US tax reform debate under way on Capitol Hill

Global Tax News

By:
As Congress heads into its two-week Easter recess, the chairmen of the tax writing committees have provided greater detail regarding their plans for tax reform.

House Ways and Means Committee Chairman Paul Ryan (R-WI) has indicated his intention to proceed with the first phase of reform legislation in the coming months, addressing business and international taxation.  Ryan would prefer a comprehensive approach to reform that would also reduce individual tax rates but has concluded that there are no circumstances under which President Barack Obama would agree to lower the highest individual tax rates and the alternative of waiting altogether until a new President takes office in 2017 has inherent risks: a number of global American companies have told Congressional leaders that absent the enactment of reforms this year they will act on their own to reduce their federal tax liabilities through cross-border mergers that will result in shifting their tax domiciles overseas.

Although the chairman is willing to consider tax reform in phases, he has expressed concern that an approach that first tackles international and corporate reform,  grounded on a reduction in the corporate rate to no more than 25 percent,  by itself will disadvantage the 80 percent or so of American businesses that are taxed at the individual level and that would otherwise remain subject to effective rates exceeding 40 percent.  As a way to level the playing field, Ryan has instructed the Ways and Means Committee staff to develop proposals to provide temporary relief to unincorporated businesses that will reduce their effective tax rates, possibly in the form of temporary tax credits.  The chairman has made clear, however, that a key principle he will follow in pursuing tax reform in phases is that each phase must be consistent and compatible with a plan to eventually reform the tax system comprehensively.  Any temporary measures agreed to this year to reduce the effective rate for non-corporate businesses would eventually be replaced by lower individual rates.

While the chairman has expressed admiration for his predecessor's efforts last year to propose comprehensive reform, he has indicated that he will not be bound by former Chairman Dave Camp's draft.  Ryan’s reform proposal is likely to differ from Camp’s in many respects.  For one thing, he is expected to use a different baseline than Chairman Camp to measure the budgetary impact of his proposals, which could provide him with greater flexibility to keep some of the tax expenditures that Chairman Camp would have eliminated in order to offset the cost of lowering the rates.  Ryan has also indicated that he is unlikely to hold extensive hearings or to convene working groups within the committee prior to proposing reform legislation; those measures were taken in the last Congress and he does not see a reason to repeat them.  Instead, he is likely to go about the task of drafting and proposing a reform plan by the summer.

In order to expedite phase one, Chairman Ryan has asked one of his members, Representative Charles Boustany (R-LA) to introduce an international reform plan this spring as a starting point for committee consideration, and it is likely that the Boustany bill will be based on the mechanism of a dividend exemption system that would exclude a significant percentage of foreign profits from US taxation when brought back into the US. 

As in the Camp formulation last year, the Boustany approach is likely as well to contain anti-base erosion provisions to prevent American companies from shifting profits to extremely low tax jurisdictions in order to take advantage of both the lower overseas rates and the low rate produced under the dividend exemption system.  Earlier this year, with the chairman's approval, Representative Devin Nunes (R-CA) introduced a proposal designed to address the concern that a reduced corporate rate would harm unincorporated businesses.  The Nunes bill creates a category of business income that is taxed at the lower rate regardless of the source of that income.  Chairman Ryan's intent is to bring these and other proposals together in the summer to produce his first phase of tax reform.

Chairman Ryan has expressed concern over whether the President ultimately will dedicate himself to the goal of tax reform and over the lack of details in reform proposals that the President has made over the past several years, including recent international reform proposals that were in President's fiscal year 2016 budget.  Noting that he speaks regularly about tax reform with Treasury Secretary Jack Lew, Ryan has stated that he intends to proceed with the hope that the President will provide the needed engagement and political support to bring about the enactment of corporate and intentional reform this year, and believes there is substantial common ground on business reform.  If, however, the reform effort stalls as a result of a lack of presidential engagement, the chairman, who under House Republican rules could remain in that position through 2020, will continue to advance a comprehensive reform plan within the Congress with the expectation that it would be enacted early in the next Administration.  

Chairman Ryan, who decided not to run for President in 2016 in order to dedicate himself to tax reform, has a reputation as an aggressive and active legislator. He has begun a serious effort that he hopes will lead to the enactment of the first phase of reform this year and thereafter to a thorough restructuring of the federal tax system.

Senate Finance Committee Chairman Orrin Hatch (R-UT) stated earlier this week that "my goal is to introduce [a tax reform bill] and mark it up in committee this year.  I get asked all the time about whether I expect this process to yield results.  So, let me make one thing clear here today: This is not an exercise.  This isn't just for show.  My only goal when it comes to tax reform is to make new law."

Unlike the Committee on Ways and Means, the Finance Committee did not convene working groups in the prior Congress; to build internal consensus, Hatch convened five working groups in February with a mandate to report back with their recommendations for reform and, if possible, legislative language, by the end of May.  Chairman Hatch and his ranking member, Ron Wyden (D-OR,) will determine where there are areas of consensus within the committee from these reports and will decide how to proceed with a reform plan.

It is possible that the two committees will take different approaches to international reform.  Chairman Ryan appears committed to the dividend exemption concept, while there may be interest in the Finance Committee in the idea of replacing the current system with a domestic corporate rate of 25 percent and a much lower global rate for foreign profits (possibly 15 percent) that could be offset by the foreign tax credit.  In either event the ultimate goal is the same; to improve the ability of American multinationals to compete with foreign trading partners who are subject to much lower rates in their home countries and facilitate the movement of profits both overseas and back to the US, while creating fiscal conditions that discourage American companies from moving their domiciles overseas.  While there may be differences in approach, both chairmen and the Administration are coordinating their efforts, including requests of the Joint Committee on Taxation and Treasury to analyze and score reform proposals. Time is short and the key players in the reform effort want to move efficiently and avoid duplication.

Recognizing, however, that the first phase of tax reform in any event would not be effective until beyond 2015 (and could be phased in and not be fully effective until even later), both chairman have indicated their intention to extend the provisions that expired at the end of 2014 in the fall.  Their preference appears to be to enact extensions through 2016 to create stability for business and what former Finance Committee Chairman Wyden referred to as a "bridge to tax reform."

Feeling considerable international pressure to act, Congressional tax writers intend over the balance of this year to dedicate their efforts to craft at least the first phase of a reform plan and are hopeful that the President will provide at least the minimum amount of political support needed to achieve a bipartisan legislative victory and public support.  If that materializes, international and business tax reform could advance in this Congress.  If it does not, the message from the tax writers will be that help is on the way and that the consensus building that is now underway and the decisions that are taken this year on the design of a reform plan will form the basis for the inevitable reform of the tax code. As Hatch stated earlier this week, "I don't believe tax reform is optional - it's a necessity."

Find out more about the rapidly evolving move toward comprehensive tax reform in the US and its impact on your business by contacting the author.