Taxes will be a major part of the budget discussions now under way in Washington. Is this an opening for comprehensive reform?

Earlier this year, the House and Senate passed very different proposals for the federal budget for the current fiscal year, which runs through September 30, 2014. 

The House version calls for tax reform that would lower the rates (the goal is 25 percent both for individuals and corporations) in a system that simplifies the Internal Revenue Code (by eliminating a great many tax expenditures) and adopts a territorial tax system, on a revenue neutral bases (the aggregate amount of tax collected would not be higher than under the current system) and proportionately neutral basis.   

The Senate-passed budget calls for tax reform but emphasizes simplification, making the US more globally competitive, and the elimination of “loopholes” and “unjustified” tax expenditures as a way to raise close to an additional US$1 trillion over ten years to offset the potential impact of proposed cuts in entitlement programs.

The core of the budget agreement reached last week in Congress was a decision by the House and Senate to begin formal negotiations between the budget committees with a goal of achieving consensus. Although both Houses passed their versions of a budget, no serious attempt was made until last week to begin a formal conference to settle their differences. The appointed budget conferees met on Thursday, October 17 to formally open their deliberations. 

The chairs of the tax writing committees, Representative Dave Camp (R-Michigan) and Senator Max Baucus (D-Montana), have been working intensively over the past several years on tax reform. While they have their differences, there is a great deal of common ground between them.  Both see the agreement reached this week as an opening. They argue that tax reform, as well as entitlement reform, both of which are substantively within their jurisdictions, are needed to address the nation’s long-term spending and debt issues.  Budget reform cannot take place without their involvement, and tax reform is their top priority.

If successful, the budget negotiations will produce a single budget plan that will contain instructions to the various other committees to produce legislation contributing to the overall budget plan. Chairman Camp appears to be moving quickly to complete a tax reform plan for committee consideration, possibly in November. Chairman Baucus and his staff are working on a white paper outline of the plan he intends his committee to consider, but he has not yet indicated when he will be ready to seek formal approval of the plan. The Senate Finance Committee considers tax legislation in the form of narrative descriptions of proposals and, as a result, Baucus’s white paper could be very close to what he proposes; in contrast, the House Ways and Means Committee considers tax proposals in the form of actual legislative language and, as a result, the staff must have formal language ready soon.

Chairman Camp has indicated that he expects to hold a robust committee markup of his tax reform proposal, at which his members will have ample opportunity to propose amendments. Because it appears likely that Camp will eliminate most tax expenditures (such as tax credits) in his proposal, and may need as well to cut deeply into tax deductions that are viewed as costs of doing business (e.g., the interest deduction, depreciation,  the deduction for advertising expenses) in order to lower the rate to 25 percent,  many of the amendments may be to restore these items. Members seeking to add items back, however, will have to justify raising the rate in order to accommodate their particular concerns.

The tax chairs are working towards a situation in which they will have a comprehensive tax reform plan ready to go when Congress turns to the implementation of the budget plan. The budget conference committee has been mandated to report its agreement by December 13. Government funding only continues through January 15, and the federal debt ceiling has been raised only through February 7The agreement is designed to force Congress to agree on a budget and at least begin the serious work of implementing it by mid-January.

There are a number of potential tax scenarios, given that both the House and Senate budgets call for tax reform (the Senate in fact is calling for significant tax increases, most likely on the corporate side) ranging from a comprehensive approach to an agreement to begin with international or corporate reform in 2014, to the possibility that an agreement on long-term entitlement cuts will be linked to some tax increases (most likely through the elimination of tax expenditures as opposed to rate increases).

The experience in Washington of the past few weeks could lead to different outcomes. Both parties and the President lost public support because of a widespread perception of  failure to work together, and may well decide going into an election year that they should seize the opportunity to get something done. Some view Republicans as having made a strategic mistake to make the elimination of Obamacare their top issue in the budget negotiation. This next round of negotiations will be on a set of issues that the public is much more sympathetic to and concerned with - the growing debt crisis. In this round, it may be very difficult for Democrats to refuse to negotiate, and there is clear movement within established Republican political circles to try and reclaim the agenda from Tea Party supporters who are viewed as having taken the last set of discussions in the wrong direction. It is also possible that this round of budget talks will also break down, once again leaving the government and US credit standing at potential risk in early 2014.

While it is far too early to predict the outcome, we know today that taxes will be a central aspect of the budget negotiations that are under way and that the tax chairs see these developments as a major opening for their efforts to achieve tax reform. They intend to move forward aggressively.