What does the Heritage Foundation have to say about potential tax reform:Study released May 10, 2011 (Part 3)

Heritage Foundation Responds to White House’s Austan Goolsbee

“Saving the American Dream: The Heritage Plan to Fix the Debt, Cut Spending, and Restore Prosperity,” Heritage Foundation, May 10, 2011 by  Stuart Butler, Ph.D. , Alison Acosta Fraser and William Beachis one of the finest papers I have ever read. Over the next few days I will post portions of this paper, but I will start off with the section on tax reform.

Thus, this tax plan includes three important senior-specific features:

  • During the transition to the new Social Security and Medicare
    systems, all seniors have a “senior’s standard exclusion” amount equal to the
    sum of the flat Social Security benefit amount plus the value of the Medicare
    defined contribution. This exemption amount will be approximately $22,500 per
    senior in 2015. This provision ensures that seniors protected from poverty by
    the Social Security and Medicare reforms are not again placed at risk by losing
    some benefits through taxation. As explained earlier, when the benefits reforms
    are fully implemented, the amount received by a senior will not be taxed.
  • Encouraging seniors to stay in the workforce longer is
    important both for their own financial security and for the health of the
    economy. To achieve this, the first $10,000 of a senior’s wages and salary is
    excluded from tax. This provision is especially important for low-income and
    middle-income seniors.
  • Because they are on Medicare and have the seniors’ standard
    exclusion to protect low-income seniors from tax, seniors do not qualify for the
    health insurance tax credit described above.

Protection for the Social Security and Medicare Trust Funds. The tax
system leaves in place the existing wage income reporting systems. Even though
the existing payroll taxes are eliminated, the revenues they would have raised
are credited appropriately to the Social Security and Medicare trust funds as
per current law.

Taxation of Businesses. The tax on businesses is a simple levy on
domestic net cash flow so that all compensation provided to employees and all
purchases from other businesses are deducted from gross domestic receipts. In
addition to its great simplification compared to the current income tax, this
means that businesses can immediately deduct purchases of new productive
equipment, thus eliminating a tax bias against business investment.

All other special provisions and credits in existing law are repealed except
for the Alternative Simplified R&D tax credit, which is retained in its
current form.

Family businesses in particular are able to grow without the uncertainty or
burden of dealing with the death tax, which is repealed.

After a brief transition period, the tax rate on businesses matches the rate
for individuals. During the transition period, the tax rate on businesses
declines from current law, 35 percent, a percentage point per year until the
business tax rate matches the individual rate. From that point forward,
individual and business rates will be the same

The business tax base includes only income generated by domestic sales of
goods and services. It excludes all foreign-source income, which is taxed in the
foreign jurisdictions according to their laws and systems. The tax is also
border-adjustable, which means that the federal taxation of exports and imports
is adjusted to level the playing field between foreign and domestically produced
goods and services. Specifically, the domestic tax is lifted from exports and
levied on imports, normalizing tax levels between countries much as a series of
locks on a canal raises or lowers boats so they can travel from point to
point.

Transition Arrangements. Special care is needed in transitioning
taxpayers from the old tax system to this Heritage tax plan. For example, it is
important that taxpayers are not subject to an extra tax burden solely because
of the transition. This would amount to retroactive taxation because the higher
tax burden would arise from actions taken before tax reform. Thus, all
current-law accrued tax “assets”—such as interest on pre–tax reform debt,
including existing home mortgages, depreciation, and accrued tax credits—are
applicable to taxable income or tax liability under the new tax system until the
tax assets are exhausted. As noted above there will be a period over which the
business tax rate declines until it matches the individual rate.

The shift to taxing only what businesses earn domestically is an important
simplification and an important step toward improving international
competitiveness. However, many businesses have accrued foreign tax credits under
current law that would be inapplicable under the new tax system. To provide
adequate time to adjust, businesses will have the option of being taxed under
the current system of worldwide taxation for up to 10 years after the enactment
of tax reform.

It is important to avoid retroactive taxation, but it is equally important to
avoid creating tax windfalls caused merely by transitioning from one tax system
to another. This would occur especially with respect to savings prior to tax
reform (“old savings”), which are invested in various assets generating income
streams and capital gains that are subject to immediate taxation at current
rates. These tax windfalls, which would be similar to winning a tax lottery,
would tend to benefit the wealthiest taxpayers and erode the tax base, thus
necessitating a higher tax rate. Thus, a transition system is provided to
prevent tax windfalls by ensuring that old savings remain subject to current
levels of taxation.

In the transition to the new tax system, employers will furnish their
employees with a statement on how they will handle that part of the employee’s
compensation that currently takes the form of the “employer’s share” of payroll
taxes paid to the Treasury. The options in the statement could include, among
others, an adjustment in the employee’s cash compensation, a contribution to the
employee’s savings or retirement account, or an allocation of the money to the
employee’s income tax withholdings. The Department of Labor would make template
forms available on its Web site for employers to use. After the transition, when
compensation and tax withholdings are fully adjusted, no further statements
would be necessary.

The Bottom Line

Economic growth is one of the fundamental underpinnings of fixing America’s
budget problems, so any changes in the tax system must ensure that growth is a
primary objective.

The Heritage tax plan fixes the labyrinth of complexities and inequities that
taxpayers must endure in today’s system by replacing it with a new system that
is flat, simple, and transparent. It encourages far greater economic growth by
lowering rates and removing multiple layers of taxation on the same income. One
low rate replaces today’s array of income and payroll tax rates, treats all
businesses the same, and allows them to compete better globally. We end today’s
disincentives to build savings—whether for retirement or for buying a house—by
taxing only income that is spent on consumption, so Americans can build better
economic security for themselves and their families. And we do all this without
raising taxes by injecting every dollar saved back into lower rates, not
so-called deficit reduction.

The Heritage plan will raise no more than the level of taxes Americans
historically have been willing to pay: 18.5 percent of the economy. Under our
tax plan, Americans will have far greater economic freedom, more opportunities,
more jobs, and higher wages.

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