Tax reform has been actively studied and discussed for the past six years by the 112th, 113th and 114th Congresses. At the start of the 112th Congress in 2011, Congressman Dave Camp (R-MI), then chair of the House Ways and Means Committee, announced the first in a series of hearings on fundamental tax reform to simplify the Internal Revenue Code and improve economic growth and job creation. Since then, Congress has held over 80 hearings on tax reform. In addition, several congressional study groups were formed and various proposals introduced. Yet, despite President Obama and congressional leaders supporting a lower corporate tax rate for international competitiveness purposes, tax reform did not occur in that six-year span.
In contrast, in his 1984 State of the Union address, President Reagan called for a tax reform “plan of action.” He received a detailed, three-volume tax reform study 10 months later. A bipartisan Congress then held numerous hearings, and about three years later, presented the Tax Reform Act of 1986 to President Reagan. [See Nellen and Porter, “30 Years After the Tax Reform Act: Still aiming for a better tax system,” Journal of Accountancy, Oct. 2016.]Will tax reform activities of the new 115th Congress and incoming President Trump follow the schedule of the last six years or that of President Reagan’s call to action? The current Congress and 45th president face some better odds than existed in 1984 in that Congress and the White House are controlled by the same party, and six years of testimony, reports and proposals exist. In addition, data from the Congressional Budget Office and Joint Committee on Taxation can help in crafting a revenue neutral bill, as has been suggested by most players. The House Republicans released a tax reform blueprint in June 2016 and have been working to convert it to legislative language. Thus, there is a lot in play for tax reform likely to occur in 2017 or 2018.
The likely contents of the Tax Reform Act of 2017–2018
Based on the activities of the past six years and the rough plans of today’s leadership, the following elements are likely to be part of a tax reform package.
- Lower rates for individuals and businesses paid for by a broader base and dynamic (rather than static) scoring. Non-corporate businesses will compute “active business income” to allow all business income to enjoy lower rates. The measure of “active business income” will likely require subtraction of reasonable compensation as it would be subject to the rates applicable to all individuals. (For a suggestion for “active business income,” see the AICPA’s December 21, 2016 comment letter on the House Republican blueprint.)
- No tax credits other than the Earned Income Tax Credit and research credit.
- Consolidation of personal and dependency exemptions, child credit and the standard deduction.
- No individual or corporate alternative minimum tax.
- Simplification for individuals created by a larger standard deduction, fewer itemized deductions (likely only mortgage interest and charitable contributions), consolidation of education incentives, consolidation of retirement plans, and a single rate structure (any reduced tax on investment income would exist through a partial exclusion).
- Carryforward of net operating losses, likely with a prohibition that a net operating loss not reduce taxable income by more than 90%.
- A territorial system with some type of mechanism to avoid sheltering income in tax havens.
- A deemed repatriation of foreign earnings at a lower rate, payable over several years.
- Repeal of the estate tax with some type of step-up of assets beyond a minimum value.
Additional suggested changes may be difficult to include in a revenue neutral bill. The House Republican blueprint suggests moving the business tax system to a border adjustable one where tax is imposed on imports, with exports exempt. To meet World Trade Organization (WTO) requirements, the system would need to be a consumption-based tax. This requires expensing of assets and exclusion of interest income and no interest deduction. Today, most countries use a credit-invoice value-added tax as their border adjustable tax. It is not clear if the blueprint approach would be viewed as WTO-compatible, or revenue neutral, as has been suggested for tax reform (particularly if the tax rates will also be reduced). Many businesses are also concerned about taxing imports.
Obstacles to tax reform
- Reaching agreement on which base broadeners to use, how progressive the individual rate structure should be; whether to keep the current business income tax structure or move to a consumption-based system; how estate tax repeal ties to the income tax treatment of assets at date of death; and whether any other taxes, such as excise and payroll, should be reformed at the same time.
- Identifying the changes needed to best support the country’s economic and societal goals (living standards, education, etc.); articulation of the goals would help.
- Creating a revenue neutral bill. About $10 billion of base broadeners are needed to lower the corporate tax one percentage point for one year. (See page 18 of the July 2015 business taxation report of the Senate Finance Committee.) For a sense of what this means, repeal of the Sec. 199 deduction would raise revenue by only $16 billion annually — allowing a corporate rate reduction to 33.5% (see page 33 of the December 2015 Joint Committee on Taxation tax expenditure report).
- Convincing the public that tax reform is needed. There was far more concern among voters about problems in the tax system leading up to the Tax Reform Act of 1986 than exists today.
What can help in the tax reform process?
- Agreement on the goals for tax reform (such as simplification, international competitiveness).
- Consideration of principles of good tax policy.
- Helping the public understand how a more simple, neutral, efficient, equitable and transparent tax system can help them, their employers, and the economy, even if they lose a few favored tax breaks.
Annette Nellen, CPA, CGMA, Esq. is a tax professor and director of the MST Program at San José State University. She is an active member of the tax sections of the AICPA, American Bar Association and California State Bar, and chairs the AICPA Tax Executive Committee. She has written several articles on tax policy and reform and maintains the 21st Century Taxation blog.