Representative Roscoe Bartlett

Some Tax Measures before the 110th Congress

Small-Business Taxation: Taxes in the Supplemental Appropriations Bills (H.R. 1591) and Minimum Wage Bills

Tax treatment of small business is a continuing focus of congressional attention, and the first months of the 110th Congress have been no exception; consideration of small-business taxation has occurred in conjunction with the federal minimum wage. The President and others have argued that an increase in the federal minimum wage -- an issue debated early in the 110th Congress -- should be coupled with consideration of tax cuts for small business. The tax cuts are viewed by their proponents as a means of offsetting the extra burden a higher minimum wage may place on small businesses.

On February 1, the Senate approved an amended version of H.R. 2, a minimum wage bill also containing a package of tax benefits for small business along with a set of revenue-raising measures designed to offset part of the revenue loss that would likely result from the benefits. In contrast, the minimum wage bill passed by the House on January 10 (also H.R. 2) contained no tax provisions. However, on February 16, the House approved a tax bill (H.R. 976) containing a set of small-business tax benefits more modest in size than the Senate's.

The two tax measures had not moved to conference by mid-March, and the House attached, without change, the tax and minimum wage provisions of H.R. 976 to a supplemental appropriations bill -- H.R. 1591 -- that it approved on March 23. On March 29, the Senate likewise attached its tax and minimum wage provisions to its version of H.R. 1591, though with several changes to the measure it had approved in February. A key issue with H.R. 1591, however, was not taxes, but its provisions regarding Iraq, and on May 1 President Bush vetoed the bill because of its Iraq-related provisions.

With taxes, the Senate's version of H.R. 1591 contained tax cuts for small business totaling an estimated $10.3 billion over five years and $12.6 billion over 10 years. The bill also contained revenue-raising "offsets" that would increase revenue by an estimated $9.1 billion over five years and $13.9 billion over 10 years. The estimated net revenue effect of the bill -- that is, the combined impact of its tax cuts and revenue increasing items -- was a loss of $1.5 billion over five years and a revenue gain of $1.3 billion over 10 years.(11) Taken alone, the tax cuts in the House-passed bill were estimated to reduce revenue by $4.6 billion over five years and by $1.3 billion over 10 years; its revenue offsets would raise revenue by $4.8 billion over five years and by $1.4 billion over 10 years. The net effect of the House bill was estimated to be a revenue gain of $225 million over five years and $45 million over 10 years.

Senate Bill. One prominent provision of the Senate version of H.R. 1591 was an extension of the "expensing" tax benefit for investment in machines and equipment -- a tax benefit provided by Section 179 of the tax code. The provision was linked to small business because it applied only to firms undertaking less than a certain level of investment. The provision is a tax benefit in that it permits firms to deduct in the first year of service ("expense") a capped amount of investment outlays rather than requiring the outlays to be deducted gradually in the form of depreciation, as is required with most tangible assets. Permanent provisions of the Internal Revenue Code cap the expensing allowance at $25,000 per year and begin a phase-out of the allowance when a firm's investment exceeds $200,000.(12) However, temporary rules initially enacted in 2003 and extended on several occasions increased the annual cap and threshold to $100,000 and $400,000, respectively. The increased amounts are indexed for inflation occurring after 2003; the amounts for 2007 are $112,000 and $450,000. The most recent extension was provided by TIPRA in 2006 and extends the increased allowance and threshold through 2009. The Senate bill provided a one-year extension, through 2010.

Another provision of the Senate bill proposed to liberalize current restrictions on the use of cash accounting -- a simplified and sometimes more generous method of accounting that is currently only available for firms having average annual gross receipts not exceeding $5 million in all prior years. The bill would have generally increased the eligibility cap to $10 million of average annual gross receipts.

Other tax benefits in the Senate bill included liberalized depreciation rules for leasehold and restaurant improvements and for new restaurants, an extension of the temporary work opportunity tax credit (WOTC) for employers of individuals in certain "high risk" groups (through 2012), and more generous rules for Subchapter S corporations (closely-held corporations not subject to the corporate income tax).

