The “Unified Framework for Fixing Our Broken Tax Code” (the “Framework”) released by the “Big Six” group of Treasury, White House, and congressional leaders on September 27 has been the focus of a lot of commentary.1 Most of this analysis has focused on the distributive aspects of the plan and on the proposed rate structure, as well as the impact on revenues and the federal deficit.

According to a Tax Policy Institute analysis, 80 percent of the tax cuts would go to the very rich—the top 1 percent and particularly the top 0.1 percent of earners—reducing revenue by $2.4 trillion over the next ten years.2 With tax cuts totaling $5.8 trillion and only $3.2 trillion3 in added tax revenue via base broadening—limiting deductions and ending exemptions for state and local taxes, for example—the plan would add at least $1.5 trillion to the deficit over the next decade, something that even congressional Republicans are acknowledging, which is a departure from their previous commitments to austerity and fiscal discipline.4

The administration has argued that these tax cuts will stimulate economic growth. While tax cuts can stimulate some growth, as individuals may spend some of the additional money they have on hand, this is not a given, and consumer purchasing is not as effective as direct government spending in producing growth. This is especially true for this tax plan, since the cuts are skewed toward the rich,5 who are less likely to spend any money they gain through tax cuts in the real economy, as they are more likely to save the money or sink the tax break money into financial investments.

The arguments against this sort of “trickle down” economics have been made persuasively over the years, and so critics of this tax plan are right to revisit them again. However, I will focus instead on the less-studied structural aspects of the plan, and in particular on the various new distinctions it makes between types of income, because the effects of these are more likely to be lasting and create more damage in the long run.

The structural changes proposed in the Framework are likely to encourage tax avoidance via offshoring and the reclassification of corporate entities, all in the name of bolstering business confidence and investment. Many of these changes, however, would result in lower tax receipts, and would increase wage and wealth inequality. Because structural proposals are more enduring than changes in tax rates, these significant long-term consequences will be difficult to reverse.

If passed and implemented, the provisions in the proposed tax reform package would exacerbate many of the most pressing economic problems of our times, including worsening income and wealth inequality, stagnating incomes, sluggish growth, and weak productivity gains. Indeed, it is precisely the opposite of what is required in a tax reform structure that would promote stable and widely distributed economic growth. While the Council of Economic Advisers has predicted6 that the tax cuts will give households an average of $4,000 more per year, not only is that result highly unlikely, the use of “average” is grossly misleading: giving back $40,000 to one family and zero to nine families, for example, results in an average of $4,000 for those ten families.

The Two Elements of Tax Reform

Any tax reform has two major elements. The first element consists of the tax rates for individuals and corporations. Rates are important because of their distributive implications and impact on revenues, as well as their incentive effects. But the tax rates resulting from reform rarely last. Republican administrations since Reagan have tended to cut the tax rates, and Democratic administrations have raised them. The top individual marginal tax rate was cut by Reagan and by George W. Bush, and raised by Clinton and Obama.7 Rates are a major focus of our political debate, and so it is understandable that they would be affected by elections and changes in administration.

The second element of tax reform is changes in the structure of the tax system—distinctions between one source of income and another—and those tend to be more lasting. When tax law makes a distinction between one type of activity and another, and thus one form of income and another, it draws a dividing line between those two forms of income. These dividing lines determine the structure of our tax system, and the distinctions they make can endure for decades. The 1986 tax reform8, for example, strengthened the corporate tax and drew a dividing line between publicly traded entities that are taxed as C corporations and whose shareholders pay a second tax on dividends, and non-publicly traded entities that are typically taxed on a pass-through basis (that is, taxes are not levied until income “passes through” to the shareholders or partners).9 This line has persisted ever since, and has led directly to the growth of the pass-through sector (especially after LLCs proliferated in the 1990s). The top individual rate and the rate on dividends have changed several times in the past thirty years, but the basic division between C corporations and pass-throughs remains the same.

