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United States president-elect Donald Trump has promised more than USD4 trillion in tax cuts, and with the White House and Congress expected to be on the same page on the issue of tax for the first time in six years, the chances of comprehensive reform of the US tax code have improved considerably.
This feature looks at the tax proposals already put forward by the key players in any future tax reform legislation.
Trump's Tax Plan
Although best described as an outline of his ambitions on tax, rather than a comprehensive plan, it is clear that, like many Republicans in Congress, Trump is aiming for lower and simpler taxes for both individuals and businesses.
On the business tax side, Trump wants to slash the federal headline rate of corporate tax to 15 percent from 35 percent – currently the highest in the OECD grouping. He has previously expressed a wish to extend that rate to freelancers, sole proprietors, unincorporated small businesses, and to pass-through entities, which are taxed within the individual income tax code. However, in a subsequent statement, Trump suggested that the rate would only be available for "all businesses that want to retain the profits within the business."
Trump is also proposing a one-time deemed repatriation tax at a reduced rate of 10 percent on the substantial untaxed earnings held abroad by US multinationals. However, US-based manufacturers would have to choose whether to elect for the full expensing of plant and equipment or retain their current right to deduct interest costs.
On personal income tax rates, Trump has aligned his plan with the policy framework published by House speaker Paul Ryan (R – Wisconsin) earlier this year (see below). This would mean that the present seven tax brackets would be reduced to three, with tax rates set at 12 percent, 25 percent, and 33 percent. This would result in a significant cut in the current top rate of income tax of 39.6 percent. No income tax would be payable on the first USD15,000 of income for single filers, and the first USD30,000 for joint filers.
In addition, "carried interest" would be charged at an individual's normal income tax rate, capital gains and dividends would have a maximum 20 percent rate, and itemized tax deductions would be capped for those earning USD100,000, and USD200,000 for married filers. However, the net investment income and estate taxes would be eliminated.
It has been estimated (by the Trump campaign) that Trump's tax plan would reduce tax revenue by USD4.4 trillion over ten years, or USD2.6 trillion on a "dynamic scoring" basis, which accounts for projected economic growth effects.
House Speaker's Tax Policy Framework
The Republican Party's policy framework for US comprehensive tax reform, released by House Speaker Ryan on June 24, 2016, also includes proposals for a cut to both individual and corporate income tax rates, for a new rate for small businesses, and for a move to a territorial international tax system.
The policy document foresees a cut in the US corporate tax rate to 20 percent, with the corporate alternative minimum tax (AMT) eliminated. Pass-through businesses would pay a maximum 25 percent rate.
Businesses would be allowed the full and immediate expensing of capital investments, but would be denied the current interest deduction (except to the extent that they receive interest income). Most other business credits and deductions would also be repealed, except for the research and development tax credit.
US-based multinational companies would be subject to tax only on US income, with a full exemption for dividends from foreign subsidiaries. Accumulated (currently deferred) foreign earnings held in cash or cash equivalents would suffer a deemed repatriation tax of 8.75 percent; or 3.5 percent for those earnings held in other assets.
However, one of the more controversial elements of Ryan's plan is the proposed move towards a "destination-basis" tax system designed to counteract the effects of foreign value-added taxes on US trade.
"Today, all of our major trading partners raise a significant portion of their tax revenues through value-added taxes," the policy paper observes. "These VATs include 'border adjustability' as a key feature. This means that the tax is rebated when a product is exported to a foreign country and is imposed when a product is imported from a foreign country. These border adjustments reduce the costs borne by exported products and increase the costs borne by imported products. When the country is trading with another country that similarly imposes a border-adjustable VAT, the effects in both directions are offsetting and the tax costs borne by exports and imports are in relative balance. However, that balance does not exist when the trading partner is the United States."
In summary, the move to a destination-basis principle will mean that goods and services exported out of the US will not be subject to US tax regardless of where they are produced. However, goods and services imported into the US will be subject to tax, also irrespective of the jurisdiction in which they are produced.
