Retroactive Taxation and the Baucus Proposal

December 13, 2013

Senator Max Baucus' tax plan is retroactive and would create problems, says Michael Schuyler, a fellow at the Tax Foundation.

Baucus has proposed three major tax code changes:

  • Deemed Repatriation: The United States has a worldwide income tax system, meaning Americans pay taxes on income earned in the United States or abroad. But Americans can defer U.S. tax on the income of foreign subsidiaries until they bring it back into the United States (repatriation). The Baucus bill would "deem" these past earnings repatriated and subject those foreign earnings to a one-time tax.
  • Repeal the Current Depreciation System, Including for Existing Assets: Baucus' plan would change the current depreciation system and create five different categories of depreciable assets. Notably, the change would apply to existing assets, not just future ones. While most revenue from this change would come from future assets, a sizeable share would come from applying the change retroactively.
  • Repeal LIFO: LIFO (last-in, first-out) is a method of inventory accounting that assumes the last items that were added to a business's inventory were the first sold (as opposed to first-in, first-out). Using LIFO usually results in higher inventory costs and lower taxable income. The repeal would be retroactive and businesses using LIFO would have to account for all past inventory.

Retroactive taxes generally mean more money for the treasury, as taxpayers have not planned in advance of the tax. There are a number of disadvantages to a retroactive tax increase:

  • Retroactive taxes can distort economic activity, reduce efficiency, and slow growth by creating uncertainty and fear that more retroactive tax hikes will be imposed.
  • Taxpayers make economic decisions based on our tax laws. It is inequitable to tax those parties based on new, harsher rules that were not in place when they took those past actions.
  • Financial strain from the Baucus proposal could be large. Many taxpayers have already committed their money to other purposes, as businesses have not planned for these unexpected taxes.

People need to be able to rely on a stable tax system, but the Baucus tax plan relies heavily on these retroactive tax increases, which violate the principles of sound tax policy.

Source: Michael Schuyler, "Retroactive Taxation and the Baucus Proposal," Tax Foundation, December 9, 2013.

 

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