David M. Katz
Expect something huge involving corporate taxes to come before Congress in the early stages of the Donald J. Trump presidency. While the biggest likelihood is a massive cut in federal corporate income taxes from the current maximum rate of 35% to 15% or 20%, broader tax reform is also a possibility, corporate tax experts say.
While the experts are relatively confident in their predictions of big tax cuts under the new Republican president and Congressional majorities swept into office Tuesday, they have little notion of how all that government revenue would be replaced.
As for the president-elect, his proposals during his candidacy have ranged from the closing of unspecified corporate tax loopholes to assertions that a supply-side approach, in which tax breaks would produce enough taxable income to pay for themselves, would do the trick.
Nevertheless, “something’s going to happen.” says Howard Wagner, national tax services managing director for Crowe Horwath, a tax and accounting firm, on Wednesday. “The Trump campaign proposed a 15% tax rate, which is not far off the House Ways and Means blueprint, which called for a 20% tax rate. So with a Republican presidency, Senate, and House, you’d expect that legislation to move forward.”
On June 24, the House Tax Reform Task Force named by Speaker Paul Ryan issued its “Better Way” reform blueprint. “This Blueprint will lower the corporate tax rate to a flat rate of 20%. This represents the largest corporate tax rate cut in U.S. history. The Tax Reform Act of 1986 reduced the corporate tax rate by 26% (12 percentage points). This Blueprint will reduce the corporate tax rate by 43% (15 percentage points),” according to the document. For his part, Trump hewed largely to his original plan of cutting the maximum corporate tax rate from to 15% from 35%.
But the results of the election mean to many observers that big tax cuts and reforms are much more likely to occur than at any time in recent memory.
“If you asked us [Monday], we would have said that taxes generally would be [a one-dimensional] issue in 2017, that [discussions of corporate tax legislation] were probably going to mirror what happened in 2016,” says Matthew Gardner, a senior fellow at the Citizens for Tax Justice, a nonprofit public policy that group that advocates “requiring the wealthy to pay their fair share” and “closing corporate tax loopholes,” according to the CTJ website.
If Hillary Clinton won, as CTJ expected, there would be “very incremental discussions on the corporate side … focusing on what to do about the pile of offshore cash that had accumulated,” he said.
In the minds of the group, tax reform would boil down to “a question of whether there was going to be a repatriation holiday or something. But probably the answer would have been that none of that was going to happen,” says Gardner.
To be sure, that issue is still on the table after the election, he acknowledged. After all, the Trump campaign promised it would provide a “repatriation of corporate profits held offshore at a one-time tax rate of 10%”
Post-election, however, repatriation “is just going to be one item on the table. There’s no element of tax reform that isn’t very much on the table … in terms of tax legislation in 2017,” Gardner says.
While the actual elements of what tax reform will look like are still very much in play, there are estimates of how much it could cost.
If the tax reform plan of candidate Trump were fully enacted, the proposal would cut federal revenue by $4.4 trillion over the next decade on a static basis under one set of assumptions, or $5.9 trillion under another, according to a Sept. 19 analysis of the Trump tax plan by The Tax Foundation, a non-profit tax research organization based in Washington, D.C.
The plan would reduce income tax revenue from individuals by $2.2 trillion over the next decade under one of the foundation’s assumptions, or $3.7 trillion under another, according to the analysis. Corporate tax revenue would fall by $1.9 trillion under both sets of assumptions, and the rest of the revenue loss would stem from the repeal of estate and gift taxes that Trump proposes.
The question on the minds of many, then, is: How will President Trump and the new Congress pay for that whopping loss of revenue?
Trump “has said repeatedly that he thinks economic growth will be the engine paying for his proposed rate reductions,” notes Gardner. “So he could go one of two ways: he could double down on his supply-side argument and say great reductions will unleash economic growth which will pay for most if not all of [the] rate cuts … or he could get real about it and come up with some loophole closers.”
Gardner doesn’t have much confidence that he’s going to do the latter because he hasn’t provided much in the way of details about loophole closing. “The cornerstone is this faith that economic growth will pay for it,” he says
Acknowledging that “lower tax rates hold the possibility to create growth,” and therefore tax revenues, Jeff LeSage, vice chairman for tax at KPMG, notes that “whether they actually do is a complex question.”
Unfunded tax cuts “potentially increase the deficit. Paid-for tax cuts generally require tax increases elsewhere to offset the revenue loss. Either way, higher deficits or offsetting tax increases have the prospect of eroding the economic benefits from the rate reduction. That balancing act is what makes tax policy so complex,” LeSage wrote in an email to CFO.
Another often-cited way to fund corporate tax cuts might be the closing of so-called corporate “loopholes,” although that term itself is often called into question. “Loophole may not be the right term,” says LeSage. “That implies something accidental. The reality is that Congress is likely to attempt to make the bill revenue neutral and that means eliminating even intentional tax preferences, tax deductions, credits, and other areas to raise revenue.”
If the principle of revenue neutrality takes hold in tax reforms, that could represent a rare potential downside for some corporations in the Republican plan. The principle “creates the possibility that for some businesses taxes could go down while others may see an increase,” LeSage noted. The unpopularity with industries that could face tax increases may be one reason that “revenue neutral” tax reform legislation hasn’t made any headway lately in Congress.
Although the Trump campaign promises on its website to close “special interest loopholes,” it provides no details about who those special interests might be. The members of Speaker Ryan’s Tax Reform Task Force, however, went further in decrying politically biased tax breaks, or “carve outs.”
“When carve-outs and loopholes are built into the tax code, they increase complexity, undermine the principle of fairness, and create economic distortions that draw resources away from more productive uses and therefore reduce economic growth,” according to the blueprint. Yet that’s the only time the term “loophole” appears in the document.
Speaking of loopholes aimed at specific industries, Crowe Horwath’s Wagner agrees that “no one knows what they’re going to be.” There is however, one tax break that Republicans feel is particularly ripe for elimination: the Section 199 deduction, he notes.
Under a proposal in the House Blueprint, the provision, also known as “the domestic production deduction,” “would no longer be necessary. Section 199 effectively provides a small rate reduction for income from certain specific activities, including domestic manufacturing, production, [some agriculture activities], and [some mining activities].”
As Republican tax reformers perceive it, the deduction “gives an unfair tax advantage to manufacturing businesses compared to service or consulting businesses that can’t get that deduction,” says Wagner. “The theory is: take away the preferential rate for one kind of business in favor of lowering rates for everybody.”