As mentioned above, regarding the US individual income tax code, the House Republican plan mirrors Trump's plan on rates on thresholds, with the top tax rate reduced to 33 percent, and three marginal rates in total of 25 percent and 12 percent. The standard deduction (currently USD6,300 for singles and married persons filing separate returns and USD12,600 for married couples filing jointly) would be almost doubled.
The House Republican plan would provide a new small non-refundable credit for dependents who are not children, and would retain an increased child tax credit, part of which would be refundable, and an earned income tax credit in some form. However, practically all other individual tax incentives would be eliminated – including the state and local tax deduction – with modifications being applied to the retained mortgage interest and charitable contribution deductions. The individual AMT would also be repealed.
With a 50 percent exclusion for capital gains, dividends, and interest income, the effective top rate on investment income would be 16.5 percent. The estate and gift tax would be repealed, and tax incentives for retirement savings, higher education, and health insurance purchases would remain.
Ryan stated that the Republican plan would be revenue neutral, after including macroeconomic growth effects through "dynamic scoring" and assuming a revenue baseline where USD400bn in expiring tax cuts are made permanent.
Trump and the Republican leadership in the House of Representatives won't be the only parties to have an input into a future tax reform bill. The Senate will have a considerable say too, and it has already considered the tax reform issue long and hard having staged a number hearings and published various reports on the subject, most recently last year.
To coincide with the start of a series of US tax reform hearings, in January 2015 the Senate Finance Committee announced the formation of five bipartisan working groups, each chaired by a Republican and Democrat Senator, covering individual income tax, business income tax, savings and investment, international tax, and community development and infrastructure. These working groups submitted their reports in July 2015.
Specific bipartisan proposals were made by the international tax reform working group, led by Rob Portman (R – Ohio) and Charles Schumer (D – New York), including the adoption of "a dividend exemption or hybrid territorial-type system, paired with appropriate base erosion measures," together with recommendations on patent boxes and deemed repatriation.
"Our report shows a bipartisan framework for how we can update our international tax code, giving US companies the tools they need to compete and win on a level playing field with their international competitors, leading to more jobs and higher wages here at home," stated Portman.
In particular, Portman and Schumer agreed that legislative action is needed to "combat the efforts of other countries to attract highly mobile US corporate income through the implementation of our own innovation box regime that encourages the development and ownership of intellectual property (IP) in the United States, along with associated domestic manufacturing."
They said that they "will continue to work to determine appropriate eligibility criteria for covered IP, a nexus standard that incentivizes US research, manufacturing, and production, as well as a mechanism for the domestication of currently offshore IP."
The working group has also backed the imposition of a transitional deemed repatriation tax at a rate significantly lower than the US statutory corporate rate on the deferred earnings held abroad by US multinationals, during the transition to the new international tax system.
Meanwhile, Senator Orrin Hatch, Chairman on the Finance Committee, has offered up his "corporate integration" plan, which is intended to eliminate the double taxation of income at the corporate and shareholder levels, and recalibrate the tax code so it favors equity funding over debt.
Under the present US tax code, a corporation's earnings are taxed under the corporate income tax system, generally at a rate of 35 percent. When the corporation distributes a portion of those earnings to its shareholders in the form of dividends, those earnings are effectively taxed a second time at the individual level. Corporate integration would allow US corporations to deduct dividends-paid from their tax calculations.
"Right now, corporations are incentivized by the tax code to raise capital by taking on debt rather than pursuing equity-based financing," Hatch said in May 2016 when calling the second hearing to discuss how his proposal could create greater tax parity between debt and equity. Presently, a corporation can deduct interest paid to bond-holders, but no similar deduction exists for dividends paid to shareholders, he observed.
Hatch added that, "as a number of studies have shown, US businesses pay an effective tax rate of about 37 percent on equity financing, while the effective tax rate on debt financing is negative. That's right: Negative. The tax code actually gives a subsidy to corporations for debt financing."
