Just as Republicans appear to be at an impasse on what tax reform approach to coalesce behind, panelists at a June 14 tax reform discussion described several options lawmakers could pursue, while also acknowledging that political and procedural realities render many potential solutions as nonstarters.
“In principle, there ought to be a deal here that would make everyone happier than they are now,” Daniel N. Shaviro of New York University School of Law said. He was part of a panel at the school jointly hosted by Tax Analysts and the American Bar Foundation.
Peter Merrill of PwC expressed concern that even though the current corporate income tax is in dire need of reform, “the options that would do the best job at fixing problems aren’t being talked about.” The United States has a corporate tax rate that is “very out of step” with other countries and that gap is increasing, he said. The U.S. is also one of the few countries that doesn’t have a territorial system. For large corporations, that combination of a worldwide system of taxation and the high U.S. statutory corporate rate “means that obviously you do not want to bring back your foreign earnings [and] you have a big incentive to move your headquarters,” Merrill said.
But those problems have solutions if lawmakers would be willing to consider them, according to Merrill. He suggested they could opt for a 1986 Tax Reform Act-style change that lowers rates and broadens the tax base, much like the Tax Reform Act of 2014 (H.R. 1), proposed by then-House Ways and Means Committee Chair Dave Camp. But that bill was not designed for the budget reconciliation process, under which the Senate’s Byrd rule prohibits legislation from increasing the deficit outside of the budget window. The Camp bill is not revenue neutral in the out years on the business side, Merrill noted.
There aren’t enough base broadeners to get the statutory corporate tax rate low enough to be truly competitive with other countries, Merrill said. He suggested lawmakers could turn to new revenue sources to support lower business tax rates, like a VAT, the House Republicans’ destination-based cash flow tax (DBCFT), or a carbon tax. But the DBCFT appears to be falling out of favor even among many House Republicans, and a VAT or carbon tax is “completely outside the realm of possibility” at this point, he said.
Meanwhile, the corporate integration proposal from Senate Finance Committee Chair Orrin G. Hatch, R-Utah, which would shift the burden of the corporate tax from corporations to shareholders, is a “very interesting proposal” that could be done on a revenue-neutral basis and help with base erosion issues, but like the other solutions, “it seems like it has zero traction,” Merrill said.
Despite controlling the White House and Congress, Republicans are finding that turning party control into party unity is proving to be a challenge. The White House released a one-page tax outline in April that contains broad tax reform principles but few details. Republicans in the House have the “A Better Way” tax reform blueprint to work off of, but concerns over key provisions of that plan, like the DBCFT, have split the Republican conference. And the Senate has largely stayed quiet, with Hatch sitting on his corporate integration plan.
Tax Cut or Tax Reform?
With all the uncertainty surrounding which path tax reform should take, some panelists predicted that lawmakers may give up on reform and take the easy route: a deficit-increasing tax cut.
Shaviro predicted that if tax reform legislation does pass this year, it would lose a lot of revenue and would not be bipartisan, which he argued would make it unsustainable. “Bipartisan buy-in is really essential to creating a stable system,” he said, adding, “I’m sort of hoping that nothing will happen this year.”
But Ray Beeman of EY argued that a major tax cut that loses revenue isn’t the path of least resistance, largely because of the process restraints imposed by reconciliation and the Byrd rule, and also because “a lot of people get squeamish about revenue reductions in the hundreds of billions of dollars.” A big tax cut “you could argue would be harder than doing tax cuts that are revenue neutral,” he suggested.
Beeman noted that the 2001 Bush tax cuts, which he said lost around $600 billion in revenue, were also passed through the budget reconciliation process, but became law at a time when the United States was running a budget surplus. And although reconciliation is designed to “grease the skids in the Senate” by allowing lawmakers to quickly pass revenue or spending legislation with only a 51-vote majority instead of the usual 60 votes, passing tax reform through reconciliation is a Faustian bargain in that legislation also has to conform to reconciliation’s “funky rules,” he said.
Asked if the Senate might change those rules to make it easier to pass a tax cut, Beeman acknowledged that it’s certainly possible because they are self-imposed, but added that “politically, the messaging on that is very difficult.” Merrill said that such a move may be tempting and noted that President Trump has even suggested that the Senate get rid of the filibuster. He also said that Senate Majority Leader Mitch McConnell, R-Ky., seems to be aware that Democrats could then do the same to them if they regained control of the Senate, and that he appears more inclined to preserve the history of the Senate.
