The broken tax code has been an important factor enabling the dramatic increase in inequality over recent decades that has led to a less dynamic and less just economy. The revenue component of the Build Back Better legislation authored by Chair Richard Neal (D-MA) and approved by the Ways and Means Committee on September 15 is a long-awaited first step toward fixing a fundamentally flawed and inequitable tax code. That portion of the bill raises more than $2 trillion in a highly progressive way to fund essential investments in a stronger and more inclusive economy.
The committee includes many of those investments in other components of the bill—clean energy, paid leave, health care coverage, and an extension of the Biden Child Tax Credit, which is already changing millions of children’s lives for the better—among other important investments and tax cuts for families.
The revenue legislation includes many critical tax reforms that make the wealthy and corporations pay more toward their fair share. However, it is not as strong as President Joe Biden’s plan in important respects. While the bill takes great strides toward tax fairness, in some ways, it should be improved as the legislative process proceeds.
Major steps toward tax fairness in the Ways and Means Build Back Better bill
Repealing major giveaways in the 2017 tax law. The bill* repeals or overhauls many of the most regressive giveaways in the Trump tax law, the Tax Cuts and Jobs Act of 2017. Rolling back these four giveaways raises nearly $850 billion over 10 years and helps ensure they are not extended. Of the four giveaways, the corporate rate cut is permanent but the other three expire after 2025.
- Top bracket rate: The bill repeals the 2017 law’s cut to the top marginal tax rate, restoring it to 39.6 percent. The top rate would apply to taxable income above $400,000 for unmarried individuals and $450,000 for couples.
- Corporate rate: The bill reverses much of the corporate tax rate cut from 2017 that provided a massive windfall to corporations without the positive effects that its boosters promised. The 2017 law cut the rate for large corporations from 35 percent to 21 percent. The bill raises it to 26.5 percent.
- Passthrough deduction (“199A”): The new 20 percent deduction for most passthrough business income was perhaps the single worst provision of the Trump tax law. More than 60 percent of it benefits the richest 1 percent, including billionaires who lobbied for it. It has created new avenues for gaming the tax code. The Ways and Means bill caps the amount of the deduction to $500,000 for couples and $400,000 for single people. This eliminates most of the windfall for the richest taxpayers, albeit not as much as a corresponding proposal from Senate Finance Committee Chair Ron Wyden (D-OR).
- Estate tax: The 2017 law doubled the estate tax exemption to what is now an astronomically high $23.4 million for couples and $11.7 for single individuals. Under these parameters, less than 0.1 percent of estates pay any estate tax. The Ways and Means bill repeals this needless giveaway for the wealthiest heirs.
Rebuilding the Internal Revenue Service (IRS). The bill provides the $80 billion requested by President Biden to rebuild the IRS. Years of budget cuts decimated the agency’s ability to pursue wealthy and corporate tax dodgers. The IRS funding is a significant advance toward a fair economy and racial equity. It will enable the IRS to reverse the trend of increasingly lax enforcement for wealthy individuals and large corporations. It will allow the IRS to better serve taxpayers by equipping the agency with modern technology.
Implementing a surtax on extremely high-income people. The bill includes a 3 percent surtax on income above $5 million—a small tax on the richest sliver of Americans that would raise $127 billion in revenue. In 2018, less than 0.04 percent of Americans reported more than $5 million of adjusted gross income, according to IRS data.
Raising the capital gains tax rate. The richest 1 percent of Americans receive 80 percent of the benefit of the preferential tax rates for capital gains and dividends, and the top 0.1 percent receive 58 percent. The bill would raise the top capital gains rate from 20 percent (or 23.8 percent when including Medicare-related taxes) to 25 percent (or 28.8 percent), raising $123 billion from the highest-income Americans. In addition, the adjusted gross income surtax on incomes exceeding $5 million, discussed above, applies to both ordinary income and capital gains.
Closing the Medicare tax loophole. The bill closes a major loophole that allows high-income business owners to avoid paying either the Medicare tax that workers and the self-employed pay on earned income or the parallel tax that investors pay on unearned income, known as the net investment income tax, or NIIT. In so doing, it essentially ensures that all Americans pay Medicare tax regardless of how they earn or receive their income and raises more than $250 billion in revenue.
Reforming the U.S. international tax code. The bill includes major reforms to the international tax system, including, most importantly, a 16.5 percent minimum tax on overseas profits applied on a country-by-country basis. This will go much further toward shutting down corporate tax havens than the weak global intangible low-tax income (GILTI) regime enacted in 2017. The bill reduces the 2017 law’s deduction for foreign-derived intangible income (FDII)—a wasteful and counterproductive giveaway that “subsidize[d] monopoly profits and encourage[d] exodus of physical capital” from the United States—in the words of Brookings’ William Gale. The bill strengthens tax code provisions aimed at preventing companies from stripping profits out of the United States. The bill also includes important provisions reforming aspects of the post-2017 international tax system that favor offshore fossil fuel income.
