As the presidential transition proceeds apace, deep questions and concerns are arising among the public and the policy community alike with respect to the first one hundred days of a Trump administration. From immigration policy to foreign policy, uncertainty and foreboding abound.
The House Republicans’ and Trump’s tax plans are also receiving priority in Congress and raising concerns.
At the center of the Trump tax reform plan are international tax reform measures and a proposal for significant changes to business tax rates. The plan cuts rates for corporate income (35 percent to 15 percent) and includes a one-time year-long repatriation holiday for offshore earnings of U.S. Multinational Enterprises (MNEs) set at a tax rate of 10 percent, well below the current rate of 35 percent, the regular business tax rate.
In the House Republican plan, the rates for repatriation are set even lower, at 3.5 percent to 8.75 percent, while the corporate rate is cut to 20 percent. Current estimates of corporate money offshore are $2.5 trillion.
The likely result of these proposals are large tax cuts for business while, ironically, encouraging further offshoring of both income and jobs. The proposals come after decades of falling corporate tax revenues as a percent of total federal revenues from 30 percent to roughly 10 percent, as can be seen in Figure 1 (below). Individual income taxes, meanwhile, have maintained their share of nearly 50 percent of federal receipts.
The Economic Policy Institute’s chart book from September (the figures above is replicated from their study) demonstrates that corporate taxes contribute less to federal revenues now than in 1950, that corporate profits have soared as their taxes have decreased, that corporate offshoring causes the United States to lose $100 billion annually in revenue, and that U.S. corporations pay on average well below statutory tax rates on the books.
Meanwhile, Treasury Secretary Jacob J. Lew estimates that a tax reform/infrastructure agreement could materialize quickly in the first one hundred days of the Trump administration, based on a previous “near-deal” from 2014.
Regarding both the House and Trump’s initial proposals, there is a misalignment of incentives with a voluntary repatriation holiday. As with the 2004 tax holiday, Trump’s repatriation plan could lose revenue over time and could encourage further offshoring. If firms know that they can get a tax deal every few years via a repatriation holiday, they are likely to stash more cash overseas in anticipation of the next holiday. Although the president-elect’s repatriation holiday rate of 10 percent is higher than the 5.25 percent set in the 2004 holiday, there is evidence that the holiday would raise less than $150 billion, far less than the $700 billion that is owed under current repatriation rates of 35 percent.
Rather than investing, many firms used the tax giveaway on their repatriated income for stock buybacks (to inflate company share prices) and increased executive pay.
The Senate Permanent Subcommittee on Investigations found in 2004 that the top fifteen firms that repatriated income to the United States with the holiday still shifted about 21,000 jobs overseas. Rather than investing, many firms used the tax giveaway on their repatriated income for stock buybacks (to inflate company share prices) and increased executive pay. A Trump or House Republican repatriation plan would do little to keep jobs in the United States or help workers buffeted by the winds of globalization and automation, as he promised repeatedly on the campaign trail.
Past Proposals for Reform
The Camp Proposal
There have been several tax reform proposals put before Congress in recent years. The tax reform proposal in 2014 proposed by Rep. Dave Camp (R-MI) (a discussion of which can be found here) advocated a traditional “lower the rates, broaden the base” approach to tax reform: lower rates to make corporate taxes more competitive while broadening the taxable base of money by closing loopholes in the tax code. But the Camp international tax reforms were wanting. The international reforms designed to address deferral included a low one-off 3.5 to 8.75 percent retroactive tax on foreign earnings that were to be repatriated. Deferral in this context refers to a loophole in the tax code that allows corporations to defer taxes on their foreign earnings until they are brought home (repatriated). Firms can defer taxes on this income year after year to avoid paying taxes by referring to the earnings as “permanently reinvested” overseas.
The proposal combined this low retroactive repatriation rate with individual tax exemptions on dividends to motivate corporations to pay out the repatriated earnings to shareholders. They cite the unlikely assumption that other OECD countries will implement similar rules for dividends and business taxes. The Camp proposal does include a plan to end deferral altogether, replacing it with a semi-territorial tax system that implements a very low tax rate on foreign earnings around 5 percent. The Tax Foundation found that the effective tax rate on foreign earnings under this proposal would be around 1.5 percent after deductions. So, while the Camp proposal technically ends deferral, it does so with a sharp reduction in the tax rate.
The Obama Proposal
The Obama Administration has also proposed tax reforms. In contrast to the Camp proposal, these reforms involved ending deferral via a one-time tax of 14 percent on repatriated earnings and then imposing an annual 19 percent tax on future foreign earnings. (See Century Foundation report on this topic). The Obama proposal would also reduce the corporate rate and capital gains rate to 28 percent, from the current 35 percent rate. Its authors argue this would be a revenue-neutral reform: the administration’s proposal would raise as much tax from rates on repatriation as it would lose on lowering the corporate tax rate.
With Trump’s plans, there is a major question about whether simultaneously lowering tax rates on repatriation and corporate taxes would be revenue neutral. While Trump’s team claims his plan is revenue neutral, other independent researchers compute it will on balance lose significant revenue. According to the Tax Policy Center’s in-depth analysis of Trump’s business tax proposals, the revenue losses would come to around $3 trillion.
