A striking feature of the modern U.S. economy is its growing openness--its increased integration with the rest of the world. The attention of tax policymakers has recently been focused on the growing participation of U.S. firms in the international economy and the increased pressure that engagement places on the U.S. system for taxing overseas business. Is the current U.S. tax system for taxing U.S. international business the appropriate one for the modern era of globalized business operations, or should its basic structure be reformed? The current U.S. system for taxing international business is a hybrid. In part the system is based on a residence principle, applying U.S. taxes on a worldwide basis to U.S. firms while granting foreign tax credits to alleviate double taxation. The system, however, also permits U.S. firms to defer foreign-source income indefinitely--a feature that approaches a territorial tax jurisdiction. In keeping with its mixed structure, the system produces a patchwork of economic effects that depend on the location of foreign investment and the circumstances of the firm. Broadly, the system poses a tax incentive to invest in countries with low-tax rates of their own and a disincentive to invest in high-tax countries. In theory, U.S. investment ...

Tax reductions enacted in 2001-2004 reduce the effective tax rate on capital income in several different ways. Taxes on capital arise from individual taxes on dividends, interest, capital gains, and income from non-corporate businesses (proprietorships and partnerships). Reductions in marginal tax rates, as well as some tax benefits for business, reduce these taxes. Taxes on capital income also arise from corporate profits taxes, which are affected not only by rate reductions but also by changes to provisions affecting depreciation, interest deductions, other deductions and credits. Finally, taxes can be imposed on capital income through the estate and gift tax. Tax cuts on capital income through capital gains rate reductions, estate and gift tax reductions, and dividend relief are estimated to cost about $57 billion per year, with about half that amount attributable to the estate and gift tax. Lower ordinary tax rates also affect income from unincorporated businesses. These tax cuts are temporary and proposals to make some or all of them permanent are expected. Bonus depreciation appears less likely to be extended. While there are many factors used to evaluate the effects of these tax revisions, one of them is the distributional effect. This report addresses those distributional issues, in the context of behavioral responses. Data suggest that taxes on capital income tend to fall more heavily on high-income individuals. All types of capital income are concentrated in higher-income classes. For example, the top 2.8% of tax returns (with adjusted gross income over $200,000 in 2009) have 26% of income, 19% of wages, 39% of interest, 39% of dividends, and 57% of capital gains. Taking into account a very broad range of capital assets, a 2012 Treasury study found that the top 1% of the population has about 19% of total income and about 12% of labor income, but receives almost half of total capital income. Estate and gift taxes are especially concentrated in the higher incomes: prior to the tax cuts enacted in 2001-2004, only 2% of estates paid the estate tax at all. If there is a significant reduction in savings in response to capital income taxes, in the long run the tax could be shifted to labor and thus become a regressive tax. Some growth models are consistent with such a view, but generally theory suggests that increases in taxes on capital income could either decrease or increase savings, depending on a variety of model assumptions and particularly depending on the disposition of the revenues. There are also many reasons to be skeptical of these models, which presume a great deal of skill and sophistication on the part of individuals. New models of bounded rationality suggest that taxes on capital income are likely to have no effect or decrease saving, as individuals rely on common rules of thumb such as saving a fixed fraction of income and saving for a target. Empirical evidence in general does not suggest significant savings responses, as savings rates and pre-tax returns to capital have been relatively constant over long periods of time despite significant changes in tax rate. If capital income taxes do not reduce saving, these taxes fall on capital income and add to the progressivity of the income tax system.

