Administration Updates its Corporate Tax Reform Proposal

Lost in all the hoopla over the Treasury’s new inversion policies was the accompanying update to their corporate tax reform outline.  You can read the whole 30-page document here, but the bottom line is that not much has changed.

The plan still treats the pass-through community as second-class citizens by broadening the tax base for all businesses while only reducing rates for those organized as C corporations.  As a result, successful pass-through businesses would be subject to 45 percent top rates on a broader base of income – a double whammy coming just three years after the Fiscal Cliff hiked their tax rates.

That’s simply a non-starter with Congress.  From Politico:

McConnell also said he’s not interested in corporate-only tax reform, noting “most American businesses are not corporations” and lawmakers are not going to “carve out one section of American business and give them breaks and leave the others with very high rates.”

The plan also makes clear just how far apart the Administration and Congress are on tax policy.

The Ways and Means Committee continues to work on an international reform package that, by all accounts, includes an innovation box as the sweetener to help offset some of the new enforcement provisions.  Meanwhile, the Administration spends two pages explaining why innovation boxes are a bad idea.

Finance Committee Chair Orrin Hatch (R-UT) continues to refine his plan to integrate the corporate and individual tax codes – something more than 100 national business groups have argued is an essential component of tax reform.  Meanwhile, the Administration stands by their budget plan to increase shareholder taxes instead.  (Exactly how combining lower corporate rates and sharply higher shareholder taxes helps to improve business taxation or encourage more investment here in the United States is not discussed in the Administration’s outline or anywhere else. It’s simply incoherent.)

And finally, while the majority in Congress stands uniformly opposed to raising taxes, the Administration’s plan explicitly calls for at least two significant tax hikes – a one-time 14 percent assessment on un-repatriated profits that would pay for new infrastructure spending, and a retroactive tax hike to offset to last year’s extender package.  As Politico notes:

The Obama administration now wants to pay for that giant tax deal approved in December. After agreeing to stick the bill’s $680 billion cost onto the deficit, the administration now wants business tax reform to cover that cost.  “Reforming the business tax system must be done in a fiscally responsible manner, including paying for December’s business tax cuts,” the administration said in an update of its business tax reform framework.   

Most observers doubt there’s any chance for meaningful tax policy this year. The net result of this framework is to make that more clear.

 

Corporate Tax Base v. Business Tax Base

As noted above, there’s lots to dissect in the Treasury update, but you need not go further than the first paragraph to find something offensive.  When it comes to the business community, it is obvious this Administration is focused only on large corporations.

America’s system of business taxation is in need of reform. The United States has a relatively narrow corporate tax base compared to other countries—a tax base reduced by loopholes, tax expenditures, and tax planning.

But the US doesn’t have a corporate tax base – it has a business tax base that includes both corporations and pass-through businesses.  The good news here is that the US business tax base is large and growing.

According to the Tax Foundation, the business tax base made up 9 percent of US income prior to the 1986 Tax Reform Act, but makes up 11 percent today.  That’s bigger.  True, the corporate tax base has declined from 8 percent of US income in 1986 to 5 percent today, but the growth of the pass-through business community during that same time from just one percent to 6 percent has more than offset that decline.

So corporate-only tax reform advocates like the Administration are fond of pointing out that the corporate tax base has eroded over the past three decades.  What they never point out, however, is that the business tax base – including both corporations and pass-through businesses – has grown significantly since the 1986 Tax Reform Act.

That’s a good news story that every tax writer in DC needs to learn.

Legislative Update and Treasury’s Effective Rate Study

Legislative Outlook, Post-Boehner Announcement

Speaker Boehner’s announcement that he plans to retire at the end of October has implications for tax policy and next year’s spending levels.  Here’s our outlook for both.

International Tax Reform:  Lots of noise on the tax front.  The latest rumors on the Ryan-Schumer plan to pair highway funding with international tax reforms are that:

  1. The plan is complete and has been sent up to the Administration for their review and sign-off;
  2. The plan is not finished and is hung up over a disagreement regarding how much to spend on highways;
  3. The plan will be presented to the Ways & Means Committee members this morning,
  4. Only options will be presented to Ways & Means Members this morning;
  5. All of the above; and/or
  6. None of the above

One rumor we’ve heard that does appear to be valid is that the innovation box and base erosion provisions have been redrafted to reflect the comments the Committee has received over the past couple months, including the addition of pass through businesses to the innovation box benefits.

Can a package of international reforms and highway funding pass?  The ascension of Kevin McCarthy to Speaker should help. He had this to say on Morning Joe earlier this week:

“If we pass a highway bill with tax reform at the same time, that’s policy. That changes the inversion process; that means more money comes back to America.  That puts a six-year highway bill on to the floor and starts moving and building roads that we need in American infrastructure.”

