D e l o i t t e & T o u c h
e LLP
Next | Previous | Table of Contents | Home | Site Search
Taxation of Business Activities
Proponents of a consumption tax believe savings and investment should be rewarded -- a goal to be achieved by taxing consumption. The flat tax, the value-added tax (VAT), and the national retail sales tax are all variations of a tax on consumption because they aim at taxing the same base. They all effectively exempt investment income from tax.
This section describes current consumption tax proposals in detail. The specifics of these particular proposals are less important than the issues they highlight.
A flat tax, in theory, is any tax system with only one marginal tax rate. A bracket with a marginal rate of zero also could be provided by allowing a standard deduction and personal exemptions. As long as only one bracket has a marginal tax rate greater than zero, the tax commonly would be referred to as a flat tax. The tax still could contain dozens of deductions, exclusions, and credits, including the home mortgage interest deduction, the charitable contribution deduction, the deduction for state and local income taxes, the exclusion for fringe benefits, the earned income tax credit, and the dependent care credit.
Many of the current flat tax proposals do more than simply apply one rate to the current individual income tax base. For example, the approach taken by House Majority Leader Richard Armey (R-Tex) effectively would convert the present-law income tax into something approaching a consumption tax. The Armey bill represents a view that emphasizes simplicity in designing a tax system.
The Armey bill, H.R. 2060, essentially imposes a flat 17-percent tax on business cash flow plus any noncash compensation paid to employees and a 17-percent flat tax on cash received, subject to a generous standard deduction but none of the current itemized deductions. The bill would repeal all of the current income tax code other than the amended rate tables, the basic definition of taxable income, and a handful of rules relating to deferred compensation and tax-exempt entities. H.R. 2060 also would repeal the estate and gift tax but keep the payroll tax in place.
One concern associated with the flat tax is whether the low advertised rates will produce the same amounts of revenue as the current income tax. A June 7, 1995, Treasury Department analysis of a flat-tax plan similar to the Armey proposal, concluded that a rate of at least 22.9 percent would be needed to make the plan revenue neutral, that is, it would allow the government to raise as much revenue as is currently raised. Although the proposal is designed to raise less revenue than present law, the extent of the shortfall will concern policymakers.
Taxation of Business Activities
The Armey bill, H.R. 2060, would replace the current corporate income tax with a tax on business activities equal to 20 percent (17 percent after 1997) of business taxable income. The tax would apply to every person engaged in a business activity, whether an individual, partnership, corporation, or otherwise. Taxable business income would be gross active income (that is, income other than investment income) reduced by an array of business deductions.
Deductions would be allowed for (1) the cost of business inputs, (2) cash wages, and (3) contributions to qualified retirement plans. Deductible business inputs would include inventory and capital investments, the cost of tangible personal and real property used in the activity, and all other taxes on the business. Neither interest nor noncash benefits would be deductible. Any excess loss could be carried forward and deducted against future profits. Any amount carried forward would be increased by an interest factor. Business inputs would not include either purchases of goods or services provided to employees or owners (such as fringe benefits) or interest or dividend payments.
This business activity tax resembles a VAT computed by subtracting the costs of inputs from gross receipts, except that H.R. 2060 allows a deduction for cash wage expenses. Note that, under the bill, cash wages are subject to tax at the individual level at the same flat rate applicable to business profits. Thus, the combination of the business activities tax and the individual tax is roughly equivalent to a VAT. In addition, taxing wages at the individual level allows a generous personal exemption that makes the personal tax more progressive. To ensure that compensation is taxed once, tax-exempt entities that pay compensation other than as cash or retirement plan contributions would be subject to an excise tax.
Many of the present-law rules relating to qualified plans, such as the limits on contributions or benefits, would be repealed or substantially modified. Some of the present-law rules, such as the fiduciary requirements, would be retained for non-tax reasons, such as participant protection.
The jurisdictional scope of the tax would be territorial. The tax generally would apply only to business activity conducted in the United States.
