Embroiled in conflicts with Democrats and establishment Republicans alike over several of his executive orders, appointments, and official statements, President Trump has not even entered the arena for what is sure to be an all-out political brawl. This future battle will be waged over nothing less than tax reform, a key pillar of the president’s campaign.
In addition to the expected combatants on the left, President Trump may face stiff resistance from within his own party as he wades into the morass that is our current national tax code.
The United States brings in over three trillion dollars in tax revenue each year. Just under half of that comes from the federal personal income tax. When most people think about tax reform, they are essentially ruminating over modifications to the income tax. While various politicians and think tanks have proposed several interesting and wildly divergent modifications to the income tax code over the years, most boil down to altering two things: marginal rates and so-called “loopholes.” Both parties advocate lowering the rates on working and middle-class earners as well as eliminating loopholes.
The impasse materializes when the question comes up of how to pay for all this, and what exactly qualifies as a loophole. Democrats want to offset the reductions by increasing tax rates on wealthier citizens or phasing out deductions at higher incomes. Republicans, on the other hand, generally pay for their plan with either spending cuts or by broadening the base. Arriving at a consensus on a particular plan has proven to be nearly impossible for over thirty years.
However, what if instead of offsetting the popular changes with politically impossible modifications to the tax code, lawmakers could find another way to pay? Surprisingly enough, each major platform in Washington overlaps with the other when it comes to a solution for this problem. Enter the corporate tax.
The numbers alone betray the tragedy that is the United States corporate tax code. At thirty-five percent, American companies are subject to the highest tax rate of any developed country in the world. Additionally, the United States is the only large Western economy to tax profit earned overseas. Despite this, the government only brings in slightly over ten percent of its revenue through this channel, roughly a fifth of what the personal income tax generates. Nearly two-thirds of corporations paid nothing in taxes, while the average effective rate paid stands at fourteen percent or lower. How can this be?
To answer that let us revisit our old friend, the loophole. A millionaire with a clever accountant may be able to perform some fancy tricks in April to shave a few bucks off his bill; multi-billion dollar corporations employ legions of specialists and lawyers to squeeze every dollar they can out of the tax code and into their coffers. The OCED estimates that over $240B are sheltered from corporate taxes each year. Even more jarring is the quirk in the tax code which only taxes profits earned overseas when they return to the United States. This rule creates the perverse situation in which a company will form a foreign subsidiary, route most of its profit through that entity, and then sit on the cash overseas without paying anything to Uncle Sam. This tax avoidance scheme and others happen with alarming regularity.
President Trump, Speaker of the House Paul Ryan, the Republican Party, and the Democratic Party all agree that something should be done. Refreshingly, they all hold similar views in their platforms regarding how to proceed.
From President Trump’s campaign:
America will compete with the world and win by cutting the corporate tax rate to 15% … A one-time deemed repatriation of corporate cash held overseas at a significantly discounted 10% tax rate, followed by an end to the deferral of taxes on corporate income earned abroad.
From Speaker Ryan’s A Better Way plan:
Restore American competitiveness by lowering our corporate tax rate from the highest in the industrialized world to 20% and shifting to a “territorial” system with more competitive rates.
From the GOP platform:
We propose to level the international playing field by lowering the corporate tax rate to be on a par with, or below, the rates of other industrial nations. We endorse [a] … switch to a territorial system of taxation so that profits earned and taxed abroad may be repatriated for job-creating investment here at home.
From the DNC party agenda:
We will make sure that our tax code rewards businesses that make investments and provide good-paying jobs here in the United States … We will end deferrals so that American corporations pay United States taxes immediately on foreign profits.
With such a convenient starting point, comprehensive tax reform should be here by the end of the year, right? Not so fast. While Democrats may be in favor of altering the way the IRS treats foreign profits, they are not necessarily willing to cut rates. Although Speaker Ryan may embrace a territorial tax system, this is different from President Trump’s goal of eliminating the deferral of taxes on foreign profits. The devil, as usual, is in the details.
The latest buzzword to make the rounds in Republican circles is the idea of a “border adjustment tax.” This approach to the corporate tax essentially exempts exports from taxation while taxing imports. Instead of greeting his party’s latest plan with enthusiasm, President Trump called the border adjustment tax too complicated, while Senator Tom Cotton (R-AR) called the idea “so stupid only an intellectual could believe [it].”
Democrats will also have their list of demands that need to be met to achieve the sixty votes required for any tax reform bill to clear the Senate. They will want to revisit their agenda for the personal income tax, and will also likely push to raise the payroll tax on high earners. When it comes to the corporate code, expect abundant carve-outs for their favored industries and plenty of penalties for their foes.
President Trump has promised a “phenomenal” tax plan sometime in the next few weeks, but it remains to be seen how much will differ from the proposal offered during his campaign. In his 1987 book, Trump showed us what he would do first — think big and maximize options. However, the Deal-Maker-in-Chief may find the deal of his life is just out of reach when he jumps into the ring of tax reform.