Fundamental Tax Reform: A Comparison of Major Tax Reform Proposals

Fundamental reform of the U.S. federal tax code remains a key goal for many policymakers. Currently, House Majority Leader Richard Armey (R-TX) and Sen. Richard Shelby (R-AL); Sen. Pete Domenici (R-NM); and Reps. Dan Schaefer (R-CO) and Billy Tauzin (R-LA) have all introduced legislation to replace the federal income tax with a broad-based consumption tax. House Minority Leader Richard Gephardt (D-MO) has proposed broadening the current income tax base while lowering rates. A side-by-side comparison of their proposals is offered on page 2 of this Special Report. In addition, other reform plans are being developed. For example, Sen. John Ashcroft (R-MO) has proposed reforming the income tax by reducing marginal rates and providing a deduction for payroll taxes. Also, Americans for Fair Taxation, a private group based in Texas, has proposed replacing the federal income, social security, medicare, and estate taxes with a 23 percent national sales tax.

In addition to political factors such as voter unhappiness with the income tax, several factors contribute to the current interest in tax reform:

  • The recognition that today’s balanced federal budget is likely to be a relatively short-lived phenomenon. A new study by the General Accounting Office predicts that, absent improvement in GDP growth rates or policy changes such as reduced social security benefits, budget deficits will reemerge by 2012 as baby boomers begin to retire. Tax reform could be an important tool as we seek to ensure a strong economy in the twenty-first century.
  • A growing awareness that the U.S. federal tax code is biased against the saving and investment that is crucial to improving U.S. economic growth. The new GAO study observes that even though federal budget deficits have declined recently, total national saving and investment remain significantly below the averages of the 1970s and 1980s (see Figure 1). In addition, the United States has one of the highest tax rates on new investment in the industrialized world.
  • The conclusions of new economic studies by academic and public-sector tax policy experts that fundamental tax reform could raise rates of saving, investment, and output. For example, a recent Congressional Budget Office report concludes that switching to a consumption-based tax system would increase national saving, reduce the cost of capital, and lead to higher levels of capital formation and GDP.

The ACCF Center for Policy Research hopes this Special Report will further the debate as policymakers, the American public, and the media confront the prospect of significant changes in the current tax code.

Consumption Tax Proposals Income Tax Proposal
Flat Tax USA Tax Retail Sales Tax Gephardt 10 Percent Tax
Description Rep. Richard Armey (R-TX) and Sen. Richard Shelby (R-AL) have introduced H.R. 1040/S. 1040, the Freedom and Fairness Restoration Act, in the 105th Congress. The bill replaces the current individual and corporate federal income taxes with a flat tax which approaches a pure consumption tax. Sen. Pete Domenici (R-NM) introduced S. 722, the Unlimited Savings Account Tax (USA Tax), in the 104th Congress. The bill would replace the individual and corporate federal income taxes and provide a credit for Social Security and health insurance taxes paid. USA is a consumption tax for individuals and a subtraction-method value-added tax (VAT) for businesses. Reps. Dan Schaefer (R-CO) and Billy Tauzin (R-LA) have introduced H.R. 2001, the National Sales Tax Act of 1997, in the 105th Congress. The bill replaces the current individual and corporate federal income tax with a national retail sales tax (NRST) on final consumers. It also repeals estate, gift, and most excise taxes. Rep. Richard A. Gephardt (D-MO) has proposed broadening the income tax base by eliminating many of the current deductions and exclusions, and instituting a lower, progressive tax rate schedule and eliminating the “marriage penalty.” The proposal will be introduced as legislation by April 15, 1998.