Under the bill, income other than gross active income, such as investment income, is not subject to tax. Investment income often is thought of as income from nonbusiness assets held by the taxpayer, such as interest income, dividends, rents, royalties, and capital gains.
The treatment of financial institutions (such as banks, savings and loans companies, and insurance companies) is unclear under the proposed flat tax. The bill simply states that the taxable income of financial intermediaries includes the value of the intermediation services provided. The complexity of determining the value of financial services has led most European countries to exempt from a VAT services for which no explicit fee is charged.
The present-law federal income tax contains a complex set of rules governing the use of a number of different accounting methods, including the cash-receipts-and-disbursements method, accrual methods, the installment method, long-term contract methods, mark-to-market methods, original issue discount accruals, and hybrid methods. The bill would eliminate virtually all of these methods.
If the intent is to exclude interest from gross income and deny the deduction for interest expense, special accounting rules may be necessary to (1) reflect accurately the time value elements of prepayments and deferred payments, and (2) distinguish leasing transactions from financing transactions.
H.R. 2060 would replace the current personal income tax rates with a single rate of 20 percent, which would be reduced to 17 percent for taxable years beginning after 1997. The tax would apply to the excess (if any) of (1) the individual's taxable income for the taxable year over (2) the standard deduction for the year.
Under the Armey proposal, taxable income would include wages, salaries, or professional fees, unemployment compensation, retirement distributions, and other amounts received as compensation for personal services actually rendered. Foreign earned income would not be taxed. Interest, dividends, capital gains, and other investment income received would not be taxed.
Under the proposal, the standard deduction would be the sum of a "basic standard deduction" plus the "additional standard deduction." As under present law, the amount of the basic standard deduction would be determined based on the individual's filing status, as shown in the following table. The amounts shown in the table are for calendar year 1995 and would be indexed annually for inflation.
Comparisons of Standard Deductions Under Present Law and H.R. 2060
| Filing Status | Present Law ($) | H.R. 2060 ($) |
| Married Filing Jointly | 6,550 | 21,400 |
| Single | 3,900 | 10,700 |
| Head of Household | 5,750 | 14,000 |
Under the bill, the additional standard deduction would be an amount equal to $5,000 times the number of dependents of the taxpayer. (Under present law, a $2,500 exemption amount is allowed for calendar year 1995 for the taxpayer, his or her spouse, and each dependent of the taxpayer.) As with the standard deduction under present law, the basic standard deduction and the additional standard deduction amounts would be indexed for inflation. This comparison does not take into account the Armey bill's repeal of the earned income tax credit.
No other individual deductions would be allowed, including the home mortgage interest deduction.
The mechanics of the Armey plan can be seen in the following example of a married couple with two dependent children filing jointly. We have constructed this example using Internal Revenue Service prior years' return data. The capital gains, dividend income, interest income, and itemized deduction amounts are roughly one-half of the typical amounts for those who had such income and deductions at this income level.
Example:
Total Income $75,000
Salary $69,488
Capital Gains $2,600
Dividends and Interest $2,912
Itemized Deductions $15,800
Under present law. This couple's taxable income would be $49,200, and its tax would be $8,706, regardless of the composition of the $75,000 of income.
Under the Armey proposal. This couple's taxable income is calculated as:
| Salary | $69,488 | |
| Minus | $21,400 | The basic standard deduction |
| Minus | $10,000 | The additional standard deduction because of the two dependent children |
| Taxable Income | $38,088 |
Note that the itemized deductions, the capital gains, and the dividends and interest are not used in the calculation.
To arrive at the family's tax, the taxable income is multiplied by 17 percent, equaling a tax of $6,475 (compared to the present-law amount of $8,706). Given this level of taxable income, the couple would save under Armey's flat tax compared to present law to the extent the flat-tax rate was lower than 23 percent.
If, however, this family had no investment income and an additional $5,512 of salary income (the sum of the capital gains and dividends and interest in the example), the flat-tax rate would have to be 20 percent or less for it to save under the proposal as drafted.
