“Government’s view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it.”
— Ronald Reagan, 15 August 1986.
This was the backdrop against which the last major reform of the US tax system was enacted in October 1986. In parallel to today, President Reagan was trying to promote economic growth through a number of policies, including both tax reform and deregulation. President Reagan supported a policy that reduced tax rates would help economic growth, following the Churchill adage that a country cannot tax its way into prosperity.
The Reform Act of 1986 simplified the tax code, broadened the tax base and reduced tax rates (for companies from 50% to 35% and for individuals from a top rate of 50% to one of 28%).
Since 1986 there have been a number of changes to specific areas of the US tax system, but there has been nothing that could be of the view that the current US tax system is no longer fit for purpose and puts US companies at a competitive disadvantage when operating internationally.
Although there are a number of hurdles to overcome, it appears that we are now closer to significant US tax reform than we have been for a long time. In this article we consider what has changed that makes so many people think that tax reform could actually happen, what US tax reform could entail and what the potential timing of reform is.
There are a number of important factors that indicate that tax reform in some shape or form is likely to occur in the US in the short term.
First, there is unified control by the Republican party of both the White House and Congress. This is the first time since the 2003–6 period (when George W. Bush was President) that one party has controlled both the White House and Congress. In addition, there is a general unified message coming from Congress and the White House that tax reform is a high-priority issue and a key aspect of economic growth plans.
In particular, President Trump campaigned on a platform of delivering economic growth, with comprehensive tax reform being a key pillar of, this growth plan. This policy has continued to be clearly messaged since he took office in January. In a recent White House briefing document entitled “Bringing Back Jobs and Growth”1, President Trump outlined a plan to create 25m new jobs and to increase annual economic growth to 4% (from the average 1.5%–2.5% rate of the past decade). For these ambitious targets to be achieved, “pro-growth tax reform” is a key policy item.
Congress, through the House Committee on Ways and Means (Chairman Kevin Brady) and the House Speaker (Paul Ryan), has also shown its support for tax reform, with Chairman Brady recently outlining how the US will “leapfrog” the world in terms of competitiveness with tax reform.
Against this background, it is worth noting that during the last period of unified control (2003–2006), tax reform was also an important policy item. However, despite the commissioning of a new panel on “Federal Tax Reform” and the completion of a report with tax reform recommendations, reform was not ultimately achieved during that period.
Control does not guarantee success in passing reform Acts, and as seen with the recent healthcare reform process, securing enough votes to pass a comprehensive reform package is not straightforward.
While we await specific proposals from Congress to start the reform process formally, commentators generally agree that three key documents provide the most insight into what tax reform might include. We summarise these documents, together with the key proposals, below.
In 2014, the then Chairman of the Ways and Means Committee, Dave Camp, developed comprehensive proposals to simplify the tax regime, broaden the tax base and reduce tax rates. As part of this work, he produced the Tax Reform Act of 2014 (HR 1 2014). This is one of the last pieces of major US tax reform legislation that was drafted and is seen by many as a starting point for future tax legislation negotiations. The importance of this document was further highlighted in 2016 when the House Republicans’ tax reform blueprint (see below) reiterated some of the provisions suggested by Chairman Camp.
The House Republicans’ tax reform blueprint “A Better Way – Our Vision for a Confident America”2 (“the Republican Blueprint”) was released in June 2016. This document had the stated goal of delivering “a 21st century tax code built for growth – the growth of families’ paychecks, the growth of American businesses, and the growth of our nation’s economy”3. Although the document did not have specific legislative proposals, it included detail on various ideas that are likely to form part of tax reform legislation, many of which had a number of similarities to the Camp HR 1 2014 proposals mentioned above.
President Trump also put forward a number of tax proposals both as part of his election campaign and after his election, including a statement that “fixing a tax code that is outdated, overly complex, and too onerous will unleash America’s economy, creating millions of new jobs and boosting economic growth”4.
Most recently President Trump released the “2017 Tax Reform for Economic Growth and American Jobs” document which was referenced by the Administration as the “biggest individual and business tax cut in American history”. This one page document reinforced the key proposals he had outlined during the election but provided limited additional clarity or detail on the proposals themselves, and more importantly how these tax cuts would be funded.
