Just prior to leaving Washington for official travel at the end of last week, House Ways and Means Committee Chairman Paul Ryan (R-WI) told reporters that he is in constant touch with Treasury Secretary Jack Lew with respect to tax reform and sees a narrow but viable window for enacting tax reform in 2015. According to Chairman Ryan, “Tax reform is a 2015 thing for sure, and it’s got to be done by summer.”
Ryan also stated that he had decided to remain in Congress rather than run for President in 2016 because he was eager to “get things done” and referred specifically to tax reform and the conclusion of various pending international trade deals as his top priorities. Secretary Lew has indicated that he is cautiously optimistic that a deal on business tax reform is achievable in 2015.
Although Republicans generally would prefer a comprehensive approach to tax reform, there is a common understanding that the Administration is reluctant to strike a deal to reduce individual rates across the board, limiting reform to business taxation. In fact, when discussing tax reform, President Barack Obama and senior Administration officials invariably refer only to the taxation of business and of the international tax system.
In his remarks last week, Chairman Ryan indicated that his is not a business-only approach, but instead, a business-first approach, in which reforms of the business tax system would be the first phase of a tax reform agenda that could take several years to complete. According to Ryan, “The challenge here is that we have a President who doesn’t want to do comprehensive reform…if we can do tax reform in phases and those phases work, well, then I’m open to doing that.”
There are two factors motivating Republican Congressional tax writers to consider acting now on business tax reform rather than rolling the dice and waiting altogether for the possibility of a Republican President in 2017.
First, as is often the case, some prominent American businesses have been proceeding to address concerns over what is generally viewed as a highly outdated US business tax system (a high corporate rate relative to most US trading partners and adherence to a worldwide system of taxation that most other nations have either abandoned or drastically limited) on their own timetable, rather than the Washington timetable, through various forms of self-help. Last year, for example, a number of prominent US companies announced plans to move their domiciles overseas through cross-border mergers and, in so doing, reduce their overall global tax rates and end their exposure to US taxation on their future non-US overseas profits. Meanwhile, others indicated that unless a consensus emerged on business tax reform by late 2015, they also would consider taking extraordinary measures to reduce their taxes. As a result, there is a serious concern among key tax writers that they do not have the luxury of waiting to beyond the next presidential election, at least with respect to business tax reform.
A second factor is the urgent need for Congress to come up with a revenue source to fund federal infrastructure projects through the highway trust fund, which will otherwise run out of funds by early summer. The President and Chairman Ryan have indicated that they could agree to fund these projects through a one-time tax on the accumulated and untaxed profits of the foreign subsidiaries of US companies, but that resolution would have to be a part of a larger business and international tax reform measure. Chairman Ryan has indicated he would be willing to support a temporary funding mechanism to keep infrastructure projects going when the trust fund runs out in early summer in anticipation of enacting multiyear funding in tax reform later in the year.
The key common elements between the Administration and Congressional Republican tax writers for a business/international tax reform are as follows:
1. There is general agreement to reduce the US corporate tax rate, although the President has proposed 28 percent, while the target rate for Finance Committee Chairman Orrin Hatch (R-Utah) and Chairman Ryan is 25 percent. Revenue forgone as a result of the rate reduction would be offset through the elimination or modification of many tax expenditures and preferences. The debate over which of these to eliminate could prove to be the most contentious part of tax reform, with lower rate advocates arguing that many of the current law tax expenditures and preferences would not be needed if the rate is reduced as low as 25 percent, and advocates of particular provisions arguing that a lower rate alone may not be sufficient to offset the need for some incentives in the tax system.
2. There is general agreement that the current US worldwide system of taxation should be scrapped, but a disagreement over a replacement system. Republicans argue for a new territorial system, under which American companies generally would be taxed on their foreign profits only when these are brought back into the US, and then at a highly reduced rate (former Ways and Means Chairman Dave Camp proposed a 95 percent exclusion from taxation for foreign profits brought back into the US, with the remaining 5 percent taxed at the new 25 percent corporate rate). However, almost any formulation of a territorial system, including the Camp proposal, is likely to contain so-called “base erosion” provisions to tax foreign profits earned in very low tax jurisdictions, as a way to prevent US companies from shifting assets overseas in order to take advantage of the new low rate of US tax on repatriated profits (as opposed to the current 35 percent rate that is imposed when foreign profits are brought into the US) as well as very low rates in some foreign jurisdictions. The President, in contrast, argues that in reality the current system is territorial in that American companies can indefinitely defer taxation on most of their foreign profits simply by keeping them out of the US, and would instead impose an immediate tax on foreign profits at a maximum level of 19 percent, subject to an allowance for taxes paid overseas. Once that tax is paid, the profits can be brought into the US without any additional taxation by the United States.
Although these approaches are different in operation, they are likely to have a similar economic result, to impose a minimum level of global taxation on American companies, payable either to the foreign jurisdiction in which the income is earned or to the United States, or to both if the foreign tax is below the minimum tax rate. A recent analysis done by Tax Notes found that the Camp base erosion approach would subject to a minimum level of taxation close to 90 percent of the foreign profits of US companies when earned, while the President’s plan would subject all foreign profits to immediate taxation: different approaches with very similar economic results. The President’s proposed 19 percent rate of tax on foreign earnings (subject to an allowance for foreign taxes paid) is estimated to raise close to US$210 billion over the next ten years. There have been signals from the Administration that the rate is negotiable.
3. The Administration would impose a one-time 14 percent tax on accumulated untaxed foreign profits of US companies, subject to an allowance for foreign taxes paid, with the new tax payable over a five year period, which would raise close to US$270 billion over the next six years for domestic infrastructure spending. Chairman Camp proposed a similar tax for the same purpose, but at a lower rate (8.75 percent) and the Administration has indicated that the rate is also negotiable. Chairman Ryan would support this approach if it is part of a package that also reduces the corporate rate and reforms the US international tax system.
The Administration’s foreign proposals would raise close to US$500 billion on US companies operating overseas over the next ten years, and, while that sum is likely to come down somewhat if, as expected, negotiations with Congress result in lower rates on foreign income than what the President has proposed, these reforms are nonetheless likely to raise significant new revenues.
There is also an understanding in Congress that, despite the immediate focus on tax reform, there will need to be a further temporary extension, most likely through 2016, of most if not all of the tax provisions that were renewed last December for 2014. Even if negotiations on business tax reform succeed, it is unlikely that the new provisions will be effective before 2016 (and possibly later), and failure to extend the provisions once again will result in tax increases.
While there are many other complex issues that will need to be resolved in the upcoming debate on tax reform in Congress, and many that inevitably will be left to be resolved in regulations, there is a great amount of common ground on key issues between the Administration and Congress in the corporate and international areas and a will to try over the next seven months or so to reach a workable legislative consensus that convinces the business community that the United States has the will and the ability to reform a business tax system universally considered to be out of step with the global economy. There is also a general understanding that the consequences of failure could be a dramatic and potentially irreversible erosion of the US corporate tax base.
And, given the rush to try and reach a consensus by late summer, there is only a limited amount of time for stakeholders to reach out to policymakers with their concerns.