The offsets in the Senate bill were generally narrowly focused provisions designed to restrict a number of types of tax-saving transactions or actions. Two of the largest in terms of revenue gain would have applied earlier effective dates to restrictions first implemented by the American Jobs Creation Act of 2004 (AJCA; P.L. 108-357), thus restricting more of the tax-saving transactions in question. One provision applied AJCA's restrictions to leasing transactions involving foreign entities; the second applied to corporate "inversion" or "expatriation" transactions -- corporate reorganizations designed to shift titular ownership of U.S. corporate groups to offshore entities. A third provision would have increased the age of children whose unearned income is taxed as their parents' income.

House Bill. Like the Senate bill, the version of H.R. 1591 approved by the House in March proposed to extend the increased Section 179 expensing allowance through 2010. However, the House bill would have further increased the allowance and phase-out threshold, to $125,000 and $500,000, respectively, and indexed those amounts for inflation occurring after 2007. The House bill would also, like the Senate measure, have extended the WOTC, but for a shorter period (through 2008).

In contrast to the Senate bill, <110>the House bill contained no provisions for leaseholds and restaurants, nor Subchapter S provisions. The House bill also contained several benefits not in the Senate bill. One inclusion prevented, in effect, an increase in the minimum wage (should it occur) from reducing the tax credit employers currently receive for social security (FICA) taxes they pay on tips that exceed the minimum wage. A second provision expanded the FICA/tip tax credit and the WOTC so that they can offset a firm's alternative minimum tax.

<110>The House bill contained fewer revenue-raising items than the Senate bill. The largest proposed to deny reduced capital gains and dividend rates to dependents under the age of 24 who do not provide more than half their own support with earned income. Like the Senate bill, the House bill proposed to increase the age where unearned income of children is taxed as parents' income.

Conference Agreement. On April 24, a conference committee approved a version of H.R. 1591 containing small business tax provisions. Overall, the agreement provided for $7.1 billion of tax cuts over five years and $4.8 billion over 10 years. These were partly offset by revenue-raising items amounting to $7.0 billion over five years and $4.4 billion of revenue raisers over 10 years, for a net revenue impact estimated at a gain of $71 million over five years and a gain of $55 million over 10 years.(13) Taken alone, the revenue-losing and revenue-gaining measures in the conference agreement fall between the House and Senate bills, in terms of their size. Like the House bill, the net impact of the conference agreement is close to revenue neutrality.

Like the House and Senate bills, the conference agreement contains a one-year extension of the increased expensing allowance, and also follows the House in increasing the allowance to $125,000 and the phase-out threshold to $500,000. The agreement would also extend the work opportunity tax credit through August, 2011 -- an extension longer than the House, but shorter than the Senate. (The credit was set to expire at the end of 2007; the extension is thus for three years plus eight months.) The conference bill also contains the Senate's more generous treatment of Subchapter S corporations, as well as the House provisions for FICA taxes on tips.

The conference bill does not contain the Senate's cash-accounting provisions nor its leasehold provisions.

The conference agreement's revenue-raising provisions include the increase in the age for the inclusion of children's income that was in both the House and Senate bills. The conference agreement also extends the period of time before which IRS interest and penalties are extended, to 36 months from 18 months -- an extension between that proposed by the House and Senate, respectively. The agreement does not contain the Senate revenue-raising provisions regarding inversions and leasing.

Taxes in the Administration's FY2008 Budget Proposal

On February 5, the Bush Administration released the details of its FY2008 budget proposal, including its tax components. In broad outline, the Administration's tax plan calls for a net tax cut, consisting of tax reductions in a number of areas along with more modest revenue-raising proposals, chiefly in the area of compliance. The Administration's budget documents state that the tax proposals' goal is to make the tax system more "simple, fair, and pro-growth."(14) The principal proposed reductions are

In the area of compliance, the largest single revenue-raising item is expanded information reporting requirements. According to the Administration's budget documents, the plan as a whole would reduce revenue by an estimated net amount of $599 billion over five years (FY2008-FY2012) and by $1,854 billion over 10 years (FY2008-FY2017). Of the tax cut proposals, the largest, by far, is that to make the 2001 and 2003 tax cuts permanent, which would reduce revenue by an estimated $373.9 billion over the plan's first five years and $1,617.2 billion over 10 years.