If the family did not have dependent children, its present-law taxable income would be $54,200 and its tax would be $10,106. Under these circumstances, the family would pay less tax under the Armey proposal than under present law, if the flat-tax rate was at 20 percent or less. If, however, its income was all from salaries, it would benefit from a flat tax only if the rate was 19 percent or less.
Thus, whether a particular family would be a "winner" or a "loser" under a flat tax depends on (1) the flat-tax rate, (2) the precise levels of basic and additional standard deductions, (3) whether the family includes dependent children, and (4) the mix of income between investments and salary. The ultimate burden of changes in business taxes must also be taken into account. For example, the nondeductibility of fringe benefits at the business level is equivalent to a tax on individuals' receipt of these benefits. This treatment is likely to affect individuals' total compensation.
Individuals also must consider the possible effects of fundamental tax reform on their level of wages, the costs of purchases, and the return on their investments. These indirect effects could have a much larger net effect on a taxpayer's pocketbook than that caused by just the direct tax variables (such as tax rate, number of dependents, and mix between wage and investment income).
Sen. Richard Lugar, a candidate for the Republican nomination for president, would replace the current income tax system with a national retail sales tax. As the name implies, this tax would be imposed on the retail sales price (that is, the price of items sold to consumers) of taxable goods or services. This proposal represents the most radical of any of the proposed departures from present law.
A national retail sales tax is a tax on gross cash receipts by a specific sector of the economy. An attempt to implement a comprehensive national retail sales tax on all items of consumption would raise issues of how to tax service sector activities that traditionally are exempt from state or local sales taxes. Other issues would arise, as well. For example, if the federal government abandons the income tax, the states could be forced to abandon their income taxes, as well. A concentration of federal and state revenue-raising activity on a retail sales tax could result in combined sales tax rates in excess of 25 percent.
The federal government currently imposes narrowly-defined excise taxes on various products or services at various points in the production and sales process. Some are imposed on manufacturers, as with alcohol and tobacco excise taxes; others are imposed at an intermediate (pre-retail) stage of the distribution of a product, as with the high-way motor fuels tax. Consumers and business users both directly bear the communications services tax ("telephone tax") and the air passenger ticket tax.
Most states and many local governments impose general sales taxes within their jurisdictions, and all states impose some form of excise tax on specified goods or services. (Alaska, Delaware, Montana, New Hampshire, and Oregon currently do not have broad-based sales taxes.) Although state sales taxes are familiar to most consumers and appear simple, several issues may arise in the application of such a tax. First, state sales taxes generally are designed to apply to most tangible personal property and selected services purchased by consumers. Persons other than consumers (that is, businesses) may be exempted from the tax in a variety of ways to avoid the "cascading" of tax that would result from multiple stages of production.
Most states also provide exemptions for acquisitions by the state and its political subdivisions, and by charitable, religious, and educational organizations. To address the regressivity of sales taxes, most states exempt food, but do tax candy, soda, and prepared meals, requiring distinctions between taxable and tax-exempt items. Similarly, most states do not tax sales of intangible property, raising issues as to whether a particular item represents taxable tangible or tax-exempt intangible property.
Moreover, most states provide broad taxation of personal property, but only limited taxation of services, raising issues whenever a business provides both taxable goods and exempt services to a customer. For example, an automotive repair shop typically provides both goods (replacement parts) and services (labor on installation of the parts) when it repairs an automobile. Controversies often arise as to whether an article or a service (such as packaging or utility services) is incorporated into a good or not. Several years ago, Florida briefly tried to tax professional services under a sales tax-like regime, but the resulting controversy led to repeal of that tax. Under a national retail sales tax, the taxation of professional services almost certainly would be raised as an issue.
Sen. Lugar has proposed that the current federal income tax and the estate and gift tax be repealed and replaced with a retail sales tax that would be collected by the states on behalf o the federal government. To date, legislation has not been introduced, so his proposal cannot be described in detail.