This is not an exhaustive list of the critical and progressive tax reforms in the bill. It takes great strides toward a fairer tax code in many other ways.
How the Ways and Means bill can be improved
Reforming the capital gains tax base. While the Ways and Means bill raises capital gains tax rates, it does not fundamentally reform the capital gains tax base. Currently, because capital gains are not taxed until sold and never taxed if never sold, billionaires can avoid paying income taxes on their gains for their entire lives—the most fundamental way that the tax code favors income from wealth over income from work. In 2019, now-Senate Finance Chairman Wyden put forward a plan to tax millionaires’ gains as they accrue, whether sold or not. President Biden took a more moderate approach: repealing the “stepped-up basis” loophole so that if an asset is never sold, gains on it would be taxed on gift or bequest. His plan exempts $1 million of gain per person and specifically protects owners of family farms and businesses. Strengthening the capital gains tax base would also enable Congress to raise additional revenue from the wealthy by further increasing the capital gains tax rate.
Enhancing bank reporting. The bill includes the essential funding for the IRS but does not currently include the other major component of President Biden’s tax enforcement initiative: a proposal to give the IRS greater visibility into the kinds of opaque forms of income that flow disproportionately to high-income people. However, Chairman Neal is working with the administration on this critical proposal, and it will hopefully be included in the House bill. President Biden’s bank reporting proposal only calls for basic information about total yearly inflows and outflows from accounts. The proposal will improve IRS audit selection so that ordinary, honest taxpayers will be significantly less likely to be audited.
Further improving the international tax system. Congress should bring the international corporate tax reforms closer in line to what President Biden has proposed. The president’s plan does more to level the tax treatment between foreign and domestic profits, including by setting the GILTI rate at 21 percent; eliminating rather than reducing the GILTI exemption that is tied to tangible assets overseas (qualified business asset investment, or QBAI); and requiring the allocation of expenses that support foreign income. His plan specifically restricts corporate inversions. It completely eliminates FDII, raising an estimated $124 billion. The Ways and Means draft reforms to the Base Erosion Anti-Abuse Tax (BEAT) regime are along broadly similar lines to the president’s proposed SHIELD—addressing corporations stripping taxable profits out of the United States to low-tax countries. But the president’s proposals are stronger and more in line with the multilateral framework for addressing corporate tax avoidance that 140 countries have now joined and that the Biden administration has played a critical role in advancing.
Corporate rate. President Biden’s plan raises the corporate rate to 28 percent while the Ways and Means bill raises it to 26.5 percent. That 1.5 percent difference means about $150 billion in forfeited revenue over 10 years. That amount could fund transformative investments, and the choice between those investments and a tiny additional increase in the corporate rate should be an easy one. One of the architects of the 2017 law, Gary Cohn, recently said, “I’m actually okay at 28 [percent.]” That level would roll back half of the rate cut from 2017.
Carried interest. The bill reforms but does not eliminate the carried interest loophole, which allows private equity and venture capital fund managers to lower their tax bills by transforming their compensation into capital gains that are taxed at lower tax rates. The reform extends the length of time that managers must hold assets in the funds to get the preferential tax treatment from three years to five years while strengthening existing rules. But carried interest is compensation for services that should be taxed at ordinary rates just like workers’ wages and salaries. It is past time for Congress to shut down this notorious loophole entirely.
Fossil fuel tax subsidies. Congress should adopt all of the proposals by President Biden to end special fossil fuel subsidies in the tax code in addition to the important provisions ending tax breaks for fossil fuel companies in the Ways and Means bill and the bill’s transformative investments in clean energy.
In sum, the Ways and Means bill is a major step forward that would dramatically change the tax code for the better. In raising more than $2 trillion of revenue, it is also a clear illustration that Congress has no excuse to shortchange the investment the country needs.
Congress has other potential revenue raisers in addition to the options identified above. For example, Chair Wyden has put forward common-sense, revenue-raising proposals in recent days. One, which would raise a reported $377 billion in revenue, is a thorough reform of partnership taxation to make taxation more closely reflect economic reality. Much of that revenue comes from simply shutting down a blatantly abusive loophole used by exchange traded funds (ETFs).
Sen. Wyden and Sen. Sherrod Brown (D-OH) have also put forward a bill to address the preferential tax treatment of stock buybacks through a 2 percent corporate excise tax, which would also raise substantial amounts of revenue.
The Ways and Means Committee bill is a good first step—but Congress should do more to fix the broken tax code.
Seth Hanlon is a senior fellow for economic policy at the Center for American Progress.
*Author’s note: This column refers to the Ways and Means product as a bill for simplicity’s sake, though it is technically recommendations to the Budget Committee pursuant to the budget reconciliation instruction.