lower income taxpayers pay either too little or too much or require onerous privacy intrusions into the income and investment information of employees and investors in order to calculate the correct NBRT surtax amount.  We concluded that the government would be preferable for this purpose than requiring sharing all employment information with brokers and invested firms while sharing all investment information with employers.

Many deductions and tax benefits required for business taxation will be abandoned because of the transition from taxing profit to taxing all value added, which includes both labor and profit.  The rationale for many tax breaks simply do not exist when the base is broadened in this away – especially those targeted to specific industries.  The biggest exclusion to be repealed will, of course, be labor costs – which is by far the biggest element of value added.  While there will certainly be some complexity involved in judging the taxability of fixed assets, this will certainly be no more complex than the current tax code – with the possibility that many investments will be deducted in the current period.

Thank you for the opportunity to address the committee.  We are, of course, available for direct testimony or to answer questions by members and staff.