Broadly, the burden of a consumption tax is borne by the ultimate consumer of the taxed goods, regardless of where in the production and distribution chain the tax is levied. The tax base on which a retail sales tax is assessed can be chosen to be identical to that used for any value-added tax (which will be described in detail in the next section). As a result, a retail sales tax can have the same economic burden as a VAT. The question presented is whether a national retail sales tax is politically and administratively more desirable than a VAT.
The start-up and overall compliance costs of the tax would be smaller than those for a VAT. A retail sales tax involves only entities that sell directly to end users of the taxed goods or services. This means that the number of taxpayers involved in a retail sales tax is small compared to the number of taxpayers involved in a VAT. Limiting the number of taxpayers limits the total cost of compliance.
Proponents believe that a national retail sales tax could be implemented relatively quickly by having the federal government piggyback on the tax experience of state and local governments. Although efficient tax collection and administration could develop if both the states and the federal government have retail sales taxes, one government probably could not collect tax for the other. First, the tax bases probably would be different. As previously noted, Alaska, Delaware, Montana, New Hampshire, and Oregon have no general sales taxes at all. Second, if the states were to collect the federal tax, similarly-situated taxpayers in different states could be treated differently. One state's collection efforts or interpretation of the federal law might be more aggressive than that of another state. If the federal government were to collect the states' taxes, the federal government would become involved in disputes as to the proper allocation of the tax with respect to interstate transactions.
The retail sales tax imposes tax only at a single stage in the production and distribution chain. This increases the opportunity for the evasion of the entire tax when just one party (the retailer) fails to meet its taxpaying duty. By contrast, a VAT (particularly a credit-invoice VAT) is, in some sense, self-enforcing. The complete amount of tax is evaded only when there is some coordination between parties at different stages of the production and distribution chain.
House Ways and Means Committee ranking Democrat Sam Gibbons, D-Florida, and others long have advocated replacing the current income tax system with a European-style value-added tax (VAT). A VAT is imposed and collected on the "value added" at each stage of the production and distribution of a good or service. The amount of value added is the difference between the business's sales revenue and purchases from other businesses. A VAT and a national retail sales tax meet roughly the same goals and have about the same economic burden.
The most comprehensive proposal to institute a VAT is a plan that couples a savings-exempt income tax with a subtraction-method VAT. Senators Sam Nunn and Pete Domenici (who is also chairman of the Senate Budget Committee) have introduced the USA Tax Act of 1995 (S.722). This bill is the most fully developed and most complex of the current proposals. The bill would replace the current corporate income tax with a subtraction-method VAT imposed on all businesses, and it would replace the current individual income tax with a savings-exempt income tax.
The complexity of the proposal should not distract attention from the significance of the changes affecting savings, investment, and foreign income. For example, for businesses, the Nunn-Domenici bill would allow expensing of capital investments other than financial instruments and would exclude financial receipts from income. The array of present-law complexities associated with investment income and with capital expenditures and inventories would be vastly reduced or eliminated for most taxpayers.
Savings-Exempt Income Tax. The current individual income tax would be replaced with a savings-exempt income tax -- a broader-based individual income tax with an unlimited deduction for net new savings. The tax would be imposed using a three-tiered graduated rate schedule.
The bill would not amend the present employment tax system. Individuals would be allowed a refundable credit for employee payroll taxes (FICA) paid by them, and businesses would be allowed a credit for employer payroll taxes paid by them.
For individuals, the savings-exempt income tax would be similar to today's income tax, with several radical changes:
* Deductions would be added for unlimited savings, child support paid, and certain educational expenses.
* Deductions would be eliminated for state and local taxes, medical expenses, and interest on home equity loans.
* Income would include withdrawals from savings, child support received, fringe benefits, and life insurance proceeds.
There would be a standard deduction and personal exemption, as well as steeply progressive rates.
Business Tax. A subtraction-method VAT would be imposed on businesses, relying on many of the accounting concepts in present law to define the timing of receipts and expenses. Businesses would pay tax on the amount by which their gross receipts from the sale of goods and services exceed their business purchases of goods and services. The business tax would be imposed at a single rate of 11 percent.