Major Features of Individual Tax

Tax Base Includes Wages, salaries, personal service income, and pension distributions (except Social security benefits). Wages, salaries, fringe benefits, interest and dividends received which are not reinvested, capital gains not reinvested, inheritances, rent, the includable portion of Social Security, profits from business activity, and reductions in net saving. Individuals do not file a tax return unless they are engaged in retail business. All retail sales of goods and services, including home purchases, rent, financial services, and health care are subject to tax. Wages, salaries, fringe benefits (except health insurance), employer-sponsored pension contributions, interest (both taxable and also interest exempt under current law), dividends, capital gains, business income, rents, royalties, unemployment compensation, and taxable portion of Social Security benefits (as under current law).
Tax Base Excludes Interest and dividends received, rent, capital gains, inheritances, and foreign source income. However, interest and dividends are taxed at the business level. Net increase in saving and repayment of debt. No specific exclusions. N.A.
Deductions/
Adjustments
None. Mortgage interest, charitable contributions, tax-exempt bonds, tuition (up to a limit), net new saving. None. Only the following are allowed: mortgage interest, ordinary business expenses, employer-provided health insurance, investment interest expenses, alimony paid, half of self-employment taxes.
Personal Exemptions,
Family of Four
$33,800. Allowances are indexed for inflation. $17,600 Schaefer/Tauzin provides every wage earner with a refund equal to the sales tax times the poverty level of income. $27,750
Tax Rate 20% (17% after third year). Progressive rates of 8-0% phased in over 5 years. Effective rate would be lower than statutory rate for most taxpayers due to payroll tax credit. 15%. Progressive rates of 10-34%, however, proposal states that 10% rate would apply for family of 4 earning up to about $61,000 per year.
Payroll Tax No change. Refundable credit for employee portion of payroll taxes. No change. No change.
EITC Repealed. Credit would be revised to reflect shift from income to consumption tax base. It would retain current code’s progressivity. Repealed. Schaefer/Tauzin provide a personal consumption refund for all wage earners. No change.

Major Features of Business Tax

Tax Base and Deductions/
Adjustments
All businesses subject to the flat tax. Tax base is gross revenue less purchases of goods and services, capital equipment, structures, land, and wages and pension benefits paid to employees. Tax and interest expense, and fringe benefits such as health insurance, are not deductible. All businesses are subject to the USA Tax. Tax base is gross revenue less purchases of goods and services, capital equipment, structures and land, and state and local government taxes. Wages and salaries, tax and interest expense, contributions to pension funds, and benefits such as health insurance are not deductible. All businesses must collect the NRST on final sale to consumer. Sales from one business to another are exempt to prevent cascading. Tax base is gross revenue from each retail sale of goods and services. No details provided. Gephardt proposes to raise taxes on large corporations by $50 billion through elimination of provisions in the current code.
Foreign Source Income,
Exports and Imports
All foreign income is exempt from tax. The tax is imposed on an “origin” basis (income from production of goods and services is taxed in country where produced); no deduction for exports nor any taxation on imports. All foreign income is exempt from tax. The tax is imposed on a “territorial” basis (only consumption within the United States is taxed). Exports are exempt and imports are taxed. All foreign source income is exempt from tax. The tax is imposed on a “territorial” basis (only consumption within the U.S. is taxed). Exports are exempt and imports are taxed. No details provided.
Tax Rate 20% (17% after third year). 11%. Employer portion of the payroll tax can be credited against the business tax. 15%. No change.

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Consumption Tax Proposals Income Tax Proposal
Flat Tax USA Tax Retail Sales Tax Gephardt 10 Percent Tax
Description Rep. Richard Armey (R-TX) and Sen. Richard Shelby (R-AL) have introduced H.R. 1040/S. 1040, the Freedom and Fairness Restoration Act, in the 105th Congress. The bill replaces the current individual and corporate federal income taxes with a flat tax which approaches a pure consumption tax. Sen. Pete Domenici (R-NM) introduced S. 722, the Unlimited Savings Account Tax (USA Tax), in the 104th Congress. The bill would replace the individual and corporate federal income taxes and provide a credit for Social Security and health insurance taxes paid. USA is a consumption tax for individuals and a subtraction-method value-added tax (VAT) for businesses. Reps. Dan Schaefer (R-CO) and Billy Tauzin (R-LA) have introduced H.R. 2001, the National Sales Tax Act of 1997, in the 105th Congress. The bill replaces the current individual and corporate federal income tax with a national retail sales tax (NRST) on final consumers. It also repeals estate, gift, and most excise taxes. Rep. Richard A. Gephardt (D-MO) has proposed broadening the income tax base by eliminating many of the current deductions and exclusions, and instituting a lower, progressive tax rate schedule and eliminating the “marriage penalty.” The proposal will be introduced as legislation by April 15, 1998.