Advocates of cutting corporate tax rates frequently make their argument based on the higher statutory rate in the United States as compared with the rest of the world; they argue that cutting corporate taxes would induce large investment flows into the United States, which would create jobs or expand the taxable income base enough to raise revenue. President Barack Obama has supported a rate cut if the revenue loss can be offset with corporate base broadening. Others have urged on one hand, a revenue raising reform, and, on the other, setting deficit concerns aside. Is the U.S. tax rate higher than the rest of the world, and what does that difference imply for tax policy? The answer depends, in part, on which tax rates are being compared. Although the U.S. statutory tax rate is higher, the average effective rate is about the same, and the marginal rate on new investment is only slightly higher. The statutory rate differential is relevant for international profit shifting; effective rates are more relevant for firms' investment levels. The 13.7 percentage point differential in statutory rates (a 39.2% rate for the United States compared with 25.5% in other countries), narrows to about 9 percentage points when tax rates in the rest of the world are weighted to reflect the size of countries' economies. (The OECD rates fell by slightly over1/2 of a percentage point between 2010 and 2012) Regardless of tax differentials, could a U.S. rate cut lead to significant economic gains and revenue feedbacks? Because of the factors that constrain capital flows, estimates for a rate cut from 35% to 25% suggest a modest positive effect on wages and output: an eventual one-time increase of less than two-tenths of 1% of output. Most of this output gain is not an increase in national income because returns to capital imported from abroad belong to foreigners and the returns to U.S. investment abroad that comes back to the United States are already owned by U.S. firms. The revenue cost of such a rate cut is estimated at between $1.2 trillion and $1.5 trillion over the next 10 years. Revenue feedback effects from increased investment inflows are estimated to reduce those revenue costs by 5%-6%. Reductions in profit shifting could have larger effects, but even if profit shifting disappeared entirely, it would not likely offset revenue losses. It seems unlikely that a rate cut to 25% would significantly reduce profit shifting given these transactions are relatively costless and largely constrained by laws, enforcement, and court decisions. Both output gains and revenue offsets would be reduced if other countries responded to a U.S. rate cut by reducing their own taxes. Evidence suggests that the U.S. rate cut in the Tax Reform Act of 1986 triggered rate cuts in other countries. It is difficult, although not impossible, to design a reform to lower the corporate tax rate by 10 percentage points that is revenue neutral in the long run. Standard tax expenditures do not appear adequate for this purpose. Eliminating one of the largest provisions, accelerated depreciation, gains much more revenue in the short run than in the long run, and a long-run revenue-neutral change would increase the cost of capital. Other revisions, such as restricting foreign tax credits and interest deductibility or increasing shareholder level taxes, may be required. This publication focuses on the global issues relating to tax rate differentials between the United States and other countries. It provides tax rate comparisons; discusses policy implications, including the effect of a corporate rate cut on revenue, output, and national welfare; and discusses the outlook for and consequences of a revenue neutral corporate tax reform.

Among potential tax reforms under discussion by Congress is revising the tax treatment of foreign source income of U.S. multinational corporations. Some business leaders have been urging a movement toward a territorial tax, which would eliminate some U.S. income taxes on active foreign source income. Under a territorial tax, only the country where the income is earned imposes a tax. Territorial proposals include the Grubert-Mutti proposal (included in President Bush's Advisory Panel on Tax Reform proposal in 2005) and, more recently, a draft Ways and Means Committee proposal and a Senate bill, S. 2091. The Fiscal Commission also proposed a territorial tax. Proposals have, however, also been made to increase the taxation of foreign source income, including S. 727, and proposals by President Obama. Although the United States has a worldwide system that includes foreign earnings in U.S. taxable income, two provisions cause the current system to resemble a territorial tax in that very little tax is collected. Deferral delays paying taxes until income is repatriated (paid as a dividend by the foreign subsidiary to its U.S. parent). When income is repatriated, credits for foreign taxes paid offset the U.S. tax due. Under cross-crediting, unused foreign tax credits from high tax countries or on highly taxed income can be used to offset U.S. tax on income in low tax countries. Some proponents of a territorial tax urge such a system on the grounds that the current system discourages repatriations. Economic evidence suggests that effect is small, in part because in normal circumstances a large share of income is retained for permanent reinvestment. Amounts held abroad may have increased, however, as firms lobbied for another repatriation holiday (similar to that adopted in 2004) that allowed firms to exempt most dividends from income on a one-time basis. Opponents are concerned about encouraging investment abroad. A territorial tax is generally not viewed as efficient because it favors foreign investment, but that increased outflow of investment is likely to have a small effect relative to the U.S. economy. Artificial shifting of profits into tax havens or low tax countries is a current problem that could be worsened under some territorial tax designs, and proposals have included measures to address this problem. Proposals also address the transitional issue of the treatment of the existing stock of unrepatriated earnings. The Ways and Means proposal would tax this stock of earnings, but at a lower rate, and use the revenues to offset losses from other parts of the plan, which would lead to a long-run revenue loss. S. 2091 has a similar approach. The Grubert-Mutti proposal does not have a specific transitional tax, but would raise revenue largely due to its disallowance of parent overhead expenses aimed at reducing profit shifting. The other two proposals also contain provisions to address profit shifting. In addition there are complicated issues in the design of a territorial tax, such as how to treat branches and dividends of firms in which the corporation is only partially owned. A number of issues arise from the ending of foreign tax credits, with perhaps the most significant one being the increased tax on royalties, which are currently subject to tax, have low or no foreign taxes, and would lose the shield of excess credits. The final section of the report briefly discusses some alternative options, including those in S.727 and in the Administration proposals. It also discusses hybrid approaches that combine territorial and worldwide systems in a more efficient way, including eliminating the disincentive to repatriate. One such approach is a minimum tax on foreign source income, which is proposed by the President in the context of current rules, but could be combined with a territorial system.

