With health care reform on the sideline, tax reform is front and center. The President and Congressional Republicans are feeling tremendous pressure to complete tax reform in 2017. Despite the chaos unfolding daily in Washington, congressional policy makers are busy moving tax reform forward. During the August Congressional recess, senior staffers for the big six tax reform decision makers were busy developing the contours of the reform plan and they are farther along than most think.
Is a 15 percent corporate tax rate in the cards? Not without the unpopular Border Adjustment Tax. The revenue needed to fund a “pro-business” 15 percent corporate tax rate is just too difficult to generate without the trillion dollars raised by the very unpopular – “anti-business” –border adjustment tax. The border adjustment tax represented a fundamental shift from the current system. Essentially it would have shifted the US system from taxing where goods are produced to taxing where goods are consumed. Businesses that rely on imported goods for sale in the US would have been most impacted, and they lobbied successfully against the border tax proposal.
The art of tax writing requires legislators to match revenue gains and losses across a tax package with hundreds of provisions, different effective dates and over a long – typically 10 years – duration to meet the Congressional budget process known as reconciliation. This arcane budget process will result in a very complex corporate tax reform plan rather than the simple 15 percent proposal laid out by the administration earlier this year.
There are three things to consider when evaluating where taxes settle:
1. Top Corporate Rates. I sense tax negotiators will peg the top corporate rates somewhere around 35-36 percent with a special rate on income from pass-through entities like partnerships and S corporations in the range of 25-30 percent. This is higher than what House Republicans are proposing (25 percent) in their blueprint for tax reform for active business income and more than double the White House proposal. By comparison, G7 countries have an average tax rate (weighted by GDP) of 33.7 percent.1
2. Effective Tax Rates. Another consideration when evaluating your top corporate tax rate is your effective tax rate after deductions and credits. For example, if you can expense your equipment (as proposed in the House GOP tax reform blueprint) in the year it is purchased, it will reduce your effective tax rate on income as compared to your marginal rate, which is usually higher. Equipment expensing is very popular with the business community and represents significant simplification of the tax code, which is one of the core goals of the House GOP tax reform plan. Expensing is also viewed favorably by Senate Republican tax writers. For these reasons, I see some form of expensing in the final deal. However, I’m hearing that expensing may include a delayed effective date or be phased in over time to reduce the revenue cost.
On the flip side of expensing, is a revenue raising proposal in the House GOP tax reform blueprint to eliminate the deduction for interest on debt used to purchase property, plant and equipment. The elimination of this deduction pushes the effective tax rate for businesses. Policymakers will weigh the relative benefits to business of expensing versus the elimination of the deduction of interest paid on debt to purchase the equipment. It is one of the many trades-offs under evaluation. As I noted in my previous article, I don’t expect the full elimination of the deduction for interest on debt, especially for industries that are capital intensive like utilities and heavy manufacturing and those in financial services that earn substantial revenue from interest income. I expect to see a special provision addressing the needs of these industries.
3. Repatriation. Another proposal policy makers are wrestling with is how to structure the so-called tax “repatriation” provision. Substantial revenue can be raised if Congress entices or requires large multinational companies to bring billions of overseas profits back to the United States. Congress can dangle lower tax rates in front of these companies for a limited period to generate billions of dollars to pay for lower corporate tax rates during those years. One idea under consideration is to require a certain amount of revenue to be repatriated each year to force taxation of the income in certain tax years to help balance tax cuts over the same period.
On the individual tax side, I see a top tax rate on wage income in the range of 35-38 percent and the overall tax cut expiring in 10 years due to budget considerations. Serious discussions are underway to limit the home mortgage deduction as a revenue raiser to offset tax rate reductions. In addition, the elimination of the deduction for state sales taxes is also likely to be included in the tax proposal when it is officially released in late September or October.
With respect to retirement plans, the tax writers are seriously considering mandating Roth after-tax treatment for employee contributions exceeding $2,500 annually. This provision would raise billions of dollars to fund lower individual tax rates. Also, related to retirement, tax writers are considering expanding the saver’s credit (government matching contribution for lower income savers) and creating a universal Roth IRA without current law eligibility limits.
I remain optimistic that tax reform will pass Congress in late 2017. For those that have been waiting for tax reform for several years, perhaps you will receive an early holiday gift.
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Boston Private is pleased to announce a partnership with Doug Fisher, a Washington Policy expert, who will offer a series of insights into a number of reform proposals making their way through Congress in 2017. Doug is Director of Retirement Policy at the American Retirement Association. In this role, Doug works with the ARA membership to protect, advise and grow their businesses through ideation and advocacy in the benefits area. Before joining ARA, Doug led Fidelity's legislative policy and thought leadership development teams involving retirement, health and welfare benefit plans. Doug has advised many Fortune 1,000 companies on the impact of legislation and regulation on the design and delivery of benefits. Before joining Fidelity, Doug served as tax counsel to the U.S. Senate Finance Committee and was involved in writing the pension, health and insurance provisions of the Small Business Job Protection Act of 1996; the Balanced Budget Act of 1997, including the Roth IRA, Simple retirement plan, medical savings account (predecessor to the health savings account); and the Health Insurance Portability and Accountability Act of 1996 (HIPAA).
1 - Tax Foundation, Corporate Income Tax Rates Around the World, 2016