Another example of a structural change that has persisted is the equivalence between the rate on dividends and the rate on capital gains, which was set by then House Ways and Means Chair Bill Thomas in 200310 (contrary to the wishes of the Bush administration, which had proposed a zero rate on dividends). This equivalence is an important structural feature that significantly reduces the pressure to make a distinction between dividends and redemptions—stock buybacks—which is the focus of several complicated sections of the Internal Revenue Code. The rate on dividends and capital gains was changed twice since then, but the structural equivalence has been maintained.11

Thus, it is important to focus on the structural features of the Framework, which draws several important new lines in the tax code. In general, every time a line is drawn in taxation, effort is needed to police it and prevent inappropriate shifting of income across it. This report will now evaluate the new lines drawn in the business and international provisions of the Framework.

Line One: Individual versus Pass-Through Income

The most important structural innovation of the Framework is taxing the business income that individuals receive via “pass-through” entities at a separate rate (25 percent) from that for other individual income. A pass-through is any entity—such as sole proprietorships, partnerships including LLCs, and S corporations—that is not taxed at the entity level; instead, under current law, its income “passes through” the entity and is taxed at the individual rate of the proprietor, shareholder, or partner. The owners of a family-run restaurant or plumbing company, or partners in a privately owned law firm or medical practice, for example, all typically receive pass-through income.

While the bulk of pass-throughs are owned by small business owners who are in the lower tax brackets, a large percentage of the aggregate taxable income flowing through pass-throughs finds its way into the hands of a relatively few high-income individuals at large accounting and law firms, investment firms, real estate partnerships, physicians groups, and the like. For such high-income individuals, dropping the rate from the current individual rate of 39.6 percent to the new pass-through rate of 25 percent is a significant gift. Under the Framework, which currently proposes a top individual rate of 35 percent, the differential would still be large, although the Framework does mention the possibility of an even-higher top bracket for high-income individuals.

The tax code has never treated pass-throughs as separate taxable entities, for good reasons. Entity taxation is problematic in any scenario, because in the end, the tax is not borne by the entity—only people can bear tax burdens—and so there is uncertainty regarding who actually bears the burden of the tax, a disputed subject12 among economists.13 In the case of C corporations, we have no choice but to tax the entity, because pass-through taxation of publicly traded entities would be an administrative nightmare; it could be done by taxing the shareholders each year based on the value of their shares, but that is also politically difficult. The income earned by pass-throughs, however, can easily be taxed when it accrues to the owners, and that is clearly the best way to maintain taxation, based on each individual’s ability to pay.

Instead, the Framework proposes to tax pass-through business income at a significantly lower rate, while keeping other types of ordinary income of individuals, such as wages, taxed at a significantly higher rate. Once drawn, this line would clearly create an incentive for high-income individuals to transform their wage income (taxed at 35 percent or higher) into business income (taxed at 25 percent) by establishing Limited Liability Corporations—normally reserved for larger non-publicly traded businesses—or S corporations, or even sole proprietorships that are normally reserved for small businesses. Precedents for this problem14 are troubling, since this is precisely the line that was crossed by hedge fund managers characterizing carried interest as capital gains rather than ordinary income and by numerous professionals using S corporations to avoid the payroll tax on wages.

The Framework acknowledges this issue and states that it “contemplates that the committees will adopt measures to prevent the recharacterization of personal income into business income to prevent wealthy individuals from avoiding the top personal tax rate.”15 But it is hard to see how this can be done, given that most business income earned through pass-throughs is the result of labor effort by the owners (lawyers, accountants, physicians, and other professionals, as well as investment managers and consultants) rather than capital investments or manufacturing (which tends to be done by C corporations). There is no meaningful distinction between those types of service activities and labor performed for a wage. Thus, it is likely that under the Framework the only people who will wind up being taxed at the 35 percent rate are those unfortunates who are employees of someone else, and who are also subject to withholding and to payroll taxes. Anyone who is self-employed (by themselves or as part of a group) will be able to benefit from the 25 percent rate, with no obvious justification (many of these businesses are hardly “small,” with revenues in the millions of dollars). For example, the president’s businesses are all pass-throughs and likely to qualify for the 25 percent rate (instead of 39.6 percent).