Recent actions by the Organization for Economic Cooperation and Development (OECD) and the G-20 industrialized nations have targeted tax haven countries, focusing primarily on evasion issues. The HIRE Act (P.L. 111-147) included a number of anti-evasion provisions, and P.L. 111-226 included foreign tax credit provisions. Some of these proposals, and some not adopted, are in the American Jobs and Closing Loopholes Act (H.R. 4213); the Stop Tax Haven Abuse Act (S. 506, H.R. 1265); draft proposals by the Senate Finance Committee; two other related bills, S. 386 and S. 569; the Bipartisan Tax Fairness and Simplification Act (S. 3018); and proposals by President Obama. Multinational firms can artificially shift profits from high-tax to low-tax jurisdictions using a variety of techniques, such as shifting debt to high-tax jurisdictions. Since tax on the income of foreign subsidiaries (except for certain passive income) is deferred until repatriated, this income can avoid current U.S. taxes and perhaps do so indefinitely. The taxation of passive income (called Subpart F income) has been reduced, perhaps significantly, through the use of "hybrid entities" that are treated differently in different jurisdictions. The use of hybrid entities was greatly expanded by a new regulation (termed "check-the-box") introduced in the late 1990s that had unintended consequences for foreign firms. In addition, earnings from income that is taxed can often be shielded by foreign tax credits on other income. On average very little tax is paid on the foreign source income of U.S. firms. Ample evidence of a significant amount of profit shifting exists, but the revenue cost estimates vary from about $10 billion to $60 billion per year. Individuals can evade taxes on passive income, such as interest, dividends, and capital gains, by not reporting income earned abroad. In addition, since interest paid to foreign recipients is not taxed, individuals can also evade taxes on U.S. source income by setting up shell corporations and trusts in foreign haven countries to channel funds. There is no general third party reporting of income as is the case for ordinary passive income earned domestically; the IRS relies on qualified intermediaries (QIs) who certify nationality without revealing the beneficial owners. Estimates of the cost of individual evasion have ranged from $40 billion to $70 billion. Most provisions to address profit shifting by multinational firms would involve changing the tax law: repealing or limiting deferral, limiting the ability of the foreign tax credit to offset income, addressing check-the-box, or even formula apportionment. President Obama's proposals include a proposal to disallow overall deductions and foreign tax credits for deferred income and restrictions on the use of hybrid entities. Provisions to address individual evasion include increased information reporting and provisions to increase enforcement, such as shifting the burden of proof to the taxpayer, increased penalties, and increased resources. Individual tax evasion is the main target of the HIRE Act, the proposed Stop Tax Haven Abuse Act, and the Senate Finance Committee proposals; some revisions are also included in President Obama's plan.