The Alternative Minimum Tax for Individuals

While EGTRRA's expiration presents a timing issue focused on a specific date, the individual AMT is an issue for which time is a critical element but in a less specific way: absent legislative action, as each year passes more and more individuals will be subject to the AMT rather than the regular tax. According to one recent study, in 2001 2.4 million individual income tax returns (1.8% of the total) contained an AMT liability; in 2004 an estimated 3.5 million returns (2.6%) had an AMT liability. In 2010, an estimated 37.1 million returns (25.6%) will owe the AMT.(15) The portion will decline for a number of years thereafter if EGTRRA's expiration occurs as scheduled, but then will resume growth. Following the November 2006 mid-term elections, Democratic leaders of the tax-writing committees indicated that AMT relief is a high priority.(16)

The reason for the increase in the applicability of the AMT is its basic mechanics. The AMT functions like a parallel income tax, with lower rates than the regular tax but with a broader base -- that is, with fewer deductions, exemptions, credits, and special tax preferences than are allowable under the regular tax. Each year, a taxpayer pays either his or her regular tax or the tentative AMT, whichever is higher. Taxpayers are permitted a flat exemption amount in calculating their AMT. However, the exemption is fixed at a flat dollar amount that is not indexed for inflation. And while the AMT only has two rate brackets (26% and 28%), the bracket dividing point is likewise not indexed. In contrast, the structural features of the regular income tax -- personal exemptions, the standard deduction, and rate-bracket thresholds -- are indexed. Thus, as time passes and incomes grow in both real and nominal terms, the AMT exceeds the regular tax for more taxpayers. The phenomenon was magnified by the rate reductions and tax cuts for married couples provided by EGTRRA and JGTRRA as well as other tax cuts enacted in the past. As described above, Congress addressed the AMT on a temporary basis in 2001 and 2003 under EGTRRA and JGTRRA by increasing the exemption amount, thus reducing the number of taxpayers who would otherwise pay the AMT. In 2004, the Working Families Tax Relief Act (WFTRA; P.L. 108-311) extended through 2005 an exemption amount of $58,000 for married couples and $40,250 for single filers. In 2006 the Tax Increase Prevention and Reconciliation Act (P.L. 109-222) extended the increased exemption for one year. Under TIPRA, the exemption amount is $42,500 (singles) and $62,550 (couples) for 2006. Absent further action, the exemption amounts will revert in 2007 to the pre-EGTRRA amounts of $45,000 and $33,750 for couples and singles, respectively.

The original purpose of the AMT was to ensure that no individual with substantial income could use tax benefits and omissions from the tax base to reduce his or her tax liability below a certain point. There are several reasons why policymakers may be concerned with the prospect of its increased applicability. First, taxpayers who become subject to the AMT face a higher tax liability than they otherwise would; some taxpayers moving into AMT status may thus view the applicability of the AMT as a tax increase. Second, taxpayers in AMT status are not able to fully participate in tax cuts enacted under the regular tax. For example, application of the AMT prevented those taxpayers subject to the AMT from fully realizing the tax cuts enacted under EGTRRA and JGTRRA. Third, the AMT introduces complexity to the tax system, and the amount of time spent in tax preparation increases for taxpayers in or near AMT status.

