11. Federal Unemployment Tax Act (FUTA) Provisions

a. Index FUTA wage base

Present Law

The minimum net FUTA tax imposed on employers is 0.8 percent of the first $7,000 of wages paid to each employee during the year. The gross FUTA tax rate is 6.2 percent, but employers in States meeting certain Federal requirements and having no delinquent Federal loans are eligible for a 5.4-percent credit, making the minimum net FUTA tax rate 0.8 percent.

Possible Proposal

The $7,000 limit on wages subject to the FUTA tax could be indexed to reflect the annual increase in average wages. In order to allow States time to make the required conforming changes, the proposal would be effective for years after 1988.

Argument for the proposal

Pros and Cons

Indexing the FUTA wage base generally would maintain the FUTA tax revenues as a constant percentage of total wages.

Argument against the proposal

Additional FUTA revenues should be generated only in response to specific needs relating to unemployment compensation, rather than in response to a general concern for revenue.

b. Extension of portion of FUTA due to expire after 1987

Present Law

Under present law, the gross FUTA tax rate of 6.2 percent of the first $7,000 in wages paid to an employee consists of a permanent component of 6.0 percent and a temporary component of 0.2 percent. (The net FUTA tax is 0.8 percent after taking into account the 5.4 percent credit for State unemployment taxes.) The funds generated by the temporary portion of the tax have been used to repay advances made from general revenues to the Extended Unemployment Compensation account. These advances have been utilized to pay for the Federal Supplemental Benefit program and the Federal share of the permanent extended benefit program.

The temporary 0.2-percent tax component is scheduled to expire at the beginning of the first year following the year in which the advances from general revenues are repaid. The advances were fully repaid in 1987. As a result, for the year beginning January 1, 1988, the FUTA tax rate will be 6.0 percent (0.6 percent after taking into account the 5.4 percent credit for State unemployment taxes).

Possible Proposal

The temporary FUTA tax component of 0.2 percent could be extended three years through 1990.

Argument for the proposal

Pros and Cons

In light of the current budget situation, it is inappropriate to allow a reduction in tax to which employers have become accustomed.

Arguments against the proposal

1. The temporary FUTA tax component of 0.2 percent was intended to serve a specific purpose, i.e., to repay certain advances. Since that purpose has been served, the tax should be allowed to expire.

2. The reduction in the FUTA tax will encourage the employment of low-income workers and will offset the increase in employer social security taxes scheduled for 1988.

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B. General Consumption Taxes

Present Law

Present law does not include any form of broad-based consumption tax. Manufacturers' and retailers' excise taxes are imposed on the sale of selected products. These taxes are not sufficiently uniform or coordinated to be considered as a general consumption tax system.

A value added tax bill was introduced by the Chairman of the Ways and Means Committee in the 96th Congress (and hearings held), but was not reported out of Committee. The 1984 Treasury Department Report to the President on "Tax Reform for Fairness, Simplicity, and Economic Growth," examined the VAT concept, but did not recommend inclusion of such a tax in the Administration's tax reform proposals.

Possible Proposals

1. Value added tax (“VAT”)

A value added tax is a multi-stage sales tax on the value added to goods and services by each business in the production and distribution chain. Since the retail price of a product is equal to the total of the values added at each stage of production and distribution, a value added tax is the economic equivalent of a retail sales tax.

Tax liability may be calculated in a number of ways. All of the member countries in the European Economic Community use the "invoice" or "credit" method. Under this method, a firm calculates the tax on its sales, and is allowed to claim a credit for the tax imposed on its purchases. Any excess of tax imposed on purchases over the tax due on sales is either refunded or carried forward as a credit against future tax liability. Imports are subject to the VAT, and the VAT on exports is credited or rebated.

Under a consumption-type VAT, a credit for tax on capital equipment purchases eliminates the burden of the tax on capital goods. Since only consumption goods bear the tax, the incidence of the tax is on consumers. The consumption-type VAT is used throughout Europe. There are, in addition to the consumption VAT, two other types of VAT. The gross product type does not allow any credit for the tax paid on capital items. Under the income type VAT, the tax paid on a capital item is credited over the life of the asset. 2. Business alternative minimum tax (“BAMT")

As an alternative to the invoice method, a multi-stage sales tax could be imposed using the subtractive method. Under the subtractive method, a firm computes its tax liability by subtracting its purchases from other firms from its sales, and by applying the tax

rate to the difference. The BAMT uses the subtractive method: a tax would be imposed on net business receipts, which are defined as the excess of any business receipts over business expenses during the taxable period. The tax also would be imposed on imports. Business receipts attributable to exports would be exempt from tax.

Credits could be allowed for (1) the employer's share of FICA and Railroad Retirement tax liabilities, and one-half of self-employment tax liability, (2) income tax liability (reduced by income tax credits), and (3) the tax equivalent of net operating losses.

Revenues from the BAMT could be used to provide a capital gains exclusion, reinstate a 5-percent investment credit, repeal the alternative minimum tax, lower income tax rates, as well as to reduce the Federal budget deficit.

Pros and Cons

Arguments for the proposals

1. Under the General Agreement on Tariffs and Trade ("GATT"), sales taxes may be imposed on a destination basis (place of consumption) rather than an origin basis (place of production). Thus, unlike an income tax, a sales tax may be imposed on imports and rebated on exports.

2. A number of studies of alternative tax systems have concluded that a broad-base consumption tax would result in greater long-run capital formation and GNP than an equal revenue broad-base income tax.

3. The subtractive method used to compute the BAMT may be less burdensome to taxpayers than the invoice method.

4. Under the BAMT, the credit for a portion of the payroll taxes mitigates the regressive impact to some extent. Specific exclusions for certain necessities (e.g., food, housing and medical costs) or increases in transfer payments could lessen the regressivity.

Arguments against the proposals

1. The 1984 Treasury Report on tax reform concluded that implementation of a Federal value-added tax would take 18 months from the date of enactment and, when fully in force, would require an additional 20,000 personnel, and would cost about $700 million to enforce.

2. A VAT is a sales tax which largely would be borne by consumers. The burden of such a tax likely would be regressive.

3. The BAMT does not operate as a conventional minimum tax since tax liability is unrelated to profitability: for example, taxpayers with losses could have substantial BAMT liability. Also, the allowance of a credit for origin-based taxes (i.e., payroll and income taxes) against the BAMT may be a technical violation of the GATT.

4. Many empirical studies of savings behavior have failed to find a significant relationship between individual savings rates and marginal income tax rates. Thus, substitution of consumption for income taxes may not have a large effect on national savings.