Paths to a fairer and broader U.S. tax system
Taxing capital is a key way to maintain and increase the progressivity in the U.S. tax system and raise the revenue needed to support government activities and investments that in turn will help ensure strong and sustainable economic growth. Why turn to capital as a source of government revenue? Taxing capital is a highly progressive form of taxation that research suggests does not seriously affect the rate of savings among high-income Americans—an important consideration in terms of encouraging future economic growth—and is a key part of optimal taxation in the United States. Yet the federal tax rate paid on capital income is, on average, relatively low, due to a combination of factors including low existing rates, special tax breaks, and the gaming of the system to avoid paying taxes on capital.
This report considers three key areas where the taxation of capital is in need of reform. The report lays out both fundamental reforms and intermediate steps that could be first taken by policymakers.
Taxes on gains on property that are too easy to reduce or entirely avoid
The tax system imposes taxes on gains on property—often in the form of capital gains taxes—but these taxes are too easy to reduce or even avoid entirely through relatively simple tax planning. This is because the U.S. tax system combines a realization-based income tax system (taxing gains often only upon sale of property) with elimination of accrued, untaxed gains at death. That makes it relatively easy for property owners to reduce or even eliminate the tax on gains on property by simply holding onto the property.
- Fundamental reforms: Tax capital gains on a mark-to-market basis, at least when it comes to publicly-traded assets, and charge asset holders for the benefit of deferring gains on property. Additional revenue from a proposal such as this has the potential to exceed $1 trillion over the next ten years.
- Intermediate steps: Tax gains on assets upon death or gift, eliminating one of the major tax benefits of continuing to hold property rather than selling it. Additional revenue due to this reform, in combination with a small increase in rates, would be close to $250 billion over the next ten years.
The shifting of corporate profits and corporate residence to avoid taxes
The United States imposes taxes on corporate profits at the entity level, much of which is borne by capital. But those taxes are too easily avoided by large multinational corporations, both through tax planning and movement of actual economic activity. There are two distinct problems with these taxes: They depend in part on what corporations report as their “source” of profits; and in part on whether the corporations are “resident” in the United States.
- Fundamental reforms: Change how the location of profits is determined by switching from a system focused on the “source” of the product or service that generates profits to the “destination” of the product or service—since destination of sales can be harder to manipulate. And shift more of the burden of capital taxation—perhaps especially the ordinary returns to capital—to the shareholders of corporations and away from the entity itself, since the residence of the owners is less likely to be sensitive to tax rates. It is possible that a reform such as this could be designed to raise many hundreds of billions of dollars more over the decade—and more efficiently, fairly, and sustainably than we do now.
- Intermediate steps: A minimum tax on foreign profits; tighten so-called transfer-pricing rules that allow corporations to manipulate where they source their profits, especially with regard to intangible assets such as intellectual property; make it harder especially for foreign-based corporations operating in the country to strip profits out of the United States via interest deductions on debt; and tighten rules on shifting of corporate residence out of the United States. Additional revenue from a package of reforms such as this could raise as much as $400 billion over the next ten years (not even taking into account one-time revenue from the taxation of un-repatriated profits).
Wealth taxes that apply to only a sliver of the population and are too easily avoided
The United States currently imposes a limited wealth tax in the form of the estate and gift taxes, which apply to transfers of wealth between generations. Recent changes have significantly limited estate and gift taxes—both increasing the exemption and reducing the rate. Further, aggressive tax planning allows large estates to escape taxation or significantly reduce their tax bills.
- Fundamental reforms: Adjust the taxation of transfers of wealth between generations by switching the estate tax to an inheritance tax so that the tax applies based on the number of recipients and their economic status rather than the estate. And consider imposing a wealth tax at more regular intervals and not just at the point at which assets are transferred between generations. While still focused on the very top of the wealth distribution, an inheritance tax could be designed to raise several hundred billion dollars over the next ten years, and a moderate wealth tax could potentially raise in the broad range of $1 trillion over the next ten years.
- Intermediate steps: The estate and gift tax should be applied to more wealth transfers and at a higher rate, and rules should be tightened to cut down the opportunities for gaming. Additional revenues due to these reforms would raise more than $150 billion over the next ten years.
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