Creating this line between the salaried earnings of high-income individuals and the business income of pass-through entities will incentivize wealthy individuals to reclassify their work as pass-through corporations, reducing their tax rate, contributing to wage inequality, and lowering overall tax receipts.

Line Two: Corporate versus Pass-Through Income

A related line drawn by the Framework is between C corporations that will be taxed at 20 percent, but with lower effective tax rates due to expensing (discussed below), and pass-throughs that will be taxed at 25 percent. This rate structure, while lower overall, has a differential that is similar to the one under current law (35 percent for C corporations, but with lower effective rates, versus 39.6 percent for individual income earned via pass-throughs), but income earned through C corporations will continue to be taxed twice (once at the corporate level, and again when distributed as a dividend), since the Framework does not change dividend or capital gain taxation.

The result of drawing this line will be a continuation of the current trend for businesses to go private and avoid the C corporation form.16 This will erode the C corporation tax base further, reducing tax receipts as businesses go private for preferential tax rates.

Figure 1

Line Three: Expensing of Investments in Depreciable Assets

Another important structural innovation in the Framework is expensing (claiming an immediate deduction) for new investments in depreciable assets other than structures made after September 27, 2017, for at least five years, with potential extension. A manufacturer buying machinery for an assembly line or a private bus company buying a fleet of vehicles could, under the Framework, could immediately deduct the cost of these investments rather than factor in depreciation of that machinery over several years, as it is required to do under current law. The Framework seems to extend this ability to all businesses, but as a practical matter, the main effect will be on C corporations, since they make most of the tangible business investments in depreciable property.

It is well established that expensing is equivalent to making the normal return from the expensed investment exempt from tax. Thus, in principle, this is a very important innovation, because it can translate into a zero corporate tax rate.17 However, it is doubtful that the immediate effect will be significant, because the normal return under current interest rate conditions is very low (as opposed to the last time effective expensing was tried in 1981,18 when interest rates were very high).

Nevertheless, expensing sets an important structural precedent that will be hard to take away after five years (a limit that presumably was set by revenue considerations). Under a different interest rate environment, expensing could become very important, and even make the United States into a giant corporate tax haven from the perspective of the rest of the world. With this new line, the harm lies in its continuation of the race to bottom in corporate taxation around the world. It is also unclear whether the expensing would do anything to revitalize U.S. manufacturing.

The important line drawn here is between businesses that would benefit from expensing because they make a lot of tangible investments—mainly old style manufacturing operations—and businesses that would not because they already deduct R&D and human capital. The latter that would not benefit are all the cutting-edge businesses in the economy (think Google, Amazon, Apple, and so on), and so expensing is unlikely to eliminate their advantage in drawing the best and the brightest. Business support for this proposal outside the manufacturing sector is likely to be lukewarm, and even manufacturers may not be enthusiastic at the moment, since absent higher interest rates, the structural change simply alters the timing of earnings, and would not help increase earnings per share.

Line Four: Interest Deductibility

If expensing (discussed above) is allowed, it should be accompanied by a limitation on the deductibility of interest paid on debt, because, if it is possible to deduct said interest, while at the same time using the borrowed funds to invest in functionally exempt returns (under expensing as well as exempt dividends from offshore subsidiaries), the result can be negative19 tax rates.20 To avoid negative tax rates, the Framework draws a line by envisaging a “partial” limit on interest deductibility by C corporations, and states further it will “consider the appropriate treatment of interest paid by non-corporate taxpayers.”21 If expensing is allowed for pass-throughs, it will be necessary to limit interest deductibility for those businesses as well.

