Following the 27 September release of a new “unified framework” for tax reform, Republican policymakers are moving on to the next phase of tax reform: crafting actual legislation. Congressional leaders have said they intend to focus much of their fall activity on developing a tax reform bill, with a goal of enactment by year-end.
The framework indicates that the reform will include lower tax rates for corporations, pass-through businesses and individuals, a territorial international tax system, a temporary provision allowing for immediate expensing of certain capital investments, some limitation on interest deductions for corporations and fewer targeted tax incentives.
“Legislation can move quickly, and there will be many moving parts to the tax policy discussions in the months ahead.“
Practical considerations related to revenue, process and politics will come into greater focus in October and November, adding to the challenges lawmakers face in meeting their target deadlines. As the congressional tax-writing committees work to draft legislation, they may intensify their focus on erosion. In these discussions, they may revisit proposals from prior plans, such as former House Ways and Means Committee Chairman Dave Camp’s 2014 legislative draft.
Key elements to date
The framework from which congressional tax writers are now working was the product of negotiations among the so-called Big Six group of administration and congressional Republican leaders. They pulled largely from the 2016 House Republican Blueprint for tax reform and the Trump administration’s April 2017 plan, with some modifications.
The framework includes:
- A 20% top corporate income tax rate
- A 25% rate for “small businesses” conducted as sole proprietorships, partnerships and S corporations
- Immediate 100% expensing of certain new investments for at least five years
- Limits on the deductibility of net interest expense for C corporations
- A territorial system for future foreign earnings through a 100% exemption for dividends from foreign subsidiaries, with accumulated foreign profits subject to a one-time tax payable over several years
- Unspecified anti-base erosion measures
- Repealing of the corporate alternative minimum tax (AMT) and the individual AMT
- Reduction in the number of individual income tax brackets from the current seven to three, with a 35% top rate (with flexibility to add a fourth rate on the wealthiest taxpayers)
- Doubling the standard deduction to $12,000 for individuals and $24,000 for married couples
- Eliminating the estate tax
While these elements provide some guideposts to what eventual legislation will look like, this is still the beginning of the legislative process, so the details of tax reform may shift considerably.
A possible focus on anti-base erosion
Policymakers will need to address the potential erosion of the US tax base and loss of US tax revenue that could accompany adoption of a territorial tax system. This is an area of great interest to both US businesses that have foreign income and to inbound companies that might be affected.
If, under a territorial system, dividends paid by controlled foreign corporations (CFCs) to their US parent company are exempt from US tax, many active foreign earnings will no longer be subject to US tax. A variety of proposals have been developed over the past six years to address base erosion, a critical issue related to this new international tax system.
In the context of the current discussions, policymakers are expected to weigh prior proposals designed to minimize base erosion. They are expected to look at anti-base erosion provisions that would apply both to inbound and outbound multinational companies.
In weighing anti-base erosion options, policymakers may consider a minimum tax on CFC earnings. The Camp plan contained such a provision, as did a 2012 plan by Senate Finance Committee member Mike Enzi (R-WY). This is also an idea that Democrats have supported.
Process and political landscape
US legislation typically moves through a multi-stage process: bills are introduced, legislative hearings are held and the bills advance through the committee process, where they are amended before being brought to the House and Senate floor for further consideration by the full legislative bodies. Legislation in the House generally requires a simple majority vote to advance. Senate rules, which protect the rights of the minority party, generally require three-fifths of the Senate (60 votes) to cut off debate and advance legislation.
Legislation can also be considered through the “budget reconciliation” process. Legislation considered under this process has to meet prescribed budgetary outcomes and only requires a simple majority vote to advance. The reconciliation process is triggered when Congress passes a budget resolution that includes reconciliation instructions directing certain committees to craft legislation hitting specific spending and revenue targets.
This is particularly relevant in the Senate, in which a narrow Republican majority faces challenges in passing legislation with 60 votes. The GOP is planning to use reconciliation to advance tax reform legislation, as it would allow the bill to pass the Senate with only 50 votes (with the Vice President breaking the tie), which means it could pass with only Republican votes.
However, legislation considered under reconciliation is subject to certain restrictions, among them what’s known as the “Byrd rule,” which prohibits the Senate from considering “extraneous” provisions as part of a reconciliation bill. A bill would also violate the Byrd rule if it increases the deficit outside the 10-year budget period.
Each title in the bill will be separately assessed against this rule. To not run afoul of this rule, tax cuts considered in tax reform would have to be offset by commensurate revenue increases, spending cuts or a combination of the two.
One way Congress could avoid violating the Byrd rule would be to make some of the bill’s tax cuts temporary, as was done with President George W. Bush’s tax cuts in 2001 and 2003. Another way would be to lengthen the budget period to allow for a longer temporary tax cut.
House Speaker Paul Ryan has said, however, that lawmakers will not extend the 10-year budget window, and the goal is to provide tax cuts that are permanent. Temporary tax changes, especially short-term ones, are viewed as having less of an impact on the economy because businesses may not make significant investments when the long-term outlook is uncertain. Treasury Secretary Steven Mnuchin, however, has said on several occasions that “permanent is better than temporary, and temporary is better than nothing.”
Budget considerations and “scoring” issues
Scoring is likely to be a critical part of the tax reform debate, particularly if lawmakers move forward under reconciliation. The two political parties have, in the past, turned to different scoring methodologies and rationales to further their policy goals, and this will likely be a hot-button political issue for tax reform.
Since 2015, House and Senate rules have required the Joint Committee on Taxation (JCT) to produce two types of revenue estimates — conventional and dynamic — for proposals to change the tax laws. Under dynamic scoring, the JCT relaxes the conventional scoring assumption that the size of the economy is fixed and models the effects of a given tax proposal on US macroeconomic variables such as output and unemployment. The JCT then incorporates the estimated macroeconomic effects into its tax revenue estimate.
Some Trump Administration officials, including Treasury Secretary Mnuchin and National Economic Council Director Gary Cohn, have signaled support for the role of dynamic scoring in analyzing tax reform and said such scoring will be a factor in considering the Administration’s tax proposals.
Lawmakers can also affect the scoring of tax proposals by using different budget baselines.
Congress has traditionally used a “current law” baseline when determining the revenue impact of tax proposals. This mean a tax cut that is scheduled to expire is assumed for budgeting purposes to expire at that point.
But, by using a “current policy” baseline, which assumes current policies will continue — for example by assuming expiring tax provisions will continue indefinitely due to repeated extension — lawmakers can dramatically affect the overall revenue numbers. It is estimated that the difference between using a current law baseline and a current policy baseline ranges from $450 to $500 billion over the 10-year budget period.
These choices about how to frame the debate about the budget impact of tax reform are important to make sense of the numbers that lawmakers will be using in the months ahead. For this reason, businesses should become familiar with the differences in scoring methodologies and their revenue implications for the various tax reform proposals.
Tax reform remains a top priority for Congress and the administration. Legislation can move quickly, and there will be many moving parts to the tax policy discussions in the months ahead. Businesses should take steps now to keep up with developments, model outcomes and engage in the process.