Major Federal Tax Reform Proposals Explained

Federal tax reform is the process of changing the laws that govern how the United States government collects revenue, impacting every individual and business. Proponents of reform often cite goals such as fostering economic growth, ensuring an equitable distribution of the tax burden, and reducing complexity for taxpayers. The conversation around tax reform is continuous, driven by evolving economic conditions and shifting political priorities. Many significant changes from the Tax Cuts and Jobs Act of 2017 (TCJA) are set to expire after 2025, forcing a debate on whether to extend, modify, or replace them.

Proposals Focused on Tax Simplification and Rate Reduction

A prominent category of tax reform proposals centers on simplifying the federal tax code by lowering income tax rates and broadening the base of taxable income. The most well-known concept is the “flat tax,” which would replace the multi-bracketed income tax structure with a single rate for all income above a certain exemption. This approach typically involves eliminating most itemized deductions and credits, making it easier for taxpayers to understand their obligations and lowering administrative costs.

Other proposals aim for simplification without a single-rate structure by consolidating the existing number of tax brackets into fewer, wider ones. For example, a proposal might feature three or four brackets instead of seven. This approach maintains a degree of progressivity, where higher earners pay a larger percentage of their income in taxes, but seeks to reduce the disincentive effects of high marginal tax rates.

These proposals often include a corresponding reduction in the corporate income tax rate. The TCJA permanently lowered the top corporate rate to 21%, and many proposals advocate for maintaining or further reducing this rate. The rationale is that a lower corporate tax rate makes the United States more attractive for business investment, discouraging companies from shifting operations overseas.

Proposals for a National Consumption Tax

A different approach to tax reform involves shifting the tax base from income toward consumption. The leading proposal is a national retail sales tax, often called the “FairTax,” which would replace federal personal income, corporate income, and payroll taxes. In their place, a single, high national sales tax would be applied to the final retail sale of all new goods and services.

The tax would be collected by businesses at the point of sale, with a proposed rate often cited as 23% to 30% on a tax-inclusive basis. This functions similarly to state sales taxes but at a much higher rate and on a broader base. This system would eliminate annual income tax filings and payroll withholding.

A feature designed to address the regressive nature of a sales tax is the “prebate” mechanism. To mitigate the disproportionate effect on lower-income households, the FairTax proposal includes a monthly payment to every household. This prebate would be equal to the sales tax paid on spending up to the federal poverty level, effectively untaxing consumption up to this threshold.

Implementing a national consumption tax would eliminate the Internal Revenue Service (IRS) in its current form, shifting the collection burden to retail businesses. Proponents argue this would boost transparency, as the tax would be visible on every receipt. It could also encourage saving and investment since income would not be taxed until it is used for consumption.

Proposals Emphasizing Progressive Taxation and Wealth

Another direction for tax reform focuses on increasing the tax burden on high-income individuals and large accumulations of wealth. These proposals aim to ensure the wealthiest Americans contribute a larger share of federal revenue. A common feature is creating new, higher marginal tax brackets for the highest incomes, such as rates of 40% or more for income above $1 million.

These proposals also often target investment income. Currently, long-term capital gains and qualified dividends are taxed at preferential rates, which are lower than the top rates on wages. Progressive reforms frequently call for eliminating this preference for high-income earners, taxing capital gains and dividends at the same rates as ordinary income.

A more fundamental proposal is the introduction of a “wealth tax.” Unlike an income tax levied on earnings, a wealth tax is an annual tax imposed on an individual’s net worth. This means the total value of a person’s assets—including stocks, bonds, and real estate—minus their debts would be subject to a tax each year.

A proposed wealth tax typically involves a high exemption threshold, so it would only apply to the wealthiest households. For instance, a proposal might levy a 2% annual tax on household net worth above $50 million. While the goal is to address wealth concentration, such a tax presents significant administrative challenges in valuing assets.

Proposed Changes to Corporate and International Taxation

Reform proposals targeting corporate taxation address how the U.S. taxes the profits of multinational corporations. The central issue is a debate between a “territorial” system, which primarily taxes domestic income, and a “worldwide” system, which taxes all income regardless of where it is earned. The TCJA moved the U.S. toward a quasi-territorial system.

A component of this system is the tax on Global Intangible Low-Taxed Income (GILTI), designed to discourage companies from shifting profits from intangible assets to low-tax jurisdictions. It subjects a portion of these foreign profits to a minimum U.S. tax. Reform proposals often revolve around strengthening or repealing provisions like GILTI.

An argument for repealing GILTI is that it would make U.S. corporations more competitive with foreign counterparts operating under territorial systems. Proponents believe this would encourage companies to repatriate foreign earnings and invest them domestically. Conversely, other proposals would increase the GILTI tax rate to further reduce profit shifting.

Another area of focus is the Base Erosion and Anti-Abuse Tax (BEAT). BEAT is a minimum tax designed to prevent companies from avoiding U.S. tax by making deductible payments to foreign affiliates in low-tax countries. Some reform proposals seek to strengthen BEAT by increasing its rate or expanding its scope to prevent erosion of the U.S. corporate tax base.

Proposed Adjustments to Specific Deductions and Credits

Many tax reform discussions focus on modifying specific deductions and credits. One of the most debated provisions is the cap on the State and Local Tax (SALT) deduction. Prior to the TCJA, taxpayers who itemized could deduct the full amount of their state and local taxes, but the TCJA imposed a $10,000 annual cap on this deduction.

The debate over the SALT deduction cap is ongoing, with proposals ranging from a full repeal to various modifications like increasing the cap amount. Proponents of repeal argue the cap unfairly penalizes taxpayers in high-tax states. Opponents contend the deduction primarily benefits high-income households and the cap makes the tax code more progressive.

Another area of focus is the Child Tax Credit (CTC), a benefit for families raising children. The TCJA temporarily increased the credit to $2,000 per child, but this provision is set to expire after 2025, at which point the credit will revert to $1,000. Current reform proposals explore further modifications to the CTC’s value and eligibility requirements.

A key aspect of the CTC debate is its refundability, which determines how much of the credit is available to families with little or no federal income tax liability. Proposals to make the credit fully refundable would allow eligible families to receive the full amount as a cash payment. This would transform the credit into a more direct form of financial support for low-income families.