First Quarter Tax Reform Update
Monday, March 20, 2017

Legislative Activity

The House

With the 115th Congress entering month three, tax reform continues to be a focal point of the political debate in Washington. Intent to move forward with their tax reform “Blueprint” released in June 2016, Speaker Paul Ryan (R-WI), House Ways and Means Committee Chairman Kevin Brady (R-TX), and other tax-writers have spent a significant amount of time and energy promoting their proposal, which would dramatically overhaul the U.S. tax system. If the Blueprint were to become law:

  • The top corporate rate would be lowered to 20%;

  • The individual tax brackets would be narrowed and lowered to: 0/12% ($0-$9,275/$9,276-$37,650) for single filers and $0-$18,550/$18,551-$75,300 for joint filers), 25% ($37,651-$190,150 for single filers and $75,301-$231,450 for joint filers), and 33% ($190,151 or more for single filers and $231,451 or more for joint filers);

  • The tax rates on investment income would also be narrowed and lowered to : 0/6%, 12.5%, and 16.5%[1];

  • There would be an 8.75% tax on accumulated offshore earnings;

  • The Internal Revenue Service (IRS) would be divided into 3 major units: (1) individual; (2) businesses; and (3) tax court; and

  • The IRS Commissioner would be replaced with an appointed Administrator who is limited in scope

Though initial expectations were that the text of the Blueprint might be available as early as March, Chairman Brady has since indicated that he now hopes to have the legislation released “during the first half of the year,” which likely means that the text of the bill will be finalized by June. Some have argued that at least part of the delay in the drafting process appears to be a result of the Blueprint originally being a “campaign” document that unexpectedly became the roadmap of the party in control of the White House and both Chambers of Congress.

Once the legislation is drafted, it will then be taken up and debated by the Ways and Means Committee – a process that will likely be contentious given the current political divide in Washington. In fact, it is presently not clear whether the proposal, as described, will make it out of Committee. To date, it is rumored that at least four Ways and Means Committee members would oppose the Blueprint (as drafted) in a markup – and given the makeup of the Committee, Republicans can only lose four votes.

The main issue dividing Republicans at the moment? The Blueprint’s Border Adjustable Tax (BAT), which would essentially: (1) disallow deductions for imports when calculating the cost of goods sold; and (2) exclude revenues earned from exporting goods from taxable income. Note too, another key issue that is causing concern among industry – and which has thus far been eclipsed by the pushback on BAT – is the proposal to eliminate the corporate interest deduction in favor of full expensing.

Despite these concerns, Speaker Paul Ryan (R-WI) is likely to exert considerable pressure to get this through Committee and out of the House. This task, however, will be extremely difficult in the face of opposition from a number of traditionally conservative stakeholders, including the Club for Growth, Americans for Prosperity, the Koch Brothers, and nearly two-hundred companies – including many of America’s largest retailers – that have come together under the umbrella of a new association – Americans for Affordable Products – opposing the BAT.

Another key factor for consideration is the current debate over repealing and replacing the Affordable Care Act. If Speaker Ryan is successful in pushing through the House repeal and replace proposal in the face of mounting opposition, he will have the wind at his back in pursuing tax reform; if not, he risks being perceived as ineffective, making it that much more difficult for him to push BAT – and thus the House Blueprint – across the finish line.

The Senate

Though Senate Republicans have generally avoided opposing BAT outright, several influential Senators have either expressed concerns about the proposal or indicated that they have doubts and are thus withholding judgement. That said, opponents of the BAT are beginning to make themselves known. For example, Senator David Perdue (R-GA) recently sent around a “Dear Colleague” letter arguing that the BAT is “regressive, hammers consumers, and shuts down economic growth.” Additionally, Senators Jeff Flake (R-AZ) and Tom Cotton (R-AR) have come out against the BAT, expressing concerns about the proposal and the potential for negative consequences. By our count, looking at publicly available sources, nearly twenty Republican Senators have expressed concerns about – or outright opposed – the proposal. Note too, support may grow weaker in the face of opposition by many of America’s largest retailers. Take, for example, the home states of some of the country’s largest retailers; it is hard to see these States’ Senators voting in favor of the proposal.

Notably, the skepticism in the Senate seems to be growing, with Senate Finance Committee Chairman Orrin Hatch (R-UT) recently acknowledging he “[does not] see [BAT] happening, not the way the House has configured it” and expressing an openness to alternatives. Other senior tax-writers, including Senator John Cornyn (R-TX) – who is also a member of leadership – have also expressed doubts about the BAT becoming law.

