Outlook for tax reform surprisingly upbeat in 2015
The 4,029-page tax code is so complex both parties want to revise it. On business tax reform, they share surprising common ground, raising the potential for partial tax reform to be enacted this year.
As the 114th Congress convenes this week, it has a golden opportunity to rid itself of its “do nothing” title and do something big – overhaul the US tax code. The time is right. Businesses want it. Individuals want it. The only question is: How much are Republicans willing to compromise to push through the reforms they want?
Not much, according to prevailing political wisdom. Having won back control of the Senate and its biggest House majority since the Hoover administration, Republicans won’t be in a compromising mood, according to many commentators. Why not wait until after 2016, when Republicans could win the White House, too?
But staying in power is an iffy proposition if Congress simply engages in trench warfare with President Obama over the next two years. Tax reform, especially business tax reform, is one of only a few issues where the Republicans and the president share common ground. Furthermore, tax reform is coming. It's just a question of when.
The current code – all 4,029 pages of it – is so complex and counterproductive to US interests in some places – that just about everyone wants to make changes. And more than 50 tax laws are only temporary – Congress keeps passing one- or two-year extensions (without revenue offsets) until the parties strike a grand bargain and finally decide what to do with our tax system. The corporate tax code is so outdated that Republicans and Democrats both want to revise it and they're not too far apart on what to do. That's where opportunity lies for reformers in 2015.
At 35 percent, the corporate tax rate is the highest among industrialized nations (third highest among 163 nations, when adding in state taxes, according to the Tax Foundation). The code contains so many economic incentives and plain old tax giveaways that corporations only pay an average 12.6 percent effective rate, according to the Government Accountability Office. The high tax rate implies high actual taxes, so it discourages foreign businesses from setting up shop in the United States.
Much has changed since 1986, when Congress last overhauled the tax code. Most industrialized countries have some form of territorial tax system: They don’t tax foreign profits. To gain the same competitive advantage, US companies have been engaging in “inversions” – re-domiciling in a foreign low-tax jurisdiction after a merger with a foreign competitor.
Because the US has a hybrid tax system, an American corporation's foreign profits are taxed but not until they’re repatriated to the US. More than $2 trillion in corporate profits of US companies are “locked up” abroad, primarily in tax-haven countries. Both Mr. Obama and Sen. Rand Paul (R) of Kentucky have floated proposals for repatriating these profits at a low rate of tax and using the new tax revenues to rebuild the infrastructure. Former House Ways and Means Chairman David Camp’s 2014 tax reform draft HR 1, formally introduced in December, provides a platform for how that could be done.
All this activity offers an opening for reformers. If Congress could revise the corporate tax structure to bring that money home, there would be enough left over to pay for job-creating infrastructure programs and perhaps one or two other programs Democrats support.
Up to now, such ideas have been blocked because Republicans and Democrats have insisted on coupling business and individual tax reform and there is little agreement on the latter. Recently, however, at least one key Republican has signaled his willingness to consider business tax reform alone. "If we can get halfway towards comprehensive tax reform, I think that's great," Rep. Paul Ryan (R) of Wisconsin told business leaders at a conference last month.
Mr. Ryan, the new chairman of the House Ways and Means Committee, is one of several would-be Republican tax reformers who are well-placed to push through legislation. Speaker of the House John Boehner has named tax reform and deficit reduction as two priorities for the Republican House. Similarly, new Senate majority leader Mitch McConnell (R) of Kentucky sees himself as “the man to make the Senate more operative,” according to is a Dec. 23 New York Times article. Sen. Orrin Hatch (R) of Utah, known for striking big, bipartisan deals during his 38 years in Congress, is the new chairman of the Senate Finance Committee. In a Dec. 12 report called “Comprehensive Tax Reform for 2015 and Beyond,” he said tax reform is his highest priority.
But there's a glitch: Business tax reform won’t happen if it only revises corporate taxes. Reducing or eliminating all those economic incentives and tax giveaways in order to lower the corporate tax rate will increase taxes on so-called "flow-through" business owners. These are mostly small and medium-sized firms (but some huge companies, too) whose business profits, gains, and other deductions and credits flow through to their owners’ personal income tax returns. Over 90 percent of business entities are now flow-through entities and many of the small business owners are in the middle class.
So corporate tax reform alone would hurt the middle class and the president has already shown a willingness to veto such legislation. Individual tax reform may have to wait, but business tax reform must address flow-through owners if it’s to be successful.
If Republicans and Democrats can compromise enough to reform business taxes this year, , the 2016 elections just may encourage some good give-and-take debates on individual tax reform, setting the stage for important changes in 2017.
– Paula N. Singer is a tax attorney with Vacovec, Mayotte & Singer LLP and author of many articles in tax journals and 11 tax guidebooks published by Windstar Publishing (now Thomson Reuters).