Owners of capital losses have the option to use the loss to offset taxes owed in future years or taxes paid in previous years, subject to limitations. Under this tax provision, owners of capital share the risk of capital gains and losses with the federal government. This parameter setting sets the return to capital as equal to the risk-free rate of return. Penn Wharton Budget Model also allows users to choose a higher return by setting the return to capital equal to the marginal product of capital net of depreciation.

What are foreign investment flows into the U.S.?
Declines in U.S. domestic saving constrain domestic investment and capital formation unless foreign capital inflows offset the saving decline. The foreign investment flows slider sets the share of domestic saving declines that are offset by foreign capital inflows. For example, federal deficit increases soak up less of domestic saving and leave more for domestic investment when a large share of new U.S. Treasury security issues is funded by foreign investors.

Why are foreign investment flows into the U.S. important?
Foreign capital, when allowed, enters the economy and offsets declines in domestic saving.
A decline in total domestic saving may arise from increased consumption spending by U.S. consumers or higher consumption expenditures by the U.S. government. Such saving declines reduce dollar-for-dollar the amount of capital formation in a closed economy. However, if foreign capital inflows offset some of the saving decline, domestic investment need not decline by the same amount as the decline in saving. Thus, the more open the economy – that is, the more that foreign capital inflows offset domestic saving declines – the smaller the displacement of domestic investment.
Private domestic saving depends on many economic factors including interest rates, inflation, expected economic growth, and others. Federal government saving, which equals the current federal budget deficit, is directly influenced by current tax and expenditure policies.
The foreign investment flows slider of the social security simulator, controls the extent to which foreign capital inflows offset domestic saving declines. Examples:

• A setting of zero percent means foreign capital inflows do not offset any changes in domestic saving. The economy is fully closed and changes in saving result in commensurate changes in domestic investment and capital formation.
• At the other extreme, setting the slider to 100 percent makes the economy fully open and foreign capital inflows offset all changes in domestic saving. Under this setting, capital formation is fully insulated from changes in domestic saving.
• At intermediate settings, foreign capital inflows offset changes in domestic saving only partially. For example, setting the slider at 40 percent means that each dollar of the current budget deficit is offset by foreign capital inflows of 40 cents. The remainder, 60 cents, of each deficit dollar must be funded out of private domestic saving. Thus, domestic investment must decline by 60 cents for each dollar of the federal budget deficit.

Under the Buffett Rule, a minimum tax rate of 30 percent of adjusted gross income (AGI) is phased in between $1 and $2 million of AGI. If the sum of certain tax payments (including income taxes and employee payroll taxes) is less than 30 percent of AGI, an additional tax equal to the difference is owed.

The minimum tax is phased in on a pro rata basis. For example, a tax filer with AGI of $1.25 million would pay 25 percent of the extra tax owed due to the Buffett Rule; a tax filer with AGI of $1.75 million would pay 75 percent of the extra tax owed due to the Buffett Rule; and a tax filer with AGI of $2 million or more would pay 100 percent of the extra tax owed due to the Buffett Rule.

The $1 and $2 million thresholds are indexed to the Consumer Price Index.

This policy limits the dollar amount of itemized deductions from adjusted gross income (AGI) to $100,000 for single filers and $200,000 for married couples filing jointly. If a tax filer's itemized deductions exceeded these thresholds, AGI would be reduced by the amount of the threshold only.

The $100,000 and $200,000 thresholds are indexed to the Consumer Price Index.

Background

Itemized deductions are amounts that tax filers may subtract from their AGI and thereby reduce the amount of income subject to tax. Tax filers can choose to subtract either the standard deduction or itemized deductions. If the sum of their itemized deductions exceeds the standard deduction, they will choose to "itemize" and deduct the greater amount from AGI. Expenses that qualify as itemized deductions include state and local taxes, mortgage interest, medical and dental expenses, charitable contributions, casualty and theft losses, and gambling losses.

Background

The Child Tax Credit (CTC) allows tax filers to subtract as much as $1,000 per child under 17 from their tax liability. If the amount of the credit exceeds tax liability, filers may receive some or all of the difference as a refund.

Eligibility for the CTC depends on income, filing status, and the number of children in the household. The amount of the credit is reduced by 5 percent of income above $75,000 for single filers and above $110,000 for married couples filing jointly. In addition, the refundable portion credit is limited to 15 percent of earned income above $3,000.

Background

The Net Investment Income Tax is a 3.8 percent tax on the net investment income of tax filers with income greater than $200,000 for single filers and $250,000 for married couples filing jointly.

Net investment income includes interest, dividends, capital gains, rental and royalty income, and certain forms of business income.

This policy would apply ordinary income tax rates to income from carried interest. Under current law, the maximum tax rate on carried interest (including the Net Investment Income Tax) is 23.8 percent. Under the proposed change, the maximum tax rate would be 43.4 percent.

Note: Revenue effects of changing the treatment of carried interest are estimated outside of the core tax model.

Background

General partners in an investment fund are typically compensated for their role as the fund's managers in two ways: a management fee related to the size of the fund's assets; and a share of the fund's profits, known as "carried interest." Income from management fees is considered ordinary income and taxed at the same rates as wages. In contrast, carried interest is treated as investment income and taxed at the same lower rates as long-term capital gains.

This policy lowers the top tax rate on income from pass-through businesses from 39.6 percent to 25 percent. The 25 percent rate is applied to all income above the lower bound of the 25 percent bracket of the indidividual income tax. Pass-through income below this limit is taxed at the same orindary income tax rates as under current law.

Background

Many businesses in the United States are organized as pass-through entities, meaning that their income is taxed through the business owners individual income tax returns rather than through the corporate tax code (income is "passed through" to the owners). Pass-through businesses include S corporations, partnerships, and sole proprietorships.

Business income from pass-through entities is treated as ordinary individual income and is subject to the same tax rates as wages, rather than the lower tax rate on C corporation profits. Unlike C corporation profits, however, profits from pass-through businesses are not subject to additional taxes on capital gains and dividends.

This policy repeals seven of the largest corporate tax expenditures:
-Accelerated depreciation
-Production activities deduction
-Last-in, first-out (LIFO) and lower of cost or market (LCM) inventory accounting methods
-Exemption of capital gains from like-kind exchanges
-Exemption for interest on private activity bonds
-Expensing of research and experimental expenditures
-Expensing of advertising expenditures

In addition, U.S. corporations would be exempted from deferred corporate income tax payments on their accumulated foreign earnings. Corporate income held abroad in cash would instead be taxed retroactively at a one-time special rate of 8.75 percent, while earnings that have already been reinvested in capital assets would be taxed at a rate 3.5 percent. The tax would be paid over a period of ten years and foreign earnings would subsequently be considered repatriated.