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February 27, 2014
Camp Tax Reform Draft Would Cut Rates While Cutting Back on Popular Tax Breaks
by Lindsey McPherson, Meg Shreve, and Luca Gattoni-Celli

Full Text Published by Tax Analysts®

House Ways and Means Committee Chair Dave Camp, R-Mich., on February 26 released his long-awaited plan to overhaul the tax code, proposing sweeping cuts and changes to individual and business tax breaks to pay for significant tax rate cuts.

Despite proposing to limit or eliminate some of the most coveted tax breaks, like the mortgage interest deduction and the state and local tax deduction, Camp said his presentation on the plan to the House Republican conference, given a few hours before the draft's release, was well received.

"People are hungry for the debate," Camp said after the presentation. "We need to be the party of growth and opportunity, and that's what tax reform can bring us."

It's unclear what details Camp shared with his colleagues, but his draft shows that he made some decisions likely to anger several constituencies. For example, Camp is proposing to eliminate the state and local tax deduction and decrease the cap on new mortgages eligible for the mortgage interest deduction from $1 million to $500,000.

The committee has information to suggest that few people will be affected by the changes to the mortgage interest deduction, Ways and Means member Charles W. Boustany Jr., R-La., said, adding that the committee still welcomes constructive input from the real estate industry on the proposal. "Just don't slam the door and say no," Boustany said. "Give us the full analysis of why this is bad."

Most lawmakers Tax Analysts talked to -- both Republicans and Democrats -- called the draft a launching point for further debate on tax reform.

Camp also referred to the draft as a discussion starter and declined to answer questions about the future of the plan, which has not been introduced as legislation but is titled the Tax Reform Act of 2014. He said he plans to conduct additional briefings with his colleagues as well as outside groups on the plan before deciding whether to move to a markup.

House Speaker John A. Boehner, R-Ohio, told reporters that House Republicans were just starting debate on the issue. "It's time to have a public conversation about the issue of tax reform," he said, adding that he expects the debate to be healthy and informative.

Rate Goal Met?

Camp's plan, which with some exceptions would take effect after the 2014 tax year, would cut the top individual and corporate tax rates to 25 percent, as he had promised. It also would get rid of both the individual alternative minimum tax and the corporate AMT. But on the corporate side, it would eliminate the bottom 15 percent rate on income under $50,000, and on the individual side, it would create a new 10 percent surtax for individuals making more than $400,000 and joint filers making more than $450,000 under a specific definition of modified adjusted gross income.

Debate has already begun on whether the surtax should simply be considered a third income tax bracket of 35 percent (Camp's proposal has a bottom individual rate of 10 percent). Even some conservative groups, such as the Heritage Foundation, have referred to it as such. Camp said that he does not consider 35 percent to be the top individual rate and that that is not how the Joint Committee on Taxation analyzed the surtax.

The legislative text identifies a 35 percent tax bracket but says that the bracket is applied to a different base of income. Under the proposal, taxpayers who fall into the bracket pay a 25 percent rate on AGI up to $400,000 for individuals and $450,000 for joint filers. Taxpayers pay a 35 percent tax above those thresholds, but on a modified AGI that counts as taxable income employer-provided health benefits, section 911 income, tax-exempt interest, section 401(k) plan contributions, untaxed Social Security benefits, and state and local municipal bond interest while excluding charitable contributions and domestic manufacturing income.

In effect, Camp is proposing to cap some tax preferences at the 25 percent bracket, according to a Ways and Means aide speaking on background.

Under Camp's proposal, capital gains and dividends will be taxed as ordinary income but only after a 40 percent exclusion. The draft makes no changes to estate and gift tax provisions, according to another committee aide speaking on background.

The standard deduction would be nearly doubled in Camp's draft from $6,100 to $11,000 for individuals and from $12,200 to $22,000 for joint filers. Single parents would get an additional deduction under Camp's plan. However, the draft also would repeal personal exemptions and the additional standard deduction. The child credit would be expanded to $1,500 per child and $500 per dependent.

Camp proposes to eliminate several itemized deductions and exclusions, including the deductions for medical and moving expenses. The charitable deduction would be kept and simplified by streamlining AGI limitations and allowing taxpayers to deduct charitable contributions made after the end of a tax year and before April 15. Taxpayers would be allowed to deduct only those contributions that exceed 2 percent of their AGI.

Corporate and Passthrough Reforms

Camp's proposal to institute a flat 25 percent corporate rate would be phased in over five years.

The plan would make permanent a modified version of the expired section 41 research credit equal to 15 percent of qualified research expenses and 15 percent of basic research payments over specific thresholds. The draft would repeal the section 199 domestic production credit starting in 2016 after a transitional phaseout in 2015.