Below is a comparison of some of the key provisions of the three proposals, highlighting the areas of commonality and difference.
|Camp 2014 Tax Reform Act (HR 1)
||House Republican's 2016 tax reform blueprint
||Trump tax proposals|
|Coporate tax rate||25% (phased in over 5 years)||20%||15%|
|Individuals' tax rates||Three rate brackets (10%, 25% and 35%)||Three rate brackets (12%, 25% and 33%)||Three rate brackets (10%, 25% and 35%)|
|Consumption tax regime||No provision||"Destination-based cash-flow" approach, with border adjustments that exempt exports and tax imports||Not stated|
|Interest expense||Limit for thin capitalization||Deductible only against net interest income; special rules to be confirmed for financial services||Business manufacturing in the US and electing full expensing for investments must forgo interest espense deductions|
|International – income tax regime||"Territorial" system, with 95% foreign dividend exemption||"Territorial" system, with 100% foreign dividend exemption||"Territorial" system (no detail)|
|Repatriation||All untaxed foreign earnings subject to tax (paid over 8 years): 8.75% for cash / cash equivalents, 3.5% for non-cash (reinvested assets)||Same as Camp||All untaxed foreign earnings subject to tax at 10%
|Cost recovery||Implemenation of a depreciation system that will broadly lengthen recovery periods
||Full expensing for investments, excluding land||Business manufacturing in the US may elect full expensing for investments (revocable within the first 3 years)|
With regard to the corporate aspects of the key documents, there are a number of proposals on which there would appear to be broad agreement in principle. There are also some proposals that, although not recommended by all parties, could still play an important role in tax reform. We comment on these key proposals in more detail below.
There appears to be a broad consensus that a reduction in the federal corporate tax rate should be included as part of any tax reform package. The current US corporate tax rate of 39% (when the average state tax rate of 4% is added to the federal rate of 35%) is the highest of the OECD members and one of the highest statutory rates globally.5
However, there are some differences in views on what the federal corporate rate should be. Chairman Camp proposed a 10% reduction in the rate (to 25%), whereas the Republican Blueprint advocates a 15% reduction (to 20%). President Trump in his proposals advocated a 15% rate.
Another area where there is strong agreement is the introduction of a mandatory deemed repatriation tax. Trump, Camp and the Republican Blueprint all included proposals on this.
It is currently estimated that US companies have approximately $2.6 trillion6 in post-1986 untaxed foreign earnings held outside of the US. A mandatory deemed repatriation tax would essentially seek to apply a tax to previously unremitted earnings held by controlled foreign subsidiaries of US companies. It is likely that US companies could then repatriate these profits to the US without incremental tax once the mandatory deemed repatriation tax has been paid.
The rates proposed for the mandatory deemed repatriation tax range from 3.5% for non-cash assets and 8.75% for cash under both the Republican Blueprint and the Camp proposals to a flat 10% rate previously proposed by President Trump in his pre-election proposals (but interestingly no rate was included in the most recent proposals). Any of these rates would be a significant reduction to the current US tax rate that would apply to companies repatriating such earnings and, accordingly, could potentially be seen as relatively attractive to US companies. In addition, this proposal could provide significant once-off revenue for the US, which could be used to fund other tax cuts/measures.
The US moving from a worldwide tax system – where worldwide income is taxed, with foreign tax credits to mitigate double taxation – to a territorial system with an exemption for dividends (either 95% or 100% depending on the proposals) is also seen as a potential change that could be included in any tax reform package. Both Camp and the Republican Blueprint advocated such a change. President Trump, in his recent announcement on tax reform, also advocated a territorial system.
One of the key issues when considering an exemption on the taxation of dividends would be whether a minimum tax threshold would be applied to qualify for the exemption. It is expected that such a measure would be needed to prevent US base erosion if the border adjustment system referenced below were not introduced.
The Republican Blueprint also included a potentially significant change to the US system in the form of a border-adjustable destination based cash-flow regime. Similar provisions were not included in either Trump’s proposals or Camp’s HR 1 2014; however, given the potential wide-reaching impact of this proposal, it is worthwhile considering.