A striking feature of the modern U.S. economy is its growing openness-its increased integration with the rest of the world. The attention of tax policymakers has recently been focused on the growing participation of U.S. firms in the international economy and the increased pressure that engagement places on the U.S. system for taxing overseas business. Is the current U.S. tax system for taxing U.S. international business the appropriate one for the modern era of globalized business operations, or should its basic structure be reformed? The current U.S. system for taxing international business is a hybrid. In part the system is based on a residence principle, applying U.S. taxes on a worldwide basis to U.S. firms while granting foreign tax credits to alleviate double taxation. The system, however, also permits U.S. firms to defer foreign-source income indefinitely-a feature that approaches a territorial tax jurisdiction. In keeping with its mixed structure, the system produces a patchwork of economic effects that depend on the location of foreign investment and the circumstances of the firm. Broadly, the system poses a tax incentive to invest in countries with low-tax rates of their own and a disincentive to invest in high-tax countries. In theory, U.S. investment should be skewed towards low-tax countries and away from high-tax locations. Evaluations of the current tax system vary, and so do prescriptions for reform. According to traditional economic analysis, world economic welfare is maximized by a system that applies the same tax burden to prospective (marginal) foreign and domestic investment so that taxes do not distort investment decisions. Such a system possesses "capital export neutrality," and could be accomplished by worldwide taxation applied to all foreign operations along with an unlimited foreign tax credit. In contrast, a system that maximizes national welfare-a system possessing "national neutrality"-would impose a higher tax burden on foreign investment, thus permitting an overall disincentive for foreign investment. Such a system would impose worldwide taxation, but would permit only a deduction, and not a credit, for foreign taxes. A tax system based on territorial taxation would exempt overseas business investment from U.S. tax. In recent years, several proponents of territorial taxation have argued that changes in the world economy have rendered traditional prescriptions for international taxation obsolete, and instead prescribe territorial taxation as a means of maximizing both world and national economic welfare. For such a system to be neutral, however, capital would have to be completely immobile across locations. A case might be made that such a system is superior to the current hybrid system, but it is not clear that it is superior to other reforms, including not only a movement toward worldwide taxation by ending deferral, but also restricting deductions for costs associated with deferred income or restricting deferral and foreign tax credits for tax havens.

A small share of federal spending is for direct provision of domestic government services, which many people may think of when considering federal spending. Since this spending is normally about 10% of total federal spending and about 2% of GDP and deficits excluding interest are projected to be as much as 7.7% of GDP by 2037, cutting this type of spending can make only a limited contribution. Transfers and payments to persons and state and local governments constitute most of federal spending, about 70%. Defense spending, currently accounting for about 20% of spending, has declined over the past 35 years, but also tends to vary depending, in part, on the presence and magnitude of international conflicts. Until the recent recession, most types of nondefense spending have been constant or declining as a percentage of output, but spending for the elderly and health care has been rising. Although some increase in the debt can be attributed to the Bush tax cuts and the conflicts in Iraq and Afghanistan, along with growth in spending on the elderly and health care, the current debt level is not the result of prolonged and significant past deficits. Debt grew during the recession and its aftermath. Federal debt held by the public had actually declined from almost 50% of GDP in 1993 to 33% in 2001; it rose slightly to 36% by 2007. During the three recession/recovery years (2008 through 2010), it rose to 62%, and is projected to continue to grow somewhat, before stabilizing for a while. The problem with the debt is due to growth in spending for health care and Social Security if current policies continue. In addition, much of the pressure on future spending arises from imbalances in Social Security and Medicare A (Hospital Insurance) trust funds; thus, keeping these funds and their financing sources intact is an objective that could constrain choices. Because contributions from discretionary spending appear inadequate to reduce the deficit to a sustainable level, limiting taxes as a percentage of output or constraining the overall size of the government to current levels would likely require significant cuts in mandatory spending, which includes entitlement programs such as Social Security, Medicare, and Medicaid. Preserving entitlements would eventually require increases in taxes; by one projection the difference between spending on Social Security plus health and taxes leaves less than 2% of GDP for all discretionary and other mandatory spending. Options include allowing the Bush tax cuts to expire, reducing tax expenditures, increasing other taxes, or introducing new revenue sources. Tax expenditures may be difficult to eliminate, but if not used to lower rates they may be a source of additional revenue. Addressing the eventual Social Security trust fund shortfall largely with tax increases would smooth burdens of accommodating longer lives across both working and retirement years. This argument might also apply, in part, to Medicare and Medicaid. Because the federal government provides about a fifth of the revenue for state and local governments, cutbacks in transfers to these governments may, in part, shift the burden of providing services from the national to subnational governments, rather than altering the overall size of government services.