Taxable receipts and deductible purchases would be measured using an accrual method of accounting including the economic performance standards of present law. Special rules would continue for long-term contracts. In addition, special rules are provided for the taxation of financial intermediaries, the qualification of pension plans, and taxation of business activities conducted by charities.
The VAT would equal 11 percent of the "gross profits" from any business activity for the taxable year. Employment, casual sales of property, and hiring of household help would not count as business activities. Gross profits generally would be the amount by which the taxpayer's taxable receipts exceed the taxpayer's business purchases for the taxable year. A loss in any year could be carried forward to future taxable years. Employer payroll taxes paid by the business could be credited against the business tax. Members of an affiliated group would be allowed to file a consolidated return if they are permitted to file a consolidated return under present law.
Taxable Receipts. Taxable receipts would include all receipts from the sale or lease of property and from the performance of services in the United States. Taxable receipts would not include (1) any excise tax, sales tax, customs duty, or other separately stated levy imposed by the federal government or by a state or local government on property or services, or (2) financial receipts, such as interest, dividends, proceeds from the sale of stock, or other ownership interests.
Business Purchases. Business purchases in connection with a business activity in the United States refer to any amounts paid or incurred to purchase property, or the use of property or services except for certain savings transactions and offshore transactions. Business purchases would not include wages paid. Specifically, no deductions would be allowed for (1) compensation to employees including fringe benefits, (2) the use of money or capital, such as dividends or interest, (3) life insurance premiums, or (4) the acquisition of savings assets or financial instruments. In addition, amounts paid for property purchased or services performed outside the United States (unless treated as an import) are not considered business purchases. As with taxable receipts, business purchases do not include federal, state, or local taxes.
Treatment of Imported and Exported Goods and Services. The business tax would be based on the principle that goods and services should be taxed in the country in which they are used rather than in their country of origin. Imported goods and services would be subject to tax, while exported goods and services would not.
Under the bill, a nondeductible import tax of 11 percent would be imposed on the customs value of any property imported for use, consumption, or warehousing within the United States, and on the cost of services imported into the United States. A business activity could treat the taxable amount of such imports as a business purchase.
Conversely, the gross receipts of a taxpayer would not include amounts received from property or services exported from the United States. As a result, taxpayers heavily engaged in the export business could have losses to carry forward.
Accounting Methods. In computing gross profits, a taxpayer generally would be required to use an accrual method of accounting. For this purpose, an amount would not be treated as incurred any earlier than under present law. Businesses currently using the cash-receipts-and-disbursements method could continue to use that method. The Treasury Department also could allow certain new businesses to use the cash method. The taxpayer's method of accounting could be changed only with permission. Special accounting rules would apply with respect to property produced under long-term contracts.
Under the business tax, business purchases would be deducted when paid or incurred, even if the purchases relate to inventory, have a useful life of over a year, or will be used to produce other property. This is a key distinction between the proposed business tax and the present income tax. Under the income tax, the cost of such property generally must be capitalized; under the bill, such costs would be expensed.
Treatment of Financial Services. The bill specifically would treat the provision of financial intermediation services as a business activity and therefore subject to the business tax. Special rules would apply to determine the taxable amount derived from financial intermediation services. In addition, the bill would permit the business user of financial intermediation services to deduct as business purchases any stated fees for the services and any implicit fees allocated and reported to it by the financial intermediary. The bill would provide a method (and reporting mechanism) for allocating the value of financial intermediation services among users of the services. No deduction would be permitted for implicit fees that are not reported.
Financial intermediation services include lending services, insurance services, market-making and dealer services, and certain other services. The Nunn-Domenici business tax would be imposed on the excess of financial receipts over financial expenses. Financial receipts generally would be all receipts properly allocable to the financial intermediation services activity other than contributions of capital; these include all amounts that qualify as gross receipts under the general provisions of the bill, such as stated fees and proceeds from the sale of property used in the business and virtually all other inflows of value.