While some lawmakers have advocated a longer budget window of 20 to 30 years, so that even temporary tax cuts that are set to expire 20 or more years at least have the feel of permanence, a longer budget window also introduces new complications, Beeman said. “The problem with using 20 or 30 years is you have to use it for the entire budget,” he said. “Entitlement horrors start creeping in, fiscal issues get severe . . . you’d have to address those issues in a budget.”
What About a VAT?
Shaviro expressed frustration that lawmakers appear universally opposed to considering a VAT, saying that it has features that both Republicans and Democrats should find attractive, depending on how it is implemented. It also happens to be a tax system used by nearly all other developed countries, he said. “If you assume the wisdom of crowds, we might be doing it the wrong way,” he said.
But he acknowledged a VAT faces major obstacles in the United States. Even outside the U.S., introducing a new tax is challenging, and there needs to be a strong motivation for doing so, Shaviro said. He noted that adoption of a VAT in other countries has historically been tied to major events like a fiscal crisis, replacement for a gross receipts tax, or a prerequisite for membership in the European Union. But barring those kinds of events, political disunity in the U.S. means that a VAT gives the opposing side the possibility to use it for its own purposes if it gains control in the future.
The only way forward for a VAT in the United States, then, is to camouflage it, and that’s what happened with the DBCFT, which was conceived as a “doable version of a VAT” that would replace the corporate income tax and ignore the individual income tax side, according to Shaviro.
Merrill also voiced some support for a consumption-style tax like a VAT. He said the U.S. relies far more on income and property taxes than consumption taxes compared with other countries, and he warned that “one of the least growth-friendly taxes is an income tax.”
However, Beeman, a former tax counsel to Ways and Means Republicans, argued that while economists may like a VAT, the idealized versions that he often heard them present at congressional committee hearings were “nothing like what it would be like after the president signs it.” The legislative process in the U.S. “really does shape the ultimate outcome of tax reform,” he said.
And while Beeman called House Republicans’ tax reform blueprint commendable, he said it would be “a very difficult proposal for the system to digest” because it’s not like most tax legislation in which the individual parts can be pulled out and interchanged. Instead, the blueprint is a proposal to transform the tax system and “operates more on a take-it-or-leave-it level.”
Meanwhile, Tax Analysts’ Lee A. Sheppard was unequivocal in her prediction: “We’re not going to have a VAT — we’re not ever going to have a VAT. We’re not going to have a [border-adjustable tax] either.” Europe is a “very different place,” and for many reasons, a VAT or a border-adjustable tax would not be easily implemented in the U.S., she said.
The U.S. is “too far down the rabbit hole importing stuff” and will not become a Germany-like exporter, Sheppard said. Also, a border-adjustable tax collection mechanism would be too intrusive for American taxpayers, she said, arguing that “we have ‘light-touch taxation’ here.” And with most U.S. states already imposing a state-level sales tax, Sheppard said, adding a VAT apparatus on top of that would spark a backlash.
Comes With the Territory
Republicans appear united in wanting tax reform to include a shift from a worldwide tax system to a territorial system, but such a move would require difficult decisions about how to stop base erosion, according to the panelists.
“When you go to zero outside the U.S. . . . that is scary, that is base erosion city,” said Sheppard, and as a result, lawmakers will need to include clawbacks to make sure corporate income is still taxed. “You need to study the clawbacks that are in that old Camp draft because there are folks on Capitol Hill that are studying that now,” she said.
One of those clawbacks lawmakers may turn to in the Camp tax plan is the excess intangibles income clawback. “The reason it appeals to people is because it’s quick and dirty . . . and also because we really do not think that a lot of the intangibles we’re talking about have been offshored already anyway,” Sheppard said. She also suggested that lawmakers may consider a minimum tax on foreign earnings along the lines of what President Obama proposed. And another option, according to Sheppard, is to make offshore intangible property a subpart F item; however, that would be a “very aggressive clawback.”
Merrill agreed that if a territorial system is adopted, anti-base-erosion measures are guaranteed to be included, but what form they would take remains unclear. “If you make your anti-base-erosion rule harsher than other countries, you haven’t really solved the problem of inverters wanting to be headquartered abroad,” he said.