The section 45 production tax credit is also slated for repeal, but it would be phased out over a 10-year period beginning in 2014; Camp proposes chopping the credit's inflation adjustment after 2014. The draft also would eliminate other tax incentives aimed at the alternative energy sector, such as the section 179D credit for energy-efficient commercial buildings and the section 45L credit for new energy-efficient homes.

The draft also would repeal the 2.3 percent excise tax on medical devices, which was enacted as part of the Affordable Care Act.

Several other popular business incentives also are targeted in the draft, including the modified accelerated cost recovery system, which would be repealed and replaced with a slower depreciation system for property placed in service after 2015.

In a highly political move that is expected to raise significant revenue, the draft proposes a quarterly excise tax on systemically important financial institutions, as defined by the Dodd-Frank Wall Street Reform and Consumer Protection Act, with assets in excess of $500 billion. The tax would be applied at a 0.035 percent rate every quarter.

On passthrough taxation, many taxpayers will likely be relieved that Camp chose not to include the so-called Option 2 unified passthrough regime from his small business discussion draft, opting instead to preserve, but tweak, subchapters S and K. However, Camp retained the proposal to make section 743(b) and section 734(b) basis adjustments to partnership property mandatory upon transfer or distribution of the property.

Although he previously refrained from taking a position on the tax treatment of carried interest, Camp included in the draft a proposal to treat as ordinary income a portion of the earnings stemming from an applicable partnership interest held in connection with the performance of services. The JCT estimated that the proposal would raise just $3.1 billion -- more than five times smaller than that estimated for President Obama's carried interest proposal.

Camp also proposed repealing the 1982 Tax Equity and Fiscal Responsibility Act and electing large partnership audit rules, replacing them with a streamlined audit regime that would shift, with some exceptions, review-year partner-level liability onto partnerships with more than 100 partners and apply the liability to the adjustment year.

Camp proposed fundamental changes to the taxation of financial instruments. Among the most drastic is a proposal to mark derivatives to market at ordinary income rates. However, the provision would not apply to transactions identified as hedges and would allow taxpayers to use financial accounting standards when identifying hedges. Also, some losses would be permanently disallowed in wash sale transactions among related parties. The draft would affect bond treatment by requiring current inclusions in income for bond market discount and by changing the debt modification rules to no longer require gain or loss recognition upon modification.

International Proposals

The international tax reforms in Camp's draft would move away from the current system in favor of a 95 percent dividend exemption upon distribution of foreign earnings. The plan also calls for a one-time transition tax on all previously untaxed foreign earnings and profits, with cash or cash equivalents being taxed at 8.75 percent and any remaining E&P being taxed at only 3.5 percent.

Camp's draft would earmark the revenue from the deemed repatriation of corporate foreign dividends to the Highway Trust Fund. A Ways and Means aide speaking on background said the revenue from the transition tax would help finance the fund as Congress works on a longer-term funding solution. The current Highway Trust Fund's expenditure authority is scheduled to expire in September.

The White House on February 26 reiterated its call for using one-time revenue raised through a transition to the Obama administration's corporate tax reform proposals for infrastructure funding. The administration said in a fact sheet that $150 billion raised from that one-time transfer would go toward the Highway Trust Fund and new infrastructure spending. The proposal will be included in Obama's coming fiscal 2015 budget plan.

Under Camp's draft, potential base erosion would be combated through the addition of a new category of subpart F income -- foreign base company intangible income -- as well as limitations on allowable interest expense deductions. Subpart F income rules would likewise be modified to subject to U.S. tax only low-taxed foreign income, including foreign base company sales income, foreign personal holding company income, and foreign base company intangible income.

Exempt Organizations

Camp's draft includes several provisions that would respond to the IRS's mishandling of exemption applications by placing limits on the agency's ability to oversee section 501(c)(4) social welfare groups. Under the draft, the IRS would be prohibited for one year from imposing any new regulations regarding the extent of political activity allowed by social welfare groups, including the proposed regulations (REG-134417-13) released in November. The House on February 26 passed a separate Camp bill to block the IRS for a year from finalizing the proposed regulations.

Under the Camp draft, social welfare groups would be required to notify the IRS of their intent to begin operations, but they would not have to file a Form 1024, "Application for Recognition of Exemption Under Section 501(a)." Instead, information normally submitted on that form would be included in the organization's first information return. The groups also would no longer have to file with the IRS a list of donors who contribute $5,000 or more per year, except those who are officers in the organization or one of its five highest-paid employees. Public disclosure of that list would still be prohibited.

The draft would place a moratorium on any new IRS conferences until the Treasury Inspector General for Tax Administration submits a report saying that the IRS has complied with all the recommendations included in a 2013 TIGTA report on IRS conference spending. Agency employees would be prohibited from using personal e-mail accounts to conduct IRS business, and employees would face mandatory termination if they act for personal gain or for political purposes. The IRS commissioner also would be responsible for ensuring that employees are aware of taxpayer rights.

