House GOP corporate tax reform plan
House Republicans released a tax plan in late June that they hope to put through the next Congress if Republicans remain in control.
The Republicans enjoy a large majority in the House. They are in greater danger of losing control of the Senate, particularly if Donald Trump loses the presidential election by a large margin. Even if Trump wins and Republicans retain control of both houses of Congress, his plan and the House plan are far apart. The two will have to find common ground.
The House plan is in a 35-page blueprint. Kevin Brady (R-Texas), the House tax committee chairman, said House Republicans are still working on the details.
Economists are calling it a cash flow tax with a cross-border adjustment or a destination-based cash flow tax.
The US corporate income tax rate would be reduced from 35 percent to 20 percent.
There would be three tax brackets for individuals: 12 percent, 25 percent and 33 percent. However, individuals would be taxed at half these rates on dividends and capital gains recognized on dispositions of corporate shares.
The US has essentially two tax systems for corporations: a regular corporate income tax and an alternative minimum tax at a lower rate on a broader base of income. Corporations must calculate both and pay essentially whichever amount is greater. The tax plan would eliminate the alternative minimum tax.
It would allow capital spending on tangible and intangible assets, but not for land, to be deducted immediately. This is called 100 percent expensing. It is the opposite of what the last House tax committee chairman, Dave Camp (R-Michigan), proposed just two years ago. Then, Republicans were advocating lengthening depreciation periods to help pay for slashing the corporate income tax rate.
The House plan would not allow net interest expense to be deducted. Interest expense could be used to offset current-year interest income, and any remaining interest would have to be carried forward and used to offset future interest income. This would give companies an incentive to buy new assets with cash rather than borrow to do so. The intention is to equalize the tax treatment of different types of financing. The blueprint says the tax committee “will work to develop special rules with respect to interest expense for financial services companies, such as banks, insurance, and leasing, that will take into account the role of interest income and interest expense in their business models.”
Kenny Marchant (R-Texas), a senior Republican on the House tax committee, said he thinks the blueprint needs a 10-year transition period between the current tax system and one that operates without interest expense deductions and with 100 percent business expensing.
The plan has not been scored, so it is not clear how much it would add to the federal budget deficit. House Republicans believe that the economic growth stimulated will help increase tax collections enough to pay for it. They are also working from a tax baseline that assumes $400 billion lower tax collections over the next 10 years if Congress makes no changes in tax law. The baseline assumes that all the tax extenders last December, including for renewable energy, will be made permanent. Thus, any decision not to extend these items further will be scored as a revenue increase.
The blueprint says the plan “generally will eliminate special-interest deductions and credits.” The only exception is the tax credit for research and development will be made permanent.
The plan would create a powerful incentive to bring manufacturing home.
It would move to a territorial system of taxing US companies. US companies would no longer be taxed on worldwide income. Dividends from offshore subsidiaries would no longer be taxed. “Subpart F” rules that allow the US to look through offshore subsidiaries and tax any passive income that has been shifted offshore will be “streamlined and simplified.” The “bulk” of them would be eliminated.
All US and foreign corporations would be taxed at the 20 percent US corporate income tax rate on income from sales of goods and services to US customers, regardless of where the goods are produced. This could raise the cost of imports. US companies would not be able to deduct the cost of imported production materials. Brady said he has not settled on whether to deny the entire deduction or only a fraction.
Income from goods manufactured in the US but sold abroad would not be taxed at all. Thus, a US company considering moving abroad and selling into the US market would face the prospect to having to pay taxes both in its new foreign home and on its income from sales to US customers.
The blueprint said the US is in a disadvantageous position because other countries with value-added taxes refund taxes on exports and tax imports. All sales income ends up being taxed somewhere. However, in the case of the US, the system breaks down. The border adjustment replicates to some extent the treatment as if the US were part of a global VAT regime.
The cross-border adjustments might not pass muster under World Trade Organization rules. The WTO prohibits cross-border adjustments of income and other “direct” taxes that encourage domestic manufacturing. House Republicans argue that their plan is closer to a consumption or cash flow tax and should be tested under the same rules for a VAT or other indirect tax that is allowed to have border tax adjustments.
Earnings that US multinationals have parked in offshore subsidiaries when the new system takes effect would be subject to a one-time tax at an 8.75 percent rate when held as cash or cash equivalents and at a 3.5 percent rate otherwise (with the ability to spread out taxes at the 3.5 percent rate over an eight-year period).
Net operating losses of US companies could be carried forward indefinitely and would be increased by an interest factor that compensates for inflation “and a real return on capital to maintain the value of the amounts that are carried forward.” No carrybacks would be permitted.
Meanwhile, in the Senate, the tax committee chairman, Orrin Hatch (R-Utah), continues working on a different approach to corporate tax reform. Hatch wants “corporate integration,” meaning to impose a single tax on corporate earnings at either the corporate or the shareholder level. His self-imposed deadline to release the details keeps getting pushed back. It is not clear how much interest in corporate integration there is in the business community.