On a more conceptual level, the AMT can be viewed as balancing conflicting goals of the income tax. On the one hand, various deductions, exemptions, credits, and other benefits under the regular income tax are thought to be useful in promoting various activities considered to be socially desirable or conducive to economic growth. On the other hand, it is often deemed desirable for a tax system to achieve a certain level of fairness, both in horizontal terms (the equal treatment of individuals with the same income but in different circumstances) and vertical terms (the relative treatment of individuals at different income levels). Further, economists argue that broad-based tax systems with low rates -- a characteristic of the AMT -- are less damaging to economic efficiency than higher-rate systems that apply to bases laden with special benefits. With the AMT, taxpayers can use the tax benefits available under the regular tax only up to a point, where considerations of equity and efficiency trigger applicability of the AMT: the benefits' economic growth and social goals are balanced with fairness and efficiency concerns. To the extent the AMT's growth has resulted from inflation and lack of indexation, it might be argued that the AMT's advance is unintended, and the balance between equity and social and economic goals intended for the AMT has been upset.(17)

A factor that substantially complicates the AMT issue is its revenue effect, which assumes increased prominence given current federal budget deficits. For example, indexing the AMT for inflation would eliminate much of the impetus of the tax's increasing applicability. According to Congressional Budget Office (CBO), indexing the AMT would reduce federal revenues by $513 billion over 10 years, an amount equal to 1.6% of federal revenues expected over the period. If EGTRRA's tax cuts are extended or made permanent, the cost of restraining the AMT would be considerably larger.(18)

Energy Taxation

Democratic leaders have stated that energy taxation is an issue they intend to address early in the new Congress. Their focus appears to be two-fold: a revenue-raising scaling-back of tax cuts for the petroleum firms that were enacted in recent years; and enactment of a new set of incentives aimed at energy conservation and promotion of alternative energy sources.

One of the revenue-raising items that is being considered is denial of the tax code's section 199 domestic production deduction to certain oil and gas related income.(19) The deduction was first enacted with the American Jobs Creation Act of 2004 (P.L. 108-357) and applies to the domestic U.S. manufacturing, extractive, and agriculture industries in general, not just to the petroleum industry. The deduction is phased in, with a rate equal to 6% of domestic production income in 2007-2009, and a permanent rate of 9% in 2010 and thereafter. Indications are that 2007 legislation may be patterned after H.R. 5218 (Representative McDermott) of the 109th Congress, which would have denied the deduction to "the production, refining, processing, transportation, or distribution" of oil or natural gas.

A second revenue-raising provision that is being considered is repeal of the five-year amortization of geological and geophysical (G&G) costs undertaken by major integrated oil companies. The Energy Policy Act of 2005 (EPACT05; P.L. 109-58) initially enacted the provision, which provides a tax benefit for oil and gas exploration and development. Economic theory indicates that, to measure income accurately, outlays that help create oil wells and other assets having value should be deducted only as the assets lose their worth. In the case of profitable wells, two-year amortization therefore likely provides favorable treatment similar to accelerated depreciation. Initially, EPCT05's treatment applied to both integrated producers (i.e., large companies) and independent producers. The Tax Increase Prevention and Reconciliation Act of 2006 (TIPRA; P.L. 109-222) lengthened the amortization period to five years for integrated producers. Democratic proposals would further lengthen the amortization period -- to seven years -- for integrated producers.

There are indications that at least part of the revenue produced by cutting energy tax benefits may be used to offset the revenue loss from expanded tax incentives to develop renewable and alternative energy sources -- for example, hydropower, biofuel and ethanol, nuclear power, geothermal power, and solar energy.(20)

On January 18, the House passed H.R. 6, containing the section 199 restriction for oil companies and lengthened G&G amortization period described above.

For a more detailed overview of energy tax policy, see CRS Report RL33578, Energy Tax Policy: History and Current Issues, by Salvatore Lazzari; and CRS Report RL33763 Oil and Gas Subsidies: Current Status and Analysis, by Salvatore Lazzari.

Scheduled Expiration of the 2001 Tax Cuts

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA; P.L. 107-16) provided a substantial tax cut that it scheduled to be phased in over the 10 years following its enactment. However, to comply with a Senate procedural rule for legislation affecting the budget (the "Byrd rule"), the act contained language "sunsetting" its provisions after calendar year 2010. Thus, all of EGTRRA's tax cuts expire at the end of 2010.