Score and Growth Projections

Camp's draft is not exactly revenue neutral; it actually would raise $3 billion from 2014 to 2023, according to the JCT's score (JCX-20-14). Excluding passthrough base broadening, the JCT projected that individual income tax payments would be lower by about $590 billion, meaning businesses would ultimately foot the bill for Camp's reforms.

A JCT distributional analysis (JCX-21-14) based on the conventional revenue estimating method found that the draft would roughly maintain relative tax burdens on various income segments over the 10-year budget window, in terms of both average tax rates and shares of tax receipts.

The JCT also projected economic and job growth in a much-anticipated macroeconomic analysis (JCX-22-14) using two different models whose structure -- and growth estimates -- differ greatly. The JCT projects $50 billion to $700 billion of revenue from macroeconomic effects, in addition to the $3 billion conventional score.

Real GDP is projected to grow 0.1 to 0.6 percent faster under the JCT's macroeconomic equilibrium growth (MEG) model, which assumes individuals do not anticipate future changes in law. But under the JCT's overlapping generations lifecycle model (OLG), which assumes individuals perfectly anticipate future changes in law, real GDP is projected to grow 1.5 to 1.6 percent faster. OLG also accounts for international effects while MEG does not.

MEG projects private sector employment and labor force participation would increase 0.4 to 0.8 percent and 0.3 percent, respectively. OLG projects both to increase 1.3 to 1.5 percent.

Democrats are "very wary of so-called dynamic scoring," Ways and Means ranking minority member Sander M. Levin, D-Mich., said.

'Not Satisfied With Waiting'

Camp said he decided to release the draft because Ways and Means is ready, adding, "I'm not satisfied with waiting."

But waiting is exactly what some lawmakers would have preferred. "It's hard to figure out the politics of doing it like this at this time," said Ways and Means member Jim McDermott, D-Wash.

Rep. Tim Huelskamp, R-Kan., a member of the Tea Party caucus, welcomed the step toward radical tax consolidation but said House Republican leaders showed they are not interested in taking up the issue by repeatedly delaying Camp.

Ways and Means member Kevin Brady, R-Texas, said House leadership has encouraged the committee to continue to educate members and the public on tax reform. "I think everyone that is in the Republican conference ran on fixing this broken code and reining in the IRS, so they're hungry for the details and they're hungry to be able to take that back home and start listening," Brady said.

But some Republicans said they'd still prefer a reform proposal that moves away from the traditional income tax system. "I'd like to see us scrap the tax code and go to a flat tax," said Rep. Louie Gohmert, R-Texas. "We can debate a flat and fair rate. I applaud a step in the right direction -- I appreciate that -- but we've got to keep pushing that we can do even more."

Ways and Means member Paul Ryan, R-Wis., who has expressed interest in taking over as chair of the committee after Camp's term is up, said he supports the deliberative process that is being taken. "We're going in the right direction," Ryan said. "We're going to move this issue as far as we can move it, and I believe at the end of the day we will reform this tax code because the status quo is completely indefensible."

Levin said Camp's plan opens the debate on tax reform but added that it would have been better if it had been drafted on a bipartisan basis. "There are pluses and minuses" to the plan, Levin said, citing changes to the treatment of carried interest as a plus.

Camp made other nods to Democratic ideas in the draft. Ways and Means member Richard E. Neal, D-Mass., said he appreciated that Camp included his proposal (H.R. 2054) to prevent insurance companies from using reinsurance with nontaxed foreign affiliates to avoid U.S. taxation.

Across the Capitol, Senate Finance Committee Chair Ron Wyden, D-Ore., and ranking minority member Orrin G. Hatch, R-Utah, issued a joint statement commending Camp for his work but adding that bipartisan tax reform is desperately needed. "We look forward to working with members in both chambers and on both sides of the aisle to move the conversation forward," they said.

White House principal deputy press secretary Josh Earnest, meanwhile, praised some aspects of Camp's plan, including the carried interest proposal, a proposal to end tax breaks for corporate jets, and the proposal to use one-time revenue for infrastructure funding.

Earnest, however, told reporters that the discussion draft failed to raise new revenue to lower the deficit, and he argued that the plan would actually raise the deficit in the long run. He also criticized the draft for not including an extension of the earned income tax credit.

"The earned income tax credit goes to working people, and the president believes that further tax breaks for working people is a good way to strengthen our economy, expand economic opportunity, and make sure that hard work is rewarded in this country," Earnest said.

Eric Kroh, Matthew R. Madara, Amy S. Elliott, Andrew Velarde, and William R. Davis contributed to this article.

Follow Lindsey McPherson (@lindsemcpherson) and Meg Shreve (@Meg_Shreve) on Twitter for real-time updates.

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