United States: Republican Tax Reform Blueprint Would Slash Rates And Cut Incentives

House Republicans released a "blueprint" for tax reform on June 24 that calls for sharp cuts in tax rates and full expensing for business investments.

The plan is the product of the House Republican task force on tax reform, one of six groups created by House Speaker Paul Ryan, R-Wis., to deliver platforms prior to the Republican National Convention in July. The task force was headed by Ways and Means Committee Chair Kevin Brady, R-Texas, but Ryan has also been credited with influencing much of the final report.

The plan uses many tenets of the cash flow tax bill proposed by Rep. Devin Nunes, R-Calif., The core principles of the blueprint include the following goals:

  • Cutting the top individual rate from 39.6% to 33%
  • Creating a 50% exclusion for dividends, interest and capital gains, resulting in a top rate of 16.5%
  • Repealing all itemized deductions except charitable giving and mortgage interest
  • Repealing estate and gift taxes
  • Cutting the corporate rate to 20%
  • Creating a separate 25% rate on business income from pass-throughs
  • Providing full business expensing while repealing the interest deduction
  • Shifting to a territorial tax system with a 100% dividend deduction

The report cannot be considered a full legislative proposal, but is instead more of a framework or set of aspirational goals. It sets target rates and lays out major principles, but leaves the details unfinished and includes no legislative language. It is probably better viewed as a campaign platform to showcase the GOP's objective for tax reform.

Republicans said the framework is meant to be revenue neutral if eventually translated to legislation, but the report acknowledges this could be achieved only by paying for the repeal of Affordable Care Act (ACA) taxes with the repeal of ACA spending changes, using a "dynamic" economic analysis, and scoring it against a "current policy" baseline that assumes expiring provisions are permanent parts of the code. Even with these changes ameliorating traditional scoring rules, the plan would appear to result in a large net tax cut and substantial revenue loss. Legislation that incorporates all of the proposals put forward could require inclusion of a new revenue source, such as a consumption of business transfer tax, as suggested by Sen. Ted Cruz, R-Texas, in his campaign for the Republican nomination.

Individual taxes

The plan calls for replacing the seven individual tax brackets for ordinary income with three tax brackets of 12%, 25% and 33%. Interest, dividends and capital gains would be taxed at ordinary income tax rates after a 50% exclusion, resulting in effective rates of 6%, 12.5% and 16.5%. Capital gains and dividends can be taxed at a rate as high as 23.8% under current law, and interest as high as 43.4%.

The standard deduction would be increased to $24,000 for joint filers, $12,000 for single filers and $18,000 for single filers with a dependent. Personal exemptions would be eliminated, but the child credit would be increased to $1,500 ($1,000 refundable) with a new, nonrefundable $500 credit for dependents. The earned income tax credit would be retained.

The plan proposes to repeal all itemized deductions except those for mortgage interest and charitable giving. It also calls for consolidating education incentives, though it does not suggest a particular remedy. The plan also asks the Ways and Means Committee to explore replacing tax-preferred retirement accounts with a single universal savings vehicle.

The plan calls for repealing the net investment income tax and the 0.9% additional Medicare tax on earned income, as well as the individual alternative minimum tax (AMT), and the estate, gift and generation-skipping transfer taxes. It also acknowledges that the health care task force report would cap the exclusions for employer-provided health care in order to pay for a new tax credit to replace the ACA.

Business taxes

The plan would create a single 20% corporate rate, down significantly from the current top rate or 35%. In addition, it would provide a top rate of 25% for active business income from a pass-through entity. Pass-through businesses would be required to pay or be treated as paying reasonable compensation to their owners at ordinary income rates.

The blueprint recognizes the need to reduce rates on business income earned through both pass-throughs and regular corporations to avoid creating a competitive disadvantage between the two. But the 25% rate for pass-throughs in the draft does not fully address the competitive disadvantage. The proportional disadvantage between a 20% corporate rate versus a 25% pass-through rate is actually greater than the current disadvantage of 35% versus 39.6%.

The plan calls for full business expensing, ending the practice of depreciation for tax purposes. Businesses could generally no longer take an interest deduction in excess of interest income, although the report says special exceptions would be created for the financial and leasing industries.

Immediate expensing combined with eliminating the interest deduction is perhaps the most controversial issue included in the blueprint. Although capital intensive businesses with significant cash balances could benefit greatly from such a change, service businesses and other growing businesses without access to internally generated funds could be at a disadvantage.

The report generally calls for the end of all targeted tax benefits, including the Section 199 deduction, but would preserve the research credit. The corporate AMT would be repealed, but net operating loss (NOL) carryforwards would be limited to 90% of income, which is similar to the biggest current AMT restriction. In addition, NOLs could no longer be carried back, but could be carried forward indefinitely.

International taxes

The plan calls for a shift from a worldwide tax system to a territorial system in which offshore earnings could be repatriated tax free with a 100% dividends received deduction. To transition to the system and raise revenue, current repatriated earnings would be subject to a one-time tax of 8.75% for cash and cash equivalents, and 3.5% for other earnings. The plan also seeks to repeal the subpart F rules.

In addition, Republicans are seeking to make the tax "border adjustable." This means no tax would be imposed on income from exporting products, services and intangibles. The World Trade Organization (WTO) generally allows export tax exceptions only for indirect taxes like value added taxes (VATs) and bars them for direct taxes like income taxes.

The report claims its business tax system would be considered an allowable indirect tax under the WTO rules. Although the low tax rates on investment income and cash flow elements of the plan make it somewhat analogous to a consumption tax like a VAT from an economic perspective, it is far from clear whether it could be considered an indirect tax under WTO rules.  

Tax administration

Republicans assert that the plan would simplify taxes enough so that most people could file their returns on a postcard. They propose remaking the IRS into a service-focused organization with a new, independent "small claims court" to resolve disputes.

Outlook

The report charges the Ways and Means Committee with developing the framework into actual legislative proposals that would be ready for enactment in 2017. But such an aggressive plan may be unlikely to be enacted as currently conceived. For one thing, the Republican Party is divided on tax reform.

Senate Finance Committee Chair Orrin Hatch, R-Utah, is focused on a proposal for corporate integration that does not fit easily into the House tax reform framework. The House plan also diverges significantly from the platform of Republican presidential candidate Donald Trump. Trump's plan includes sweeping rate cuts, but does not propose full business expensing. Trump's international plan is not a traditional territorial system, but instead would apply a very low universal business rate to worldwide income without deferral as a sort of global minimum tax. For an analysis of the tax platforms of the presidential candidates, see our side-by-side comparison.

In addition, even if Republicans regain the White House and retain both chambers of Congress, they are not expected to get close to the 60 votes needed in the Senate to overcome procedural hurdles. The most likely avenue for tax reform remains a bipartisan compromise. Still, the framework is a very good indicator of where Republican leaders like Ryan will seek to drive tax policy.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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