In addition, EGTRRA provided for a temporary reduction in the individual alternative minimum tax (AMT) by increasing the AMT's exemption amount, but scheduled the AMT relief to expire at the end of 2004.

The Jobs and Growth Tax Relief and Reconciliation Act of 2003 (JGTRRA; P.L. 108-27) provided for the "acceleration" of most of EGTRRA's scheduled tax cuts -- that is, it moved up the effective dates of most of the tax cuts EGTRRA had scheduled to phase-in gradually, generally making them effective in 2003. (The phased-in repeal of the estate tax was not accelerated by JGTRRA.) Many of JGTRRA's accelerations, however, were themselves temporary and were scheduled to expire at the end of 2004. Also, JGTRRA temporarily implemented a reduction in the maximum tax rate on dividends and capital gains, reducing the rates to 15% (5% for individuals in the 10% and 15% marginal income tax brackets). The reduction was initially scheduled to expire at the end of 2008.

In 2004, Congress thus faced two "expiration" issues related to EGTRRA and JGTRRA. One was a question for the longer term: the scheduled expiration of EGTRRA's tax cuts at the end of 2010. The second was the expiration of JGTRRA's accelerations at the end of 2004. In September, Congress addressed the second of these with enactment of the Working Families Tax Relief Act (WFTRA; P.L. 108-311). WFTRA generally extended JGTRRA's accelerations of EGTRRA's tax cuts through 2010 -- that is, up to the point at which EGTRRA's cuts are scheduled to expire. WFTRA also extended EGTRRA's increased AMT exemption for one year.

In 2005, TIPRA extended JGTRRA's dividend and capitals gains rate cuts along with its AMT reduction. The dividend and capital gains cuts were extended through 2010; the increased AMT exemption through 2006.

Notwithstanding the various extensions and accelerations, the issue of EGTRRA's scheduled expiration at the end of 2010 remains and was debated in Congress throughout 2006. The debate over extension of the tax cuts has centered on three broad issues: its likely impact on the federal budget deficit, its possible effect on long-term economic growth, and its results for the fairness of the tax system. In general, opponents of an extension have argued that it would exacerbate a budget situation already made difficult by the looming retirement of the baby-boom generation and resulting stresses on the social security system. Those supporting extension maintain that the tax cuts -- through their positive effects on work effort and saving -- will stimulate long-term growth, a development that will ease the adverse effects of the tax cuts on the budget. (Opponents question whether these effects will be large enough to offset the extensions' budget effects.) With respect to fairness, opponents of extending the measures argue that the tax cuts reduce the progressivity of the tax system by providing larger effective tax-rate reductions for upper-income individuals than for persons in lower income brackets. Proponents of the tax-cut extensions emphasize that they would provide tax cuts across all income classes.

Tax Administration: The Tax Gap and Tax Shelters

Given congressional interest both in revenue-reducing measures (for example, scaling back the AMT) and concern about the federal budget deficit, it appears likely that policymakers will also focus attention on possible revenue-raising measures that would, in effect, help pay for tax-cuts elsewhere. One possible area is tax administration; in the Senate Finance Committee, leaders from both parties have expressed interest in closing the "tax gap" and in possibly restricting "tax shelters."

The "tax gap" and "tax shelter" concepts are closely related, but not synonymous, so clarification is useful. The tax gap is a concept defined by the Internal Revenue Service for use in administering the tax code -- it is the difference between the amount of tax voluntarily and timely paid by taxpayers and the actual tax liability of taxpayers. The tax gap thus includes both deliberate (and illegal) tax evasion and non-payment that occurs for more innocent reasons: for example, taxpayer error or simple inability to pay. The concept of "tax shelter" is less precisely defined, but is generally an economic concept (though whether to make it a legal one as well is, in fact, an issue that has been debated in congress and elsewhere). A tax shelter is tax-planning device that individual or corporate taxpayers use to either illegally evade or legally avoid taxes in ways that were not intended by policymakers.