There are two problems with this line. The first is the continuing differential treatment of debt and equity, since interest will be partially deductible while dividends presumably will not be, and interest will be taxable in full to the recipient while dividends qualify for a reduced rate. This is a notoriously difficult line to police, especially with modern financial instruments.22 Policing this line requires constant IRS attention, and it distorts corporate financial decision making and may induce them to take on more debt than they can afford when the next downturn in the economy arrives.

The second problem is that financial institutions will have to be excluded, because they cannot function without the interest deduction (a bank earns interest and if it cannot deduct interest it will be grossly over-taxed). But it is notoriously hard to draw a line between financial institutions and other C corporations, especially in this age of “shadow banks”23 (non-banks that operate like banks) and FinTech (hi-tech firms that offer financial applications).24

Line Five: Domestic versus Foreign Profits

The Framework adopts “territoriality”; that is, it exempts in full for the recipient any dividends received from foreign subsidiaries in which a U.S. parent owns at least a 10 percent stake. The Framework also adopts a one-time corporate tax on past offshore earnings, with a lower rate for illiquid assets than for cash equivalents, and with the liability spread out over several years (presumably to mitigate the hit to the financial statements, since these $2.5 trillion are largely deemed permanently reinvested offshore and no reserve has been taken for tax).25 While this treatment of past earnings is likely to result in large repatriation of funds, the experience of the 2004 amnesty has shown26 that this does not translate into more jobs but instead benefits wealthy shareholders through share repurchases (that is, when the corporation acquires its own shares from the shareholders).

The obvious line drawn by the Framework here is between domestic profits (which would be taxed at 20 percent, but potentially with a lower effective rate due to expensing) and foreign profits (which would be taxed in the United States at zero). This creates an obvious incentive to shift profits from the U.S. to foreign jurisdictions, especially in tax havens where the foreign tax rate is also zero. This incentive certainly also exists under current law, but it is mitigated by the current tax on dividends (since the multinational cannot currently repatriate without paying tax at 35 percent). Adopting a dividend exemption—even with a lower corporate rate—would significantly increase the incentive to shift profits overseas (the new lower corporate rate, even with expensing, is not very different from the current effective rates of most U.S.-based multinational enterprises that already write off R&D and human capital costs).

The Framework addresses this problem by imposing a current minimum tax on the foreign profits of U.S. multinationals. But it does not specify the rate, and while any minimum tax would be an improvement over the current situation in which most offshore income is taxed at very low rates, presumably the intent would be to set the minimum rate at significantly below the 20 percent domestic rate. Any such differential would preserve the enhanced incentive to shift profits offshore in the knowledge that they can be repatriated tax-free.27 Instead of solving the problem of offshore profits, the differential would exacerbate it, curtailing corporate tax receipts further.

In addition, the minimum tax preserves the existing line between U.S.-based multinationals (subject to the minimum tax) and foreign-based multinationals (not so subject, if the right jurisdiction is chosen). The result will be continuing inversions (that is, transactions in which a U.S. corporation becomes a subsidiary of a new parent incorporated in a low-tax jurisdiction and not subject to strict Controlled Foreign Corporation (CFC) rules).28 The Framework promises to “level the playing field between US-headquartered parent companies and foreign-headquartered parent companies,” but it is unclear how this can be achieved, as long as U.S.-resident corporations pay any tax based on residence, since it is always possible to find lower tax foreign residence jurisdictions.29

From the perspective of foreign multinationals in some jurisdictions, it is possible that the lower U.S. corporate tax rate plus expensing will make the U.S. a giant corporate tax haven. However, if the resulting effective tax rate is too low, this will trigger foreign CFC rules that typically hinge on the effective tax rate in the target jurisdiction, and are designed to prevent avoiding taxes through offshoring and inversion.

Conclusion: Can Fewer Lines Be Drawn?

