House Ways and Means Chairman Dave Camp’s tax reform plan hasn’t generated a groundswell of support for comprehensive tax reform this year, but it offers two important lessons for the tax issue that Congress likely will address: the “tax extenders,” several dozen lapsed tax breaks (mostly for corporations) that Congress perennially extends. First, it embraces the principle that policymakers should pay for continuing any extenders. Second, it eliminates various inefficient tax loopholes, thereby generating significant savings that could pay for any extenders that policymakers think are worth continuing.
The tax extenders are costly — about $50 billion a year in lost federal revenue. In fact, policymakers could erase about 15-20 percent of the total expected increase in the debt as a share of the economy over the next 25 years by paying for any extenders that they continue. The Camp plan shows how it could be done.
First, the Camp plan assumes at the start that the tax extenders expire, consistent with current law and conventional budget rules. That meant it had to offset the cost of any extenders that it continued in order to meet its goal of revenue neutrality.
While we’ve explained that revenue neutrality is an inadequate goal for tax reform given the challenge of long-term deficits — and that the Camp plan likely wouldn’t even meet this inadequate goal after the first decade — the plan advances a principle that policymakers should follow: they should pay for any extenders that they continue.
Similarly, while one can question Chairman Camp’s decisions about which extenders to continue, the basic principle that lawmakers should pay for continuing any of them is sound.
Second, the Camp plan provides full legislative detail of how policymakers could pay for the tax extenders by closing loopholes (though it doesn’t earmark those revenues specifically to offsetting the extenders). The plan’s list of revenue raisers includes:
- Closing the S corporation loophole. An S corporation is a “pass-through” company, which means that it doesn’t pay corporate tax on its profits, but those profits are passed through to shareholders, who pay personal income taxes on them. Many S corporation shareholders receive both wages from the firm and a share of firm profits, but they pay payroll tax only on their wages. This gives them an incentive to underreport their income that consists of wages in order to reduce their payroll tax liability. The Camp plan would close this loophole, raising $15.3 billion over ten years.
- Eliminating the “like-kind exchange” tax break. The sale or exchange of property for money or other property generally triggers capital gains tax, but no tax is levied on the exchange of property for what the tax code loosely defines as “like-kind” property. Any gain from a like-kind exchange is deferred from tax until the owner sells the replacement property and, if the owner passes the property to an heir instead of selling it, capital gains tax is permanently eliminated.
This tax break was apparently intended to exempt small-scale and informal barter transactions from taxation and reporting requirements. But, as the New York Times notes, “Over the years . . . the practice of exchanging one asset for another without incurring taxes spread to everyone from commercial real estate developers and art collectors to major corporations.” The Camp plan would close this loophole, raising $40.9 billion over ten years.
- Reducing tax avoidance by
lifeinsurance companies. Insurers commonly shift U.S.-earned profits to affiliated reinsurers based in Bermuda or other tax havens. The Camp plan would restrict this activity, raising about $8.7 billion over ten years.
- Restricting the generous tax treatment of corporate-owned life insurance. Businesses can generate substantial tax savings with arrangements that involve taking out insurance policies on their employees or owners. While nominally “insurance,” many of these policies are effectively investment vehicles. In a nutshell, a business buys insurance, has the insurer invest the premiums on its behalf, and then receives tax breaks on the resulting gains. Further, the company can generally deduct the cost of the premiums; some of the most aggressive uses of corporate-owned life insurance involve companies trying to maximize those deductions. The Camp plan adopts an Obama proposal to tighten the tax rules related to corporate-owned life insurance, which would raise $7.3 billion over ten years.
In saying that policymakers should pay for the extenders and showing ways to do it, the Camp plan performs a valuable service.