The Tax Gap. Leaders of both tax-writing committees have expressed interest in looking for ways to reduce the tax gap. Congressional interest appears to be especially high in the Senate Finance Committee, which conducted hearings on the tax gap in July 2006, and where the gap has been an issue in the confirmation of Eric Solomon to be Assistant Secretary of the Treasury for Tax Policy.(21) In its most recent report on the gap, the IRS estimated its size was $345 billion for tax year 2001 -- an amount equal to 16.3% of taxes actually owed and somewhat larger than the $260 billion federal budget deficit projected for FY2006.(22)

As defined by the IRS, the tax gap consists of three components: nonfiling (failure to file a return), underreporting (understating income or overstating deductions), and underpayment (failure to pay reported taxes owed). Of these, underreporting is by far the largest, comprising 83% of the total gap, with underpayment making up 10% and nonfiling 8%. Among the different tax categories, the largest component of the gap was, by far, the individual income tax, accounting for 71% ($245 billion) of the total, followed by employment taxes (17%, or $59 billion), corporate income tax (9%, or $32 billion), and estate taxes (2%, or $8 billion). Within the individual income tax category, the largest component consisted of underreported business income (55%, or $109 billion).(23)

Proposals to reduce the tax gap have included both changes in the tax law and changes in IRS tax administration. Congress may thus address the issue either through its oversight or legislative functions. Legislatively, the staff of the Joint Committee on Taxation (JCT) has issued two reports outlining numerous legislative approaches for reducing the tax gap.(24) The reports contain proposals aimed at restricting tax shelters and closing perceived "loopholes," as well as measures that would address non-compliance by other means, including simplification and/or clarification of tax laws, increased withholding, and increased information reporting. A number of the reports' proposals were included as revenue-raising measures in the Tax Increase Prevention and Reconciliation Act of 2006; it thus appears likely that if additional legislation is considered to address the tax gap, it may include items from the JCT report.

In September 2006, the Department of the Treasury's Office of Tax Policy issued a report outlining a strategy for reducing the tax gap.(25) Although the report was lacking in specifics and contained only preliminary information in some areas, it listed a number of different ways in which the IRS might attempt to reduce the tax gap, including strengthening reporting requirements, making efforts to enhance access to data, enhancing examination and collection authority, revising penalties, issuing addition regulations and guidance for taxpayers, increasing research, improving information technology, and establishing more efficient compliance activities.

The report also, however, argued that a component of reducing the tax gap should be reduction in tax-code complexity, which, in the words of the report, "makes the tax law too difficult for taxpayers to understand and for the IRS to administer." It also stated that "enforcement activities should be combined with a commitment to taxpayer service," and that compliance proposals "should be sensitive to taxpayer rights and maintain an appropriate balance between enforcement activity and imposition of taxpayer burden."(26)

The Treasury Department's qualifications illustrate what is probably the chief policy issue related to the tax gap -- the question of how vigorously to address it. There are few policymakers or tax analysts who object -- in principle -- to the idea of reducing the tax gap. In broad terms, non-compliance not only reduces federal revenues directly (and can thus be viewed as contributing to the budget deficit), the gap also damages the perceived fairness of the tax system on the part of taxpayers who are compliant. Beyond the agreement in principle, however, there are disagreements over the extent to which concerns about taxpayer rights and the overall level of tax burdens should mitigate efforts to shrink the tax gap.

Tax Shelters. In popular usage, the term "tax shelter" denotes the use of tax deductions or credits from one activity to reduce taxes on another. In economic terms, a tax shelter can be defined as a transaction (for example, a paper investment or sale) that reduces taxes without resulting in a reduced return or increased risk for the participant.(27) But so vague and general is the term in most usages, that it could also be defined simply as a tax saving activity that is viewed as undesirable by the person or agency observing the activity and using the term.