Congress has long been concerned with ensuring that contributions for which tax deductions are claimed directly benefit charitable activities. Private foundations, a traditional arrangement that allows donations to non-active charitable entities, typically pay grants out of earnings on donated assets. Another arrangement that is growing rapidly is the donor advised fund (DAF). A taxpayer contributes to a DAF, taking a tax deduction. The fund sponsor makes grants to active charities, advised by the donor. Unlike private foundations, DAFs are not required to pay out a certain proportion of assets as grants each year. DAFs have become increasingly popular in recent years, partly due to commercial funds (e.g., Fidelity) with limited traditional charitable interests. Provisions enacted in the Pension Protection Act of 2006 (P.L. 109-280) required DAF sponsors to report data on grants. The data are reported at the sponsoring organization level, where sponsoring organizations may maintain multiple individual DAF accounts. The 2006 act also directed the Treasury Department to study DAFs, with Congress expressing particular interest in issues relating to potential restrictions on deductions and minimum payout requirements. The Treasury study was released in 2011. Senator Chuck Grassley, Senate Finance chairman at the time of the 2006 legislation, has criticized the study as being "disappointing and nonresponsive." The Treasury did not recommend restrictions on deductions (such as those that apply to private foundations where grants are typically made out of earnings), appealing to the lack of legal control by the donor. However, evidence from public comments in the report and sponsor websites indicate that sponsoring organizations typically follow the donor's advice, thus suggesting that donors have effective control over donations and, in some cases, investments. Private foundations have a 5% minimum payout rate (and actual payouts are only slightly above that amount). The Treasury also did not recommend a minimum payout for DAFs, indicating that more years of data are needed. The Treasury also appealed to the higher estimated average payout rate of DAF sponsoring organizations (9.3% in 2006) as compared to foundations. This report uses 2008 data to examine the minimum payout requirement, finding results similar to those found by Treasury. The average payout rate was 13.1%. More than 181,000 individual DAF accounts were maintained by roughly 1,800 DAF sponsoring organizations. Most individual accounts were maintained by institutions with a large number of accounts (two-thirds of all DAF accounts were held by sponsoring organizations that maintained at least 500 accounts; nearly half of all DAF accounts were held by commercial DAF institutions). Assets in DAF accounts were $29.5 billion, contributions were $7.1 billion, and DAF accounts paid out $7.0 billion in grants. Because DAF accounts have heterogeneous objectives, in some cases to manage giving with high payout rates and in others to establish an asset base, a DAF sponsor can have a high average payout rate although many accounts have little or no payout. In both 2006 and 2008, a substantial share of DAF sponsoring organizations paid out less than 5% of assets each year. To provide some insight into the payout behavior of individual DAF accounts, sponsoring organizations that reportedly maintained only one DAF account in 2008 are analyzed separately. Although the average payout rate was over 10%, more than 70% of DAF sponsoring organizations with a single DAF account paid out less than 5%, and 53% had no grants. In contrast, less than 4% of sponsors with 100 or more accounts, accounting for 87% of DAF accounts, have a payout rate of less than 5%. This suggests that a minimum payout rate for sponsors would not be effective; an effective minimum payout requirement would need to be applied to individual DAF accounts.

This book is an overview of issues associated with the marriage penalty. The first section explains how the marriage penalty (and the marriage bonus) arises and why it is not possible to achieve simultaneously the goals of marriage neutrality and horizontal equity across families in a progressive tax system. The second section discusses the size of the marriage penalty, the bonus and importantly, the notion that the marriage penalty is not a precisely defined measure. The next section outlines the issues of equity, efficiency and simplicity that are part of the frame work for evaluating policy and the final section discusses various legislative proposals in light of these objectives. The book also estimates the effects of current tax policies on families of different types and sizes and analyses proposals to address the marriage penalty and the child tax credit. It contains a history of the development of tax provisions affecting the family.