Financial expenses would include all expenditures that qualify as business purchases under the general rules, such as the cost of office supplies, equipment, and machinery; travel expenses; and the cost of real property used in the business. Certain financial outflows also would count as financial expenses, including (1) payments of principal and interest on borrowings associated with the financial intermediation services business; (2) the cost of financial instruments, and any payments made under financial instruments; (3) claims and cash surrender values paid in connection with insurance or reinsurance services; and (4) payments for reinsurance.
Governments. Government entities would not be subject to the business tax on public utility services, mass transit services, or any other activity involving an "essential governmental function." Any government activity that could be considered "frequently provided by business entities" would be subject to business tax. The governments of possessions of the United States would not be subject to the business tax.
Tax-Exempt Organizations. The bill generally would exempt only the following types of entities from the business tax: (1) instrumentality's of the United States, (2) present-law charitable organizations (except organizations that test for public safety or foster amateur sports competition), (3) certain qualified benefit plans and trusts, (4) religious and apostolic organizations, (5) cemetery companies, (6) certain title and real property holding companies, (7) cooperative hospital service organizations, and (8) cooperative educational service organizations. However, these entities would be subject to the business tax on activities that would be subject to the present-law unrelated business income tax.
Other traditionally tax-exempt organizations would be fully subject to the business tax.
Individual Tax. The individual tax proposed in the Nunn-Domenici bill would be a broad-based income tax (the savings-exempt income tax) with an unlimited deduction for new savings. In other words, it is a modified version of a personal consumption tax, except that borrowing would not be included in income, but rather would only reduce (but not below zero) the net savings deduction. In comparison with the treatment of borrowings under a personal consumption tax, under the Nunn-Domenici bill, a net borrower would not pay tax on an amount greater than income in a given year, even though the net borrowing reflects additional consumption. The additional consumption would, in effect, be taxed as the loan is repaid, since such repayments do not constitute new savings.
The individual tax would have a three-tier graduated tax rate structure. As under present law, separate rate schedules would apply based on an individual's filing status. The rate structure would change for the first four years from 1996 to 1999. After 1999, the individual income tax rate schedules would be as shown in the following table. These amounts would be indexed for inflation occurring between 1996 and 1999.
Selected Individual Income Tax Rates Under S. 722 (in 1996 dollars)
| Taxable Income ($) | Income Tax | |
| Single | 0- 3,200 | 8 percent of taxable income |
| 3,201-14,400 | $256, plus 19 percent of amount over $3,200 | |
| Over 14,400 | $2,384, plus 40 percent of amount over $14,400 | |
| Married Filing Jointly | 0- 5,400 | 8 percent of taxable income |
| 5,401-24,000 | $432, plus 19 percent of amount over $5,400 | |
| Over 24,000 | $3,966, plus 40 percent of amount over $24,000 |
Gross Income. Gross income would be defined broadly under the bill. Most present-law elements of gross income would be included, such as salaries and wages, pensions, alimony payments, dividends, distributions from partnerships and proprietorships, rents, royalties, interest (other than tax-exempt interest), includible social security benefits, and proceeds from the sale of assets. The bill would include new items in gross income such as child support, most fringe benefits, and annuities and life insurance proceeds.
Exclusions from gross income would be limited to tax-exempt bond interest, gifts and bequests, certain government transfer and similar payments, certain health care payments and reimbursements, certain military pay and veteran's benefits, and a portion of social security payments (generally as under present law).
Net Savings Deduction. Taxpayers would be allowed a deduction for any increase in their net savings during the year. Net savings would be the taxpayer's additions to qualified savings assets during the year in excess of taxable withdrawals. Qualified savings assets would include stocks, bonds, securities, certificates of deposits, interests in proprietorships and partnerships, mutual fund shares, life insurance policies, annuities, retirement accounts, and bank, money market, brokerage and other similar money accounts. Qualified savings assets would not include investments in land, collectibles, or cash on hand.
Any annual decrease in net savings would constitute taxable income. Borrowing would not be treated as a withdrawal from savings, but would reduce (but not below zero) the amount of net savings that could be deducted in a taxable year. Certain types of debt would not reduce deductible net savings in a taxable year; these types include mortgage debt on a principal residence, debt (of $25,000 or less) to purchase consumer durables, credit card and similar debts, and $10,000 of other debts.
