The release this week of the Trump Administration's tax reform principles, along with the disclosure by Speaker Paul Ryan (R-Wisconsin) of a letter from the Congressional Joint Committee on Taxation relative to the budgetary implications of cutting the corporate tax rate, is likely to begin the process of forcing some key decisions and defining the roles that the White House and Congress will take as the debate on tax reform accelerates in the Congress.
The White House release, although brief, confirmed that the President supports deep tax rate cuts across the board.
- It would bring the rate on business income (whether through corporations or pass-throughs) to 15 percent, and would reduce the highest individual rate from 39.6 percent to 35 percent (with only two additional brackets at 10 percent and 25 percent), eliminate the alternative minimum tax, double the standard deduction (eliminating federal taxation for couples earning less than $24,000), and provide tax relief for families with child and dependent care expenses.
- On the international side, the plan would shift the US to a territorial system and would impose a one-time tax on the deemed repatriation of US corporate profits held overseas (the plan does not specify at what rate these profits would be taxed or over how long a period of time the tax could be paid). The plan would eliminate the estate tax and the 3.8 percent tax on investment income under the Affordable Care Act.
- On the individual side, the plan proposes the elimination of all tax expenditures except for the home mortgage and charitable deductions, and, on the business side, the plan calls for the elimination of "tax breaks for special interests" without specifying which ones would be targeted.
Treasury Secretary Steven Mnuchin in announcing the plan indicated that more detail would follow in the coming weeks and that revenue losses would be offset through base broadening, mostly through the elimination of many tax expenditures, and through an increase in GDP growth, which he projects at 3 percent or above as a result of the economic policies of the Administration, including tax reform.
While Congressional Republican leaders welcomed the release, noting that it signaled a great deal of common ground with their plans for tax reform, much of the reaction on the Hill relates to the fact that a more robust set of offsets may be needed under Congressional budgetary rules.
The House Republican tax writers meet this weekend in a retreat for the purpose of deciding on the path forward for tax reform, where the offset issue will almost certainly be discussed among other key items.
Process and next steps
Concerned that Democrats may be unwilling to support tax reform, Republican leaders have been planning to use the budget reconciliation process to pass it, a procedure that requires only a simple majority in the Senate, rather than the normal 60-vote margin needed to proceed to debate − a substantial benefit given that Republicans hold just 52 seats in the Senate. However, the privilege of proceeding with a simple majority has substantial limitations, including the rule that the provisions may not lose revenue outside of what is usually a ten-year budget scoring window. President George W. Bush's 2001 individual tax cut legislation was scored as losing $1.6 trillion in the budget window but was allowed in reconciliation because, by its own terms, it would sunset in ten years, with no budget impact thereafter.
The Joint Committee on Taxation (JCT) this week in a letter to Speaker Paul Ryan (R-Wisconsin), released the night before the White House tax plan was issued, contrasted the Trump plan with the 2001 tax cuts, noting that, unlike cuts in individual tax rates, a corporate tax cut beyond two years has long-tail revenue losses outside of the ten-year window (lower rates cause losses to be carried forward further and an acceleration of repatriation that might have taken place in later years) and, as a result, a corporate rate cut beyond two years will either have to be offset or approved by a 60-vote margin, which would require the support of eight Senate Democrats as well as the support of all Senate Republicans. In other words, while Republican leaders in Congress approve of the President's aspirational goals for cutting rates and economic growth, the President's plan is unlikely to fit within Congressional budget rules; in the coming months, one of the key roles of Republican leaders will be to conform the plan those complex rules. (The JCT has in recent years taken macroeconomic effects into account in evaluating the impact of tax legislation, but the savings from doing so have been modest.)
In that regard, there has been a great deal of speculation over the fate of the House proposal for a border adjustable corporate income tax (BAT), which was not included in the White House plan but which would reportedly raise well above $1 trillion. The BAT has come under intense criticism from a growing number of Senate Republicans and some in the House as well and has split the business community. In fact, yesterday Senate Assistant Majority Leader John Cornyn (R-Texas) suggested that the BAT would not be included in tax reform.
However, immediately following the release of the JCT letter indicating that any corporate rate cut beyond ten years will need offsets, the Speaker announced that he is open to modifications to the BAT, including long phase-in periods for certain sectors (retail, for example) and there also have been discussions about the possibility of excluding financial transactions. For his part, Secretary Mnuchin indicated that while the Administration does not support the BAT in its current form, it is open to a discussion of modifications to it.
Senior House Republican tax-writing staff also believe that the White House decision to embrace territoriality will also revitalize the BAT in some form because a pure territorial system will require rules to prevent the erosion of the US corporate tax base (corporations moving to extreme low tax jurisdictions) and to prevent aggressive transfer pricing, both of which they believe are adequately addressed through the BAT (the 2014 Camp tax reform proposal contained base erosion provisions to address these concerns). The President will likely continue to insist on some type of provision to level the playing field in trade, taking into account import taxes and tariffs that are charged by US trading partners.
In some ways, the White House tax plan championed the easy part of tax reform, the reduction in rates and simplification of the tax system. The hard part may be left to the Congress, given that it is its rules that make it hard. In the coming months, the tax writers will have to decide how much of tax reform must be offset (will the JCT and the Parliamentarian settle for offsets only for the corporate rate reductions?) and which offsets will garner a consensus among Republicans if Democrats ultimately decided not to support the effort. There is almost universal agreement among the tax writers that a 15 percent business rate is unachievable under Congressional budget constraints. As a result, stakeholders will have to evaluate whether the offsets affecting them limit the overall benefits of rate reduction that is higher than 15 percent.
And, given concerns over ever-rising federal debt and the expected debate this fall over legislation to authorize an even higher debt limit for the United States, members will also need to decide what their comfort level is for a tax reform plan that at least in the near term is likely to increase deficits.
Find out more about the implications of these developments by contacting either of the authors.