Not everyone is convinced.  Politico reports this am that Finance Chair Orrin Hatch remains “doubtful” a deal can be struck in time:

“Frankly, I don’t see how you can do what they want to do in this length of time frame that we have,” said Hatch. “We need to solve the highway bill now.”   

Meanwhile, taxwriters were targeted with competing letters on international reform, the first from left-leaning economists who dislike them and the second from a small group of US-based multi-nationals who support them, particularly the innovation box parts of the plan.

Where that leaves us is anybody’s guess, but the renewed focus on the larger tax reforms will once again push off action on the much needed extenders bill.  It’s now October, and those provisions have been expired for more than nine months.  Just saying.

Budget and Debt Limit: On the other side of the ledger, Boehner’s pending retirement freed him up to negotiate a short term spending bill to keep the government open through December 11th, and appears to set the stage for a Boehner-led year-long spending bill to move through Congress prior to the end of October.  The goal is to get next year’s contentious spending and debt limit votes out of the way before McCarthy takes over as Speaker, to give him a clean start so to speak.

Treasury gave that effort a little momentum with their most recent debt limit letter, which suggests the government will run out of credit and need to shut down around November 5th, about a month earlier than previously thought.  The earlier drop dead date is attributed to lower than expected tax revenue collections.  Not good.

So two tracks for tax and spending for the month of October – track one is the on-going Ryan-Schumer effort to couple highways with international tax reforms, and track two is the effort to fund the government for 2016 coupled with raising the debt limit before the November deadline.  It is possible these two negotiations are combined before the end of the month, but for the moment they appear to be taking place in two different rooms with two different groups of negotiators.  Should be an interesting October.

New Treasury Effective Rate Study

Economists at the Department of Treasury and NBER last week released a paper reviewing the average taxes paid on business income, by entity type.  We went through a similar exercise several years ago (you can read our study here), so we printed up a copy and took a look.  Here’s the headline graph:

Treasury Rate Chart

As you can see, the average tax rates for S corporations and C corporations are in the same basic range, while the averages for sole proprietorships and partnerships are significantly lower.  Below we itemize our initial thoughts regarding the substance of the paper and the quality of the estimates.

Click here to read the full post.

A Tale of Two Speeches

The president gave his State of the Union speech last Tuesday, while his Secretary of Treasury spoke to the Brookings Institution the following morning.  The president didn’t mention tax reform, whereas Lew devoted nearly his entire speech to building the case for action this year.  It was a head-scratching juxtaposition that still has us wondering if Treasury and the White House are on speaking terms these days.

  • You can read the president’s speech here
  • You can watch the Lew speech here

Lew’s speech in particular is worth watching.  His focus was on the tax reform “framework” Treasury put forward three years ago coupled with a message that there are many areas of overlap between the Administration and Republicans.  That’s debatable, to put it mildly, but one obvious area where there is no overlap is the treatment of pass-through businesses.  Here’s Politico’s take:

Lew “glossed over a key area of contention: how to deal with small businesses that file on the individual side of the tax code. Many Republicans, including Senate Finance Chairman Orrin Hatch, and some Democrats say it is impossible to adequately address the needs of those businesses, which range from mom and pop stores to big law and financial firms.”

And:

Lew might have talked about “business tax reform” quite a bit on Wednesday, but he seems to be sending mixed messages to small businesses. Last week, he met with a group of small business trade groups to talk tax reform, and Reuters is reporting that Lew actually suggested some of them incorporate if they want to receive the benefits of a lower tax following a tax reform: “Lew’s answer was that some such firms, which are known as ‘pass throughs,’ would probably be better off becoming corporations, according to three people who were in the room and asked not to be named.”

So what does this all mean for the prospects of tax reform?  Our friends at Cornerstone Macro made this observation:

President Obama has not held a single public event designed to promote tax reform. During the last few weeks, Obama held events across the country to promote free community college, tout lower FHA fees for homeowners, and discuss other administration priorities. Over the years, he has held hundreds of public events of one kind or another to push his legislative agenda. To the best of our knowledge, he has never held a single event designed to promote tax reform.

President Obama has made clear his primary interest in tax policy is to raise revenue to pay for new spending.  Unless that changes, and quickly, it is going to be very difficult for Congress and the Treasury to come together to reform the tax code this year.

 

S-CORP in WSJ

The Wall Street Journal featured an op-ed co-authored by S-CORP President Brian Reardon and Advisory Board Chair Tom Nichols last week. The piece calls on Congress and the Administration to make Main Street businesses an equal partner in tax reform by restoring the parity in the top tax rates paid by pass-through businesses and C corps.

The op-ed came the day before the President’s State of the Union address where, contrary to expectations, the President neglected to mention tax reform and instead proposed raising capital gains taxes on businesses and other taxpayers.  As Brian and Tom point out, while President Obama’s plan is offered under the guise of helping the middle class, these changes will ultimately hurt the middle class by increasing the already heavy tax burden shouldered by many employers.