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One major goal of the President's tax plan is revenue neutrality, which means that the plan is intended to raise about the same revenues as projected under current law from 1986 through 1990. The estimates supplied by the Department of the Treasury show that the President's plan would be approximately revenue neutral over that five-year time span. The Treasury estimates that the difference in overall revenues between the proposal and current law would be $11.5 billion over the 1986 to 1990 period. This difference in revenues from the entire proposal (less than 0.5 percent of total revenue over the five-year period) is clearly insignificant from an estimating standpoint.

The Treasury Department revenue estimates show that the taxes paid by corporations would increase and those paid by individuals would decrease. In 1990, the Treasury estimates that corporate income taxes would rise by $25.2 billion (22.7 percent), and individual income taxes would decline by $26.9 billion (5.2 percent). Over the five-year period from 1986 through 1990, corporate revenues are estimated to rise by $118.4 billion (24.4 percent), while individual revenues would fall by $131.8 billion (6 percent).¹ Because of this apparent shift in taxation from individuals to corporations, apprehension has arisen that the new tax system would hurt capital formation and reduce the growth in the economy.

Revenue Estimates and Revenue Neutrality

The type of revenue estimates used in discussions of tax reform and revenue neutrality are static five-year cash-flow revenue projections. Although these revenue projections are an important part of the budgetary process, they do not account for the full effects of many tax changes. Two important limitations to cash-flow revenue estimates are that they are restricted in their time horizon and that they do not reflect changes in future tax deferrals over time. Because the long-run revenue potential of any new tax system can differ significantly from its short-run revenue effect, limiting the estimation period to five years may provide a misleading indication of a new system's revenue potential and its allocation of tax payments between corporations and individuals. This is especially true if provisions are phased in (or due to expire) during the first five years.

A second limitation of the five-year cash-flow estimates is that they ignore the effect of changes in tax deferrals beyond the five-year period. A tax deferral is a future tax liability that results from current actions. For example, depositing $2,000 in an Individual Retirement Account (IRA) results in a tax deduction this year and a concomitant future tax obligation (deferral) when those funds are withdrawn. Where tax provisions affect tax liabilities in the future, it is important to look not only at current tax effects, but at those future tax changes as well. In the case of tax deferrals, the present value of a tax change provides useful information about the long-run tax burden that it is likely to impose. The present-value effect also indicates the change that is likely to occur in investment incentives. In order to measure the present value of a tax change, it is often necessary to extend one's time horizon well beyond the conventional five-year time span.

In this study, the Congressional Budget Office (CBO) analyzes the revenue effects of several major corporate income tax provisions included in the President's tax plan. Provisions analyzed here include (among others) the proposed changes in the system of tax depreciation, the investment tax credit (ITC), and the maximum corporate tax rate. These provisions have large revenue effects in 1990; the Treasury estimates that the change in depreciation will raise $21.2 billion in 1990, repealing the investment tax credit will raise $44.6 billion, and corporate rate reduction will reduce revenues by $42.0 billion in that year.² The addition of a 10 percent dividends-paid deduction is estimated to lower revenues by $6.7 billion in 1990.

With the notable exception of the change in depreciation rules, the revenue estimates for these provisions probably provide a fairly accurate account of their longer-run revenue effects relative to GNP since they are immediately phased in and do not give rise to future tax deferrals. The depreciation rule changes, however, do have significant effects on revenues well after 1990 and affect the long-run revenue potential of the proposed tax system. Therefore, the short-run revenue effects associated with the depreciation changes may provide a misleading indication of the future revenues and investment incentives to be generated from such changes. These future revenue effects are the focus of this paper.

Other Revenue Provisions

Other provisions of the President's tax plan have major effects on federal revenues. Among these are the rate cuts for individuals (-$72.7 billion in 1990; -$260.6 billion in 1986-1990), the change in the personal exemption (-$48.0 billion in 1990; -$193.1 billion in 1986-1990), the repeal of the deduction for state and local taxes (+$40.0 billion in 1990; +$148.9 billion in 1986-1990), the repeal of income averaging (+$4.9 billion in 1990; +$8.7 billion in 1986-1990), and the repeal of the second earner deduction (+$9.0 billion in 1990; +$33.7 billion in 1986-1990). The President's proposal also includes a recapture of the rate reduction on accelerated depreciation that is estimated to raise $57.6 billion over the 1986-1989 period, but would have no long-run revenue effect. In general, these provisions result in straightforward tax changes and do not involve long phase-in periods or changes in future taxes; their long-run revenue effects (relative to GNP) are likely to be approximated by their 1990 effects.

There are, however, several other major provisions for which the five year and 1990 revenue estimates may be misleading as to their longer-term revenue effect. These include the matching of income and expense for multi-period production (+$14.1 billion in 1990; +$44.0 billion in 1986-1990), the changes in the rules regarding the taxation of capital gains (+$5.4 billion in 1990; +$18.5 billion in 1986-1990), the elimination of private-purpose bonds (+$4.5 billion in 1990; +$13.0 billion in 1986-1990), taxation of some health insurance benefits (+$4.0 billion in 1990; +$17.4 billion in 1986-1990), and tax changes regarding retirement saving (+$5.8 in 1990; +$20.6 billion in 1986-1990). The 1990 revenue estimates for these provisions may be significantly different from their long-term revenue effects, relative to GNP. The potential long-run revenue effects from these and other major tax provisions are further discussed in the last section of this paper.

Supplemental Estimates of Corporate Tax Provisions

Two sets of supplementary revenue estimates are presented in this paper. The first set looks at the 20-year effects of corporate tax provisions on the taxation of income from a fixed composite corporate investment undertaken today. The second set of estimates extends the time horizon from 5 to 15 years and examines the profile of the cash-flow revenue estimates of the general corporate tax provisions. This second set of estimates is based on aggregate gross corporate investment and includes the effect of the growing level of corporate investment over time.

The basic results of this study indicate that the general corporate provisions included in the President's tax plan (depreciation rule changes, the investment tax credit, the corporate rate cut, and the partial dividend deduction) will probably reduce the tax burden on income earned in the corporate sector in the long run. Compared with current law, this means that the overall effect of these general provisions related to taxing corporations probably provide a tax cut over time. The President's tax proposal may still raise taxes paid by the corporate sector (compared with current law) in the long run because there are many base broadening provisions that affect selected industries, such as oil and gas production, defense contracting, or financial services. However, the longer-run revenue potential of the system as a share of GNP is likely to be much less than would be shown by a simple extrapolation of five-year revenue estimates to future years.

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1. The Treasury Department also asserts that "when fully effective, the President's proposals would raise total corporate tax payments by an estimated 9 percent, and would lower total individual tax payments by 7 percent." The term "fully effective" is not defined. This would appear to be inconsistent with long-run neutrality because individual receipts under current law are almost five times greater than corporate receipts. See The President's Tax Proposals to the Congress for Fairness, Growth, and Simplicity.

2. The President's Tax Proposals to The Congress for Fairness, Simplicity, and Growth, Appendix CA. The rate reduction revenue estimates are calculated assuming enactment of many other base-broadening provisions, in addition to the ones considered here.