Legislative Update Tax Reform—A Work in Progress
With high tax rates and a worldwide (as opposed to territorial) system of taxation, U.S. corporate tax laws encourage new multinational corporations to organize outside the U.S. and encourage existing U.S. corporations to "elect" a territorial system by being acquired by a foreign-based multinational or moving their headquarters outside of the U.S. (generally in taxable transactions these days, which has slowed, but not stopped, such economically-compelled movements). If our corporate tax system is not overhauled soon -- by lowering rates, moving toward a territorial system or both -- more of our U.S.-based multinational corporations will be acquired by foreign parent companies, will relocate abroad or continue to plan for most of their growth to occur outside of the U.S. As a result, major decisions about such items as where to produce goods, perform services or conduct research and development will be made by boards of directors in foreign lands, and leaving our children to work for U.S. subsidiaries of multinational corporations headquartered abroad, rather than for multinational corporations headquartered in the U.S. If Congress did nothing more than move to a territorial system, the playing field for U.S. corporations would be leveled in the sense that all corporations doing business in the U.S. would be subject to the same tax rate (high, low or medium) on all of their U.S.-sourced income and activity. In such a case, U.S. corporations would not be penalized by being subjected to U.S. taxes (even if deferred) on activities abroad. If Congress lowered the highest corporate tax rate to 25 percent or less, corporations would have an economic incentive to locate more of their assets and income-producing activity in the U.S. and less abroad.
Last year at this time, we described the long-term outlook for comprehensive tax reform as depending on the development of a bipartisan agreement on the mix of spending cuts and revenues necessary to reduce the deficit. With recent changes to the Bush-era individual tax rates and deductions setting the stage for renewed interest in overall fundamental tax reform, the House Committee on Ways and Means and the Senate Finance Committee are stepping up their levels of activity. On May 9, the two committees teamed up to launch TaxReform.gov, a new website "dedicated to obtaining input from the American public on tax reform." "Max & Dave @simplertaxes" -- Chairmen Max Baucus (D-MT) and Dave Camp (R-MI) of Senate Finance and Ways and Means, respectively, have been tweeting multiple times a day since May 8 about their tax reform efforts ("#Taxreform will improve the lives of Americans, boost the economy and create jobs") and how bad the Tax Code is. One may wonder, if those tweets are true (and who could argue with such tweets?) why the Code has been allowed to languish in such a state of disrepair.
HOUSE COMMITTEE ON WAYS AND MEANS
Mr. Camp has taken the lead as the GOP's voice on tax reform and announced that he intends to move a tax reform bill through his committee by the end of 2013. Under Mr. Camp's relatively transparent efforts, Ways and Means has held more than 20 hearings on tax reform, and hearings keep popping up on the calendar. Ways and Means has issued full discussion drafts, including legislative language, on international tax reform, financial products and small business proposals. Eleven subject matter working groups, each with a Republican Chair and a Democratic Vice Chair, have been organized, covering the key substantive and economic areas of the Code. Many industry groups are focusing on these efforts. More than 1,300 public comments have been received and posted on Ways and Means website, many of which were summarized in a 560-page pamphlet issued by the Joint Committee on Taxation on May 6. Although both parties are involved at the macro level, the effort is strongly directed and managed by Mr. Camp.
The Ways and Means budgetary approach expects to attain revenue neutrality overall, to be achieved through very rough revenue neutrality in each of the three areas of international, domestic corporate and business, and individual taxes. This was not the outcome in 1986, when overall corporate tax increases funded overall individual tax decreases. Note that the 2012 effort to pare down the list of tax expenditure "extenders" had minimal success, and Mr. Camp has since studiously avoided triggering a public debate on eliminating tax expenditures.
SENATE FINANCE COMMITTEE
Senate Finance Chairman Baucus has said that he wants to pass a bipartisan bill out of his committee. That will be a challenge to accomplish by the end of 2013. Committee members have been holding private weekly meetings based on publicly issued bipartisan staff papers on tax reform options and intend to continue sounding out the members in this fashion. Seven papers have been issued thus far, each covering particular substantive areas. It is not clear how many more of these papers will be released, although the effort has been picking up momentum. In fact, Mr. Baucus will be challenged to produce a bipartisan tax reform plan at all, since he wants to use some new revenues to reduce the deficit and Republicans want to reduce the deficit only through spending cuts.
PRESIDENT OBAMA AND TREASURY
Tax reform can be difficult for a President who appears to believe that free trade, a territorial tax system and low corporate tax rates are good for the long-term success of American businesses but who also derives significant support from constituent groups that are worried about the short-term effects of implementing such policies. The Administration's strategy for tax reform over the past four years is indicative of these practical realities. The President's 2014 budget tax proposals, mostly repeating prior Obama Administration proposals, suggest that U.S. tax reform should be incremental and also should raise a net amount of $890 billion over 10 years -- with roughly two-thirds of that net coming from individuals (although some commentators believe all would ultimately come from individuals).
So what is the outlook for comprehensive tax reform? The fundamental issue that divides the two political parties is whether or not tax reform should raise new revenues. A critical subsidiary question, politically loaded, is whether elimination of tax expenditures (running at $1.3 trillion per year) would be considered a "tax increase" or a "spending cut." There appears to be a bitter political dividing line on these issues. Concerns about corporations, corporate intellectual property and corporate jobs leaving the U.S. (or U.S. corporations setting their growth priorities outside of the U.S.) seem to be subsidiary issues, although many economists and policymakers believe they should be driving reform.
It may be too early to tell if the effects of the sequestration will change the political calculus regarding raising revenue or cutting spending. There have been recent rumblings that the GOP would attempt to tie an agreement to engage in tax reform to an increase in the Federal debt ceiling. Treasury has announced that, due to the budgetary savings from sequestration and increased revenues from new taxes and economic growth, the need to deal with the debt ceiling may not be pressing until sometime after Labor Day.
Two wild-card factors in the tax reform mix are the announced retirement of Mr. Baucus and the requirement that Mr. Camp step down from his committee chairmanship, both at the end of 2014. Their impending step downs could motivate these men to push tax reform to a successful conclusion by 2014 but also may decrease their clout, making it more difficult for them to bring legislators supporting varied constituencies to the table. The most likely outcome of this activity will be progress in discussions that set the direction for future fundamental tax reform but low expectations for actual results before the mid-term elections or beyond.