If the Framework is adopted, these structural features of tax reform will be hard to change further down the road—in particular, the lower tax rate for pass-through income, expensing, and territoriality. These would be popular provisions that even future Democratic administrations would find hard to touch (as shown by the disastrous experience with “check the box,” which is still with us, despite repeated commitments to abolish it).30

The Framework should draw fewer lines, and those should be defensible. The pass-through proposal should be dropped, because the line between pass-through business income and wages cannot adequately be defended. Instead, the current distinction between C corporations and pass- throughs should be retained, since that line (public trading) is more easily defended, because it relates to non-tax attributes, and because the tax code should not resort to unnecessary entity taxation. The expensing proposal should also be dropped, because it creates unjustified winners and losers, and because it requires limits to interest expense that cannot adequately be defended (the debt/equity and bank/non-bank lines). Finally, territoriality should be dropped, since the domestic/foreign line cannot adequately be defended.

Instead, much of the current structure should be retained: a top rate for individuals that also applies to pass-through income; and a lower rate for C corporations, with a second tax on dividends and capital gains. These elements should be accompanied by two major changes. The first would be to set the dividends and capital gains rate at the top ordinary income rate—as was done for capital gains in 1986—even if the result is a lower rate on ordinary income. A lower rate for capital gains is required to mitigate lock-in. While a mark to market regime—under which taxpayers would be taxed on the appreciation of their assets regardless of whether they are sold—would be another worthwhile change, but it is not politically feasible, and the gain from taxing the rich more on dividends and capital gains offsets the lower corporate tax and lower tax on wages. It makes sense to tax shareholders more than corporations in a world in which corporations are more mobile than shareholders.

The second change would be to extend the new corporate tax rate to foreign income, past as well as future. There is no competitiveness reason not to tax past accumulated earnings in full. For future earnings, the only way to prevent profit-shifting and allow tax-free repatriations is to apply the same rate to all corporate income, regardless of where it is earned. The rate should be set at whatever level is needed to maintain future competitiveness, and the existence of robust CFC rules in most of the world means that the effective rates of our major competitors are not so low that this would require a rate below 20 percent (with part of the tax reduction made up from dividends). Such a rate would still lead to incentives to invert to countries with no CFC rules, but that line can be defended by redefining corporate residence by location of headquarters and imposing a corporate exit tax. That is what our major competitors do, and there are no inversions from European countries or Japan: if a European or Japanese corporation wishes to change its corporate residency, it has to shift the actual location of the headquarters and pay a hefty exit tax on a deemed sale of all its assets.

In sum, the Framework is a deeply flawed proposal that is not only skewed toward the rich, but also relies on drawing lines that cannot possibly be defended, resulting in even more tax avoidance by the rich. A tax system that addresses inequality, is enforceable, and brings relief to working families would do more to stimulate growth and productivity than the structural changes discussed above, which will only stimulate tax dodging and the transfer of income to the top of the income and wealth distribution. We can and should do better.