We understand that any such border-adjustable tax system could potentially operate as follows:
The introduction of such a system has been widely debated over the past few months, and this debate is likely to continue in much more detail as tax reform progresses. Applying this regime would likely have a very different impact on companies depending on the industry they operate in and the markets they supply. Given the complexity of these proposals, it is far from certain that such a proposal would be included in any final package. The current thinking in the US appears to be that the chances of this system being introduced are reducing as the weeks pass, but it is also clear that there is still some support for the regime from certain industry sectors and politicians.
The US mid-term elections will be held in November 2018. At this time, the US electorate will vote on all of the House of Representatives seats and on 34 of the 100 seats in the Senate. Depending on the outcome of this election, the profile of Congress may be very different. Given the potential changes that could arise at this time, combined with the broad consensus that tax reform is required, it would appear that there is momentum to have tax reform passed before the elections.
The process of how legislation gets enacted in the US is complex. The House of Representatives and the Senate need to pass identical legislation, with the President then having the power to sign or veto the legislation.
The process in the House of Representatives is that a proposal is converted into draft legislation and then approval of the draft legislation is sought from the House Ways and Means Committee. The Bill can then move forward towards a vote by the full House.
On the Senate side, the Finance Committee would take action in relation to a Bill and would identify any suggested amendments that need to be made. Additionally, the Bill could then be amended by changes from the floor of the Senate.
As an identical Bill needs to be passed, a conference committee from the House and the Senate could then be formed to seek a resolution if divergence arises on the draft legislation. Votes are held in both the House and the Senate on the final Bill (with the Senate needing a super-majority if the reconciliation process is not to be used).
The early statements coming from the Trump administration indicated that it was working towards getting tax reform passed as soon as possible, with August 2017 as a deadline. However, the Secretary of Treasury (Steven Mnuchin) has noted in recent interviews that this deadline was “highly aggressive to not realistic at this point”.
While expected within the next number of months, the draft tax legislation has yet to be released and in this context, most commentators are currently suggesting that a 2018 time frame for completion of US tax reform is more realistic.
Outside of the timing question, there are a number of key issues that could influence the proposals becoming law.
It is also important to note that the Republicans do not have a super-majority of 60 seats in the Senate. The Senate generally requires a majority of 60 votes to approve legislation, and accordingly support from the Democratic party would be required for a Bill to pass the Senate. There is a process known as Budget reconciliation, which enables legislation to be approved by a simple majority; however, one of the key downsides of this procedure is that, broadly, it cannot be used where the measure would increase the deficit beyond the Budget period (generally 10 years). This means that if it were believed that proposed US tax reforms would give rise to an increase in the Budget deficit, they would have only a 10-year life (i.e. they would not be permanent measures). The uncertainty that attaches to such temporary measures could adversely impact on the effect of any reform measures.
In addition, although it has always been the stated intention that tax reform would be comprehensive and would deal with both corporates and individuals, there is a risk that only certain elements of reform (either individual or corporate) will be addressed in order to gain the necessary political support to pass the legislation. Some of the more controversial or difficult measures may be excluded if the political climate or Budget does not support the adoption of same.
The failure of several administrations over the past 30 years to deliver US tax reform shows how difficult comprehensive reform is to achieve. The recent healthcare reform legislative developments only reinforce the point that one party having control of both Congress and the White House does not guarantee that legislative change can be effected efficiently. However, although it still appears likely that tax reform will occur, practically – because of political and economic influences – these changes may fall short of the far-reaching tax reform that a number of people had anticipated.
1 See Bringing back jobs and growth
2 See A better way (Our vision for a confident America)
3 See 'Built for growth': Bold, pro growth tax reform
4 See Bringing back jobs and growth
5 See OECD
6 Staff of the Joint Committee on Taxation, letter to Ways and Means Committee Chairman, Kevin Brady, and Committee member, Richard Neal, on “an estimate of the total amount of undistributed, non-previously-taxed post-1986 foreign earnings” (31 August 2016)
Written by Harry Harrison, Partner and Susan Roche, Director
First published in Irish Tax Review, Vol. 30 No. 2 (2017) © Irish Tax Institute