Standard Deductions. Under the bill, in addition to certain itemized deductions , each taxpayer would be entitled to two types of standard deductions: (1) a family living allowance, and (2) a personal and dependency deduction. As with the standard deduction under present law, the amount of the family living allowance would be determined based on the individual's filing status as shown in the following table.
Comparison of Family Living Allowance Under S.722 with Present-Law (1995) Standard Deduction
| Present-Law Filing Status |
Present-Law Standard Deduction |
S.722 Family Living Allowance |
| Single | $3,900 | $4,400 |
| Married Filing Jointly | $6,550 | $7,400 |
A taxpayer would be allowed a personal and dependency deduction of $2,550 for the taxpayer, a spouse, and each dependent. (This amount is comparable to the $2,500 exemption amount allowed for calendar year 1995 for the taxpayer, his or her spouse, and each dependent of the taxpayer under present law.)
As under present law, the amounts of these standard-type deductions would be indexed annually for inflation.
Itemized Deductions. The bill would continue deductions for qualified home mortgage interest, (but not home equity indebtedness) and charitable contributions. In contrast to present law, these itemized deductions would be allowed in addition to the standard deduction, rather than instead of the standard deduction. In addition, taxpayers could continue to deduct alimony. Other itemized deductions allowable under present law generally would be eliminated, including those for state and local taxes and medical expenses. The bill would allow a new deduction for certain qualified educational expenses, limited to $2,000 per eligible student per year and to $8,000 in total per year.
Credits. The bill would allow certain credits against the amount of tax due. First, a foreign tax credit would be allowed in a manner similar to that under present law. Second, a credit would be allowed for the employee share of payroll taxes paid by the taxpayer. Third, for low-income individuals, an earned income credit similar to that under present law would be allowed. All other existing credits would no longer be allowed.
The Nunn-Domenici bill involves more complex computations for individual taxpayers than the proposals for the flat tax and the national retail sales tax. The following example shows how the Nunn-Domenici bill would apply to individuals; it uses the same family of four to facilitate a comparison. The example assumes that all proceeds from sales of capital assets and all dividends and interest received are reinvested and that the family receives no child support or fringe benefits.
Example:
| Total Income | $75,000 |
| Salary | $69,488 |
| Capital Gains | $2,600 |
| Dividends and Interest | $2,912 |
| Itemized Deductions | $15,800 |
Under the Nunn-Domenici proposal: This couple's taxable income is calculated as:
| Gross Income | $75,000 | |
| Minus | $5,012 | capital gains, dividends and interest reinvested |
| Minus | $7,400 | the basic standard deduction for joint filers |
| Minus | $10,200 | the four $2,550 personal and dependency deductions |
| Minus | $9,480 | present-law itemized deductions of $15,800 x 60%[approximate portion of itemized deductions attributable to mortgage interest and contributions |
| Taxable Income | $42,908 |
The couple's tax is then calculated as:
$3,966, plus 40% x ($42,908 minus $24,000), or
$3,966, plus $7,563 = $11,529
Less FICA Credit $5,316
Tax $6,213
As noted in the example for the Armey plan, under present law, this couple's taxable income would be $49,200, and its tax would be $8,706, regardless of the composition of the $75,000 of income. Under the Nunn-Domenici plan, its tax would be $6,213. If, however, this family did not reinvest its investment income (capital gains, dividends, and interest), its tax would be $8,218. If the couple had no dependent children but did reinvest its investment income, its tax would be $8,253. If the couple had no dependent children and did not reinvest the investment income, its tax under the Nunn-Domenici plan would be $10,258. Further, as noted, this example takes no account of the effect of changes in business taxation or of economic responses to the proposal.
Next | Previous | Table of Contents | Home | Site Search
Copyright © 1996 Deloitte & Touche LLP. All rights reserved Copyright and Legal Information.
For feedback or suggestions contact the webmaster@dtonline.com