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contributions to charity, casualty and theft losses in excess of 10 percent of AGI, investment expenses and employee business expenses in excess of 2 percent of AGI, and a few other "miscellaneous" expenses. The alternative way in which deductions may be claimed is by using the so-called standard deduction amount, which allows taxpayers to remove a fixed portion of their adjusted gross income from taxation without the burden of itemizing individual deductible expenses. Only individuals with sizable deductible expenses, or typically those with middleto high-range incomes, find it advantageous to itemize their deductions.
The standard deduction amounts for 1993 are $6,200 for married taxpayers who file a joint tax return; $3,700 for a single taxpayer; and $5,450 for a taxpayer who qualifies as the head of a household. In addition, an additional standard deduction amount is available to those 65 or older and those taxpayers who are legally blind. This additional standard deduction is $700 for each taxpayer who files a joint return and $900 for those who file either as single or as the head of a household. These amounts are adjusted annually for inflation.
Personal exemptions are allowed for the taxpayer, his or her spouse (if married and filing a joint return), and each dependent. Each exemption claimed reduces income subject to taxation by $2,350 for tax year 1993 (and will be adjusted for inflation for future years). Exemptions function like deductions, adjustments, and exclusions. The personal exemptions combined with the standard deduction amount are designed to remove low-income households from the tax rolls, and exempt a minimum level of income from taxation for other families.
The expression "tax-exempt" is used to describe types of income and organizations which are not subject to taxation. Interest income from State and local bonds, for example, is exempt from Federal income taxes. Certain qualifying nonprofit organizations are exempt from Federal income taxation. These provisions are not described as exemptions on the tax return, however; they are more properly termed "exclusions."
Taxable income, the narrowest measure of income used on the income tax return, is equivalent to adjusted gross income reduced by the amounts claimed for personal exemptions, and either the standard deduction or itemized deductions. Taxable income is the base upon which the income tax rate is applied to calculate income tax liability, either through the tax tables or the tax rate schedules.
Tax credits are subtracted from the first computation of the tax bill, which is derived from the tax tables or tax rate schedules, and hence, credits reduce tax liability directly. Tax credits are available to all taxpayers, whether they itemize deductions or not. Examples of tax credits include the credit for the elderly and the permanently and totally disabled, the earned income tax credit, the credit for child and dependent care expenses, and the foreign tax credit. These credits can be divided into two categories. "Refundable" credits are those which can exceed tax liability, resulting in a direct payment from the Treasury. (The direct payment is called a "refund" even when nothing has been paid to be refunded.) Non-refundable credits can only be used to the extent they eliminate tax liability; they cannot result in a payment.
Tax liability is the amount of Federal income tax owed by the taxpayer to the Federal Government, after taking into account allowable tax credits, but before subtracting withheld taxes and estimated tax payments already paid. Thus, tax liability represents the taxpayer's total Federal income tax bill for his/her tax year. A taxpayer's tax liability may be negative, if the amount of refundable tax credits exceeds his calculated tax bill before allowing for the credits. Non-refundable credits can only reduce tax liability to zero, but cannot make a taxpayer's tax liability negative.
If tax liability exceeds Federal taxes withheld, estimated quarterly taxes paid, and certain other credits, then the taxpayer will owe the Federal Government additional Federal individual income taxes.
A tax refund is a payment by the Federal Government to a taxpayer whose withheld taxes or estimated tax payments exceeded his final tax liability, entitling him to a refund to remedy his having overpaid his tax bill. A taxpayer with negative tax liability is also entitled to a tax refund, although this refund is not a refund of overpaid taxes, but a payment of a negative tax. In any case, a tax refund is based on the taxpayer's individual tax situation and is not part of a general plan to reduce tax collections.
The flow chart illustrating the relationship among the income tax terms discussed in this report appears on the following page.
Additional Taxes Due
Less Personal and Dependency Exemptions
Standard Deduction Amount
Less Tax Credits
Less Estimated Tax Payments and Withholding
Section 2. Corporate Income Tax
Tax Rates and Receipts
An income tax has been assessed upon corporate earnings continuously since 1909. Table 1 provides a compilation of the marginal rates of tax imposed on corporate income from 1909 to 1993. Table 2 shows total corporate income tax receipts, as percentage of total Federal receipts, in billions of dollars and as percents of gross domestic product (GDP), for fiscal years 1960–92.