A Current Proposal for Reform
In a recent panel discussion sponsored by the Bernard L. Schwartz Rediscovering Government Initiative, noted authority Reuven Avi-Yonah of the University of Michigan Law School proposed ending the deferral altogether—repatriating offshore profits at a rate of between 20 percent and 30 percent—and simultaneously lowering of the corporate tax rate.
In addition, Avi-Yonah proposes a destination-based corporate tax system (where a corporation is taxed based on where they sell their goods and services, instead of being taxed based on their origin or the corporation’s legal domicile). This is called a destination-based or a territorial tax system. Simply put, a firm’s goods that are sold in the United States are taxed in the United States, no matter the country the firm is headquartered. The taxes closely resemble sales or value-added taxes, but are levied on the business or corporation’s total sales in the United States, not the consumer of the products. Combining this with individual tax reforms that raise taxes on capital gains could result in a constructive and comprehensive replacement of the current patchwork of business taxes and loopholes.
A destination-based cash flow tax, per Avi-Yonah’s report, would also help U.S. exporters relative to importers to the United States. By taxing corporations via a destination-based border-adjustable tax, U.S. exporters can sell their goods abroad at lower prices because exports are not subject to the tax. In fact, proponents claim it could attract businesses into the United States looking to benefit from the de facto tax break for exporters. On the other hand, a price will be paid by importers, which could have adverse affects on consumers purchasing imported goods.
Based on Avi-Yonah’s analysis, the Growth and Investment Tax system proposed in a 2005 George W. Bush tax reform advisory panel closely resembles the current plan of House Speaker Paul Ryan, which also advocates a territorial tax system. This includes a destination-based cash flow tax that would be created through five reforms:
- The U.S. government would lower the corporate tax rate to 20 percent,
- Businesses could expense capital investments,
- Businesses would cease paying taxes on profits earned overseas (these taxes will be replaced by the border adjusted tax),
- Businesses would not be able to deduct interest as a business expense, and
- The corporate tax would be “border adjusted” or destination-based.
Avi-Yonah’s destination-based solution is different. He criticizes the House Republican plan’s territoriality for its low rates of taxation and lack of progressivity: sales taxes are generally regressive. The regressive nature of a destination-based cash flow tax could hurt consumers purchasing imports subject to the tax as corporations pass on the cost of the tax to consumers. What is more, the Republican plan currently on the table would let corporations that offshored their money off the hook with a low one-time repatriation of 10 percent, then implement the destination-based tax at around twenty percent.
However, Avi-Yonah believes there is room for agreement between the two parties if there are sufficiently high taxes on capital income, dividends, and interest. Without the progressive taxation of capital, a tax reform plan with a destination-based tax could adversely impact American working families, as prices could rise on goods with many imported components.
Prospects for Reform in the Next Administration
Although Secretary Lew argues that there will be an agreement on tax reform, most participants in the corporate tax panel at the above-mentioned Bernard L. Schwartz Rediscovering Government Initiative’s “Paying for Progress” conference last November were in general agreement that there was little chance of raising revenues through the tax reform overhaul. On the panel, Avi-Yonah predicted that offshoring would increase under the Trump plan. Eric Toder of the Tax Policy Center agreed that both the House Republican plan and the Trump plan would likely result in a significant tax cut, with little chance of raising revenue. Matt Gardner of Citizens for Tax Justice added that further offshoring to tax havens with zero percent tax rates will occur, because the Trump team does not wrestle with the tougher issue of ending inversions (relocating a company’s legal domicile in a low-tax nation) and offshoring. David Borris of the Main Street Alliance argued that corporate tax cuts leave small businesses and workers to foot the tax bill.
Presently, the likely outcome of the tax cuts that Congress is poised to employ is that tax revenues are cut back, budget deficits will increase, and fear of rising deficits is used by Congressional Republicans to justify cuts to social programs. The tax reform proposals of Congressional Republicans appear to be revenue-negative, so defending social programs may fall to Democrats.
It may even be possible that the one novel part of the House plan, the destination-based tax, will be killed by corporate retailers like Wal-Mart, who are worried that taxing imports could raise the prices of the goods they sell. Economist Jared Bernstein suggests this is a strong possibility. If that part of the plan is scuttled, there will be little revenue-raising potential in the House Republican plan.
Prior to the presidential elections, Senator Elizabeth Warren proposed reforms to the corporate tax system that could raise revenue by ending deferral, mitigating inversions, and minimizing reductions in corporate tax rates. Other groups like the AFL-CIO have been supporting this kind of solution for years. These plans have been shelved in the current political climate. Goldman Sachs Economic Research predicts that while a destination based system may offer unique benefits, Congress will likely move away from such an overhaul, partly because of retailer opposition and from the impact it may have on raising consumer prices and inflation.
No matter how the plans shake out in the new congressional session, a tax giveaway on the scale that is advocated by the Trump team or the House Republicans could lead to lost revenue and, as noted, a false justification to cut social programs necessary to millions of Americans.
Such a future would likely add to income inequality in America.