Tax shelters can be either legal (tax "avoidance") or illegal (tax "evasion"). To the extent tax shelters are illegal, they therefore contribute to the tax gap; to the extent that they are legal but unintended uses of the tax law ("loopholes"), they reduce tax revenue beyond the loss caused by the tax gap. Like the tax gap, tax shelters not only reduce tax revenue directly, but raise questions about tax fairness among taxpayers not using shelters. In addition, while some shelters lack economic substance, others involve the actual shifting of economic resources solely for the purpose of saving taxes, and may thus reduce economic efficiency.

Congress has evinced considerable interest in tax shelters in recent years and has enacted some restrictions into law. The American Jobs Creation Act of 2004 (AJCA; P.L. 108-357) contained a number of provisions designed to restrict tax shelters. In part, the act's provisions were directed at specific tax shelters -- for example, leasing activities and the acquisition of losses for tax purposes ("built in" losses). In addition, the act included provisions -- for example, revised penalties and reporting requirements -- designed to restrict sheltering activity in general.(28) In 2006, the Senate version of TIPRA contained a number of tax shelter restrictions, but the provisions were not included in the conference committee bill. Prominent among the provisions was what the bill termed a "clarification" of the economic substance doctrine that has been followed in a number of court decisions related to tax shelters. Generally, the economic substance doctrine disallows tax deductions, credits, or similar benefits in the case of transactions determined not to have economic substance. The Senate version of TIPRA would have integrated aspects of the doctrine into the tax code itself. A similar measure was contained in the Senate version of the AJCA, but was not adopted, and given the relatively large revenue estimates associated with the measure -- the Joint Tax Committee estimated that the Senate's 2006 provision would increase revenue by $15.8 billion over 10 years -- it is possible that the economic substance doctrine will again receive congressional attention in the 110th Congress.

International Taxation

There are some indications that Congress may include the tax treatment of U.S. firms' foreign income in any search for additional tax revenue. For example, during the summer of 2006, Democratic leaders included a call to "end tax breaks that reward companies for moving American jobs overseas" in the general policy agenda they outlined in the lead-up to the mid-term elections.

Economic theory is skeptical about whether tax policy towards U.S. multinationals can have a long-term impact on domestic employment, although short-term and localized impacts are certainly possible. Taxes can, however, alter the extent to which firms engage in overseas operations rather than domestic investment. Under current law, a tax benefit known as "deferral" poses an incentive for U.S. firms to invest overseas in countries with relatively low tax rates. In general terms, deferral permits U.S. firms to indefinitely postpone U.S. tax on their foreign income as long as that income is reinvested abroad in foreign subsidiaries. Deferral is generally available for active business operations abroad, but the tax code's Subpart F provisions restrict deferral in the case of income from passive investment. If made, proposals to restrict deferral may consist of expansion in the range of income subject to Subpart F.

In recent years, however, the thrust of legislation has been more in the direction of expanding deferral and cutting taxes for overseas operations than for expanding Subpart F. For example, the American Jobs Creation Act of 2004 cut taxes on overseas operations in several ways, while in 2006, TIPRA restricted Subpart F in the case of banking and related businesses receiving "active financing" income and in the case of the "look through" treatment overseas operations receive from other firms (see also the discussion of TIPRA, below). Further, several analysts have recently argued that attempts to tax overseas operations are either counter-productive or outmoded in the modern integrated world economy. (Traditional economic analysis, however, suggests that overseas investment that is taxed at a lower or higher rate than domestic income impairs economic efficiency.)

H.R. 25, the Fair Tax Act of 2005, repeals the income tax, employment tax, and estate and gift tax. The Act redesignates the Internal Revenue Code of 1986 as the Internal Revenue Code of 2005. It imposes a national sales tax on the use or consumption in the United States of taxable property or services. The bill sets the sales tax rate at 23 percent in 2007, with adjustments to the rate in subsequent years. It also allows exemptions from the tax for property or services purchased for business, export, or investment purposes and for State government functions. Further, the bill sets forth rules relating to: (1) the collection and remittance of the ales tax; and (2) credits and refunds. Moreover, the bill allows a sales tax rebate for certain families, based on family size and income.