Interest in fundamental tax reform is growing. Various legislative proposals have been introduced and the Administration's Greenbook has proposed numerous changes to the U.S. international tax system. On August 27, 2010, the President’s Economic Recovery Advisory Board, chaired by Paul Volcker, released a report summarizing options, most of which have been considered previously, for reforming the tax system.
As we face the prospect of tax reform, it is important to consider the different types of fundamental tax reform, the international aspects of tax reform, and the kinds of transitions rules that are needed should the United States shift to a new system of taxation. These issues are certainly not the only items that need to be given consideration as the United States considers fundamental tax reform; these considerations generally represent the threshold questions which must be asked as we consider alternative systems of taxation.
TYPES OF FUNDAMENTAL TAX REFORM
Basic Corporate Tax Reform
- Generally, this involves lowering the tax rate and broadening the tax base.
- Examples of this type of tax reform include the 1986 Tax Relief Act, the 2005 President's Advisory Panel on Federal Tax Reform, the 2007 Treasury Department Report, the Rangel "Mother" Bill, and the Wyden-Gregg tax reform proposal.
- Under corporate integration, income from corporate sources would no longer be taxed twice, either by eliminating the tax at a corporate level (i.e., allowing a deduction for dividends paid by corporations), or at the individual level (i.e., giving corporate shareholders an exclusion, tax credit, or preferential tax rate).
- Examples of this type of tax reform include the 1992 Treasury comprehensive business income tax (CBIT) and the 2007 Kleinbard business enterprise income tax (BEIT).
VAT to Replace the Corporate Tax
- If a VAT were to replace the corporate tax, a higher corporate tax would be replaced with a lower rate consumption tax.
- Examples of this type of tax reform include the 1995 Nunn and Domenici "USA tax" and the 2007 Treasury Department report's business activity tax (BAT).
Comprehensive Consumption Tax
- Under this type of reform, a new business tax, with expensing, combined with a tax on individuals creates comprehensive consumption tax. Past proposals suggested an individual tax (on wages) combined with a business tax (allowing a deduction of wages, denying a deduction for interest, and allowing immediate expensing).
- Examples of this kind of reform include the 1994 Armey flat tax and the 2005 President's Advisory Panel growth and investment tax (GIT).
INTERNATIONAL ASPECTS OF TAX REFORM
When contemplating fundamental tax reform, consideration must also be given to international aspects of tax reform. These include, but are not limited to:
- If basic tax reform or corporate integration is the type of tax reform considered, how should foreign source income be taxed?
- Should the United States shift from a worldwide to a territorial system of taxation?
- Is there a specific country's territorial system that could work well in the United States?
- What can be learned from countries like the United Kingdom and Japan transitioning to territorial systems?
TAX REFORM AND TRANSITION RULES
If the United States undertakes fundamental tax reform, consideration must be given to how we go from the current system of taxation to the new one. Considerations include:
- What transition rules are necessary if we shift from the current system to a new system?
- What grandfathering should be permitted?
- What rules will be necessary to address "churning" issues?
- What should be done to prevent retroactive tax increases?
As interest in fundamental tax reform grows, the U.S. Chamber of Commerce urges you to use the resource links above for valuable material on the issues that need to be considered.