  1. “Unified Framework for Fixing Our Broken Tax Code,” U.S. Treasury, September 27, 2017,
  2. “A Preliminary Analysis of the Unified Framework,” Tax Policy Center, September 29, 2017,
  3. “Big Six Tax Framework Could Cost $2.2 trillion,” Committee for a Responsible Federal Budget, September 27, 2017,
  4. Lisa Mascaro, “‘Deficit no longer a dirty word for GOP,” Los Angeles Times, October 5, 2017,
  5. Joseph Stiglitz, “Deja Voodoo,” Project Syndicate, October 4, 2017,–stiglitz-2017-10.
  6. Council of Economic Advisers, “Corporate Tax Reform and Wages: Theory and Evidence,” October 16, 2017,
  7. “Historical Highest Marginal Income Tax Rates,” Tax Policy Center, March 22, 2017,
  8. “Economic Impacts of the Tax Reform Act of 1986: Short-Run and Long-Run Perspectives,” Congressional Budget Office, June 1, 1987,
  9. Even large, privately held entities with thousands of shareholders are typically taxed as pass-throughs, but since 1987, almost all publicly traded entities are taxed as C corporations.
  10. Joel Friedman and Aviva Aron-Dine, “The Capital Gains and Dividends Tax Cuts and the Economy: New Treasury Reprot Paints Misleading Picture,” Center on Budget and Policy Priorities, March 27, 2006,
  11. “Federal Capital Gains Tax Rates, 1988-2013,” Tax Foundation, June 13, 2013.
  12. Kimberly A. Clausing, “Who Pays the Corporate Tax in a Global Economy?,” National Tax Journal 66, no. 1 (2013),
  13. Li Liu and Roseanne Altshuler, “Measuring the Burden of the Corporate Income Tax Under Imperfect Competition,” National Tax Journal 66, no. 1 (2013),
  14. Some experts have estimated the revenue loss to carried interest at $180 billion, but this number would be dwarfed by the revenue lost if the pass-through proposal in the Framework were enacted. Victor Fleischer, “How a Carried Interest Tax Could Raise $180 Billion,” New York Times, June 5, 2015,
  15. “Unified Framework for Fixing Our Broken Tax Code.”
  16. “CBO Examines Business Income Shifting of Pass-through Entitites,” Lexis Nexis, December 1, 2012.
  17. For example, assume that a taxpayer earns $100 subject to tax at 50 percent, and that she can invest the after-tax proceeds at 10 percent. Under a normal income tax, the taxpayer pays $50 upon earning the income, and then invests the remaining $50 at 10 percent, earning $5 in interest income on which she pays $2.50, with $52.50 left after tax. If the interest were exempt from tax, she would have $55 after tax. If, instead, she is allowed to expense the original $100, she would pay no tax initially, and her investment of $100 would grow to $110. When that amount is taxed at 50 percent, the result is $55 after tax. This shows that (under certain assumptions) expensing is equivalent to exempting the income upon the expensed amount from tax.
  18. Julian E. Zelizer, “How America’s Vision of Progressive Tax Reform Died,” The Atlantic, September 28, 2017,
  19. “The 35 Percent Corporate Tax Myth,” Institute for Taxation and Economic Policy, March 9, 2017,
  20. For example, suppose a taxpayer borrows $10,000 and then buys an asset that appreciates to $15,000, which it then sells for a capital gain of $5,000, taxable at 20 percent, or $1,000. If the borrowing produces $5,000 of interest deductible against the taxpayer’s other income at 35 percent, the result is a tax benefit of $1,750, for a net tax liability of negative $750. If the $5,000 return on the asset is exempt instead of taxed at a preferential rate, the net tax liability would be negative $1,750.
  21. “Unified Framework for Fixing Our Broken Tax Code.”
  22. “Present Law And Issues Related To The Taxation Of Financial Instruments And Products,” Joint Committee on Taxation, December 2, 2011,
  23. Perry G. Mehrling, “Regulating the Shadow Banking System,” Institute for New Economic Thinking, April 3, 2011,
  24. “Fintech,” McKinsey and Company,
  25. Under accounting rules, no reserve needs to be taken for the future tax on dividends if the income is declared to be permanently reinvested outside the United States.
  26. Eduardo Porter, “Will a Corporate Tax Holiday Give Workers Anything to Cheer?,” New York Times, September 26, 2017,
  27. Our major competitors in the EU and Japan, which use a territorial system, are subject to strict Controlled Foreign Corporation (CFC) regimes that minimize the incentive to artificially shift profits overseas.
  28. “Designing Effective Controlled Foreign Corporation Rules,” Organization for Economic Cooperation and Development, October 5, 2015,
  29. “Unified Framework for Fixing Our Broken Tax Code.”
  30. Frank Sammartino, “Taxation of Pass-through Businesses,” Tax Policy Center, January 30, 2017,