Hatch said that "the bias in favor of debt under our tax system incentivizes businesses to base financing decisions, not necessarily on market conditions or their specific situations, but on relative tax consequences. …. While debt isn't inherently an inferior option, businesses and economic sectors that are over-leveraged are, broadly speaking, more vulnerable to losses in the event of an economic downturn."
He concluded that "the favored tax status of debt incentivizes the use of complicated and often wasteful tax-planning strategies that redirect resources away from projects and ventures that will lead to growth."
So Will Tax Reform Actually Happen?
Those who have taken an interest in tax developments at the federal level in the United States would be forgiven for remaining somewhat skeptical about the prospect of comprehensive tax reform following years of stalemate on the issue in Congress. However, the November 8 elections appeared to have altered the political landscape markedly. For the first time since President Barack Obama's first two years in office, the executive and the legislature will be controlled by the same party. And even though Trump and the Republican leadership have not always seen eye to eye, there appears to be a great deal of harmony on the issue of taxation.
Post-election comments by Representative Kevin Brady (R – Texas), who, as chairman of the House Ways and Means Committee, will have a large role to play in shaping a tax reform bill, suggests there is unity between congressional Republicans and the president-elect on tax. Speaking on radio on November 12, Brady reiterated his commitment to work with the President-elect on tax reform in 2017, saying he has "something no other Chairman in recent history has, which is a green light from [the House Speaker Paul Ryan] to do big things: tax reform, health care reform, welfare reform, and Medicare. All those big issues that we've always dreamed of doing, we've got a Speaker and leadership who are saying 'bring it on' in a big way."
On the pro-growth tax reform objective, he said: "Our goal in this tax plan is instead of a tax code designed to wring money from you, ... we want to leapfrog America back in the lead pack of the best places on this planet to make that investment, to bring that new manufacturing and research plant."
"We're going all in for growth with the lowest tax rates in modern history for every type of business. We redesigned the code so we can compete and win anywhere in the world, especially here at home."
Indeed, if Brady turns out to be right, tax reform will result in "a tax code so clear and simple more than 95 percent of Americans will be able to file using a simple postcard-style system."
However, those taxpayers looking forward to a big tax cut and simpler taxes should not get their hopes up too soon. The legislative process is unlikely to be plain-sailing even if the Republicans do have a majority in Congress.
Democrats are likely to fight tooth and nail against any tax reform bill that reduces taxes for the wealthy, contains substantial giveaways to large corporations, and is seen to be fiscally irresponsible. But while Democrat opposition will not matter so much in the House, where the Republicans have a comfortable majority, in the Senate the margin is much narrower and it may take just a few Republicans to rebel on certain aspects of a tax reform bill for the process to bog down.
What's more, with so many options on the table, it is not a given that the Republican leaderships in House and Senate are in complete agreement on what form tax reform should take. Senate Republicans for instance are thought to be very uncomfortable with Ryan's "destination-based" corporate tax plan. So there are likely to be many hours of negotiations ahead to reconcile House and Senate proposals.
Ominously, Senator Ron Wyden, the leading Democrat on the Senate Finance Committee, suggested earlier this year that the more outlandish tax cuts proposed by Republican candidates in the presidential race – presumably, including Trump's – would almost certainly hit the buffers in the Senate.
"Here's my take on where these campaign proposals are going: I have a better chance of playing in the NBA than these multi-trillion dollar tax giveaways have of passing the Senate," he quipped in a speech on tax reform in February 2016.
It is fairly safe to assume that we won't be seeing Wyden turn out for the Portland Trail Blazers any time soon. So does this mean that tax reform will be as elusive under Trump's presidency as it was under President Obama's? Given that this issue seems to be a high priority for the president-elect and House Republicans, it seems unlikely that Congress will be as inactive on tax as it has been for the past few years. But there are likely to be compromises along the way.
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