Corporate Income Tax Base
The Internal Revenue Code ("Code") allows corporations various deductions, credits, exclusions and deferrals (collectively "reductions") against earnings in the determination of income subject to tax. Certain of these reductions, for example, the deduction for the cost of labor directly related to the production of inventory, can properly be allocated to income generated in a particular year. Accordingly, this cost of earning taxable income should be allowable as a deduction in a normative system which taxes net corporate in
Other types of reductions against corporate earnings result from Code provisions that provide economic incentives to certain classes of corporations or for corporations engaging in particular activities. Such reductions are known as tax expenditures. A tax expenditure can be thought of as analogous to a direct outlay of funds by the Federal Government and results in lower tax receipts than would be paid otherwise through the corporate income tax. (See Part VI., "Federal Tax Expenditures.")
An example of a corporate tax reduction constituting a tax expenditure is the orphan drug credit. For periods before June 30, 1992, corporations may qualify for a credit of up to 50 percent of the amount of qualified testing expenditures attributable to drugs for rare diseases. This expenditure has been justified by Congress as an appropriate subsidy for the production of drugs which, although necessary for the health of a small percentage of the population, would not be commercially available otherwise. The availability of the credit would have been extended through June 30, 1993, in the conference agreement to H.R. 11, the Revenue Act of 1992, but that bill was vetoed by the President. The Joint Committee on Taxation has estimated that the orphan drug credit will lose less than $50 million over a 5-year period.
It is sometimes difficult to determine whether a particular reduction should be viewed as a tax expenditure or as a true cost of earning income. For example, interest is generally fully deductible on debt issued by a corporation. In 1989, the Committee on Ways and Means held 7 days of public hearings on mergers, acquisitions,
and corporate transactions that increase the aggregate levels of corporate debt. Several witnesses testified that the corporate interest deduction is an inappropriate tax expenditure resulting in a subsidy for merger and acquisition activity. Other witnesses stated that interest expense is a cost of doing business for a corporation and should be fully allowed as a deduction in a normative income tax system.
Some reductions, such as depreciation deductions for plants and equipment, exhibit qualities of both costs of earning income and tax expenditures. The staff of the Joint Committee on Taxation assumes, for example, that a normal tax structure would permit straight-line cost recovery deductions on structures and equipment over the useful life of the asset, and that additional depreciation deductions should be considered tax expenditures.
B. STRUCTURE OF THE CORPORATE INCOME TAX
Four years after the passage of the first tax on corporate income in 1909, the 16th amendment and the Revenue Act of 1913 (Ch. 16, 38 Stat. 114) imposed an income tax on individuals. Since that time, the Code has required a "two-tier" system of taxing corporate income. Corporate earnings are taxed when received or accrued, depending upon the accounting system utilized by the corporation. Such earnings are generally taxed again when distributed to shareholders. For example, a corporation with taxable income of $100,000 would be subject to a 34-percent rate and pay $34,000 in corporate income taxes. If the remaining earnings of $66,000 were distributed as dividends to shareholders, it would be subject to individual income tax rates of 15, 28 or 31 percent, depending on the tax bracket of the shareholder. If all shareholders receiving dividends were in the 31 percent top individual bracket, then $20,460 in individual income taxes would additionally be levied. Thus, the $100,000 in corporate earnings could be subject to total income tax of $54,460, representing a 54-percent rate.
The two-tier tax system has been the subject of significant policy debate for several years. Some commentators believe that there is little theoretical justification for assessing two levels of taxation on corporate earnings. Several forms of full or partial integration_of the corporate and individual tax systems have been suggested. For example, a shareholder credit equal to the tax assessed on corporate earnings has been proposed, as well as a shareholder exclusion of a portion of distributed corporate earnings. In conjunction with the legislation leading to enactment of the 1986 Act, the Committee on Ways and Means adopted, and the House passed, a proposal which would allow a 10 percent dividends-paid deduction for corporations to be phased in over 10 years. The provision was not adopted, however, by the Senate Finance Committee or the conferees to the 1986 Act.
On the other hand, other commentators view the two-tier tax system as properly assessing tax upon the privilege of doing business in corporate form. Clearly, the Federal Treasury obtains significant revenues as a result of the two-tier system. In addition, Congress has taken several actions in the recent past to strengthen the two-tier system. In the 1986 Act, Congress repealed an exception to taxation of corporate earnings on the liquidation of a cor