Major Features of Individual Tax

Tax Base Includes Wages, salaries, personal service income, and pension distributions (except Social security benefits). Wages, salaries, fringe benefits, interest and dividends received which are not reinvested, capital gains not reinvested, inheritances, rent, the includable portion of Social Security, profits from business activity, and reductions in net saving. Individuals do not file a tax return unless they are engaged in retail business. All retail sales of goods and services, including home purchases, rent, financial services, and health care are subject to tax. Wages, salaries, fringe benefits (except health insurance), employer-sponsored pension contributions, interest (both taxable and also interest exempt under current law), dividends, capital gains, business income, rents, royalties, unemployment compensation, and taxable portion of Social Security benefits (as under current law).
Tax Base Excludes Interest and dividends received, rent, capital gains, inheritances, and foreign source income. However, interest and dividends are taxed at the business level. Net increase in saving and repayment of debt. No specific exclusions. N.A.
Deductions/
Adjustments
None. Mortgage interest, charitable contributions, tax-exempt bonds, tuition (up to a limit), net new saving. None. Only the following are allowed: mortgage interest, ordinary business expenses, employer-provided health insurance, investment interest expenses, alimony paid, half of self-employment taxes.
Personal Exemptions,
Family of Four
$33,800. Allowances are indexed for inflation. $17,600 Schaefer/Tauzin provides every wage earner with a refund equal to the sales tax times the poverty level of income. $27,750
Tax Rate 20% (17% after third year). Progressive rates of 8-0% phased in over 5 years. Effective rate would be lower than statutory rate for most taxpayers due to payroll tax credit. 15%. Progressive rates of 10-34%, however, proposal states that 10% rate would apply for family of 4 earning up to about $61,000 per year.
Payroll Tax No change. Refundable credit for employee portion of payroll taxes. No change. No change.
EITC Repealed. Credit would be revised to reflect shift from income to consumption tax base. It would retain current code’s progressivity. Repealed. Schaefer/Tauzin provide a personal consumption refund for all wage earners. No change.

Major Features of Business Tax

Tax Base and Deductions/
Adjustments
All businesses subject to the flat tax. Tax base is gross revenue less purchases of goods and services, capital equipment, structures, land, and wages and pension benefits paid to employees. Tax and interest expense, and fringe benefits such as health insurance, are not deductible. All businesses are subject to the USA Tax. Tax base is gross revenue less purchases of goods and services, capital equipment, structures and land, and state and local government taxes. Wages and salaries, tax and interest expense, contributions to pension funds, and benefits such as health insurance are not deductible. All businesses must collect the NRST on final sale to consumer. Sales from one business to another are exempt to prevent cascading. Tax base is gross revenue from each retail sale of goods and services. No details provided. Gephardt proposes to raise taxes on large corporations by $50 billion through elimination of provisions in the current code.
Foreign Source Income,
Exports and Imports
All foreign income is exempt from tax. The tax is imposed on an “origin” basis (income from production of goods and services is taxed in country where produced); no deduction for exports nor any taxation on imports. All foreign income is exempt from tax. The tax is imposed on a “territorial” basis (only consumption within the United States is taxed). Exports are exempt and imports are taxed. All foreign source income is exempt from tax. The tax is imposed on a “territorial” basis (only consumption within the U.S. is taxed). Exports are exempt and imports are taxed. No details provided.
Tax Rate 20% (17% after third year). 11%. Employer portion of the payroll tax can be credited against the business tax. 15%. No change.