Importantly, though, not only are Senate Finance Committee members questioning the BAT, but they are also not wedded to the Blueprint. In fact, the Committee is proceeding as if it may need to do its own bill, with Republican tax-writers seeking to understand the real-world impact of the Blueprint. From our perspective, it is likely that any Senate bill could be informed by former Ways and Means Committee Chairman Dave Camp’s (R-MI) comprehensive tax reform legislation (e.g., bank tax, base erosion measures, etc.). Though how and when the Senate proceeds will depend on many factors, an optimistic view suggests that the Finance Committee could be prepared to move forward with its draft as early as April. Note, it seems unlikely that there will be many hearings on the bill, as very little of what might be included is likely to be conceptually new.

Given the makeup of the Senate (52 Republicans and 48 Democrats/Independents), as the Senate moves forward with its own debate on tax reform, Senate Democrats have the potential to wield significant influence over the tax reform process. While the Senate Democrats have pushed back on the Blueprint (see the leaked Senate Democratic Finance Committee staff memo), calling it regressive and urging Republicans to fill out the details, they have nevertheless pledged to work with the GOP in an effort to come together on a solution that both parties can support.

However, while this all adds extra pressure to do tax reform on a bipartisan basis, Republicans have the fallback option of reconciliation. Nevertheless, doing tax reform under reconciliation also comes with certain drawbacks, as it cannot add to the deficit in any year outside the 10-year budget window. The Byrd Rule’s restrictions on reconciliation could require sunsetting at least portions of the tax policy changes called for in the Blueprint – something Republicans want to avoid if possible. Nevertheless, Republicans do not want to miss the opportunity to lower rates, thus – as Senate Majority Leader Mitch McConnell (R-KY) continues to remind his fellow Senators – reconciliation remains a real (and increasingly likely) possibility.

The Administration

At the White House, a group of the nation’s largest retailers (who oppose BAT) recently met with President Trump to discuss the BAT and its negative implications for businesses and the economy.  Though the President walked back his earlier comments suggesting that the BAT may be overly-complicated, he has at the same time failed to fully embrace the concept (or at least the concept as proposed in the Blueprint).

Though President Trump’s recent address to a joint session of Congress acknowledged the need to encourage U.S. exports, the President’s advisors (chiefly Secretary of Commerce Wilbur Ross) made clear that he was not endorsing BAT. Many considered this a loss for Speaker Ryan and the House proposal, as the BAT needs buy-in from the Administration if it is ultimately going to move forward in the tax reform debate. Notably, the Trump Administration had another opportunity to express (or withhold) its support of BAT: the “skinny budget.” However, no mention of the BAT was made; he did, however, promise to release more detailed tax proposals in his full Budget to be released later this spring. That said, while nothing has been confirmed, it appears that President Trump may be more in line with the Senate in questioning whether a BAT is appropriate and effective. That said, there still appears to be a divide even within the White House, with the political staff favoring the BAT and the policy staff generally opposing it.

Timing and Next Steps

As indicated above, the timing of tax reform is largely dependent on the success of the House Blueprint. Assuming the proposal moves forward largely as is, the House is aiming to wrap up debate and successfully enact tax reform by August. However, the likelihood that final action on tax reform – if it happens – slipping until the end of the year appears to be a more real possibility, as the politics of the BAT seem to be slowing the process. In fact, while Chairman Brady is still proceeding publicly as though Congress will be able to enact tax reform by August, Leader McConnell and Chairman Hatch last week both expressed skepticism that tax reform will get done by August, suggesting that it could even slip to 2018. Notably, the Administration did not cede this, but also would not rule it out.

Beyond the difficulties that lie ahead for tax-writers, the Congressional calendar is also standing in the way of the tax reform debate. The must-do’s for this Congress include: (1) Healthcare: With GOP intra-party fighting already underway in the face of their proposal to repeal and replace the Affordable Care Act, and because the Senate cannot move tax reform through reconciliation until the healthcare reconciliation package is finalized, it is clear that healthcare reform will require a significant amount of Members’ attention (and floor time); (2) Debt Ceiling: The Treasury Department’s borrowing authority will need to be increased given that the current suspension of the debt ceiling expired on March 15 – though estimates suggest the Treasury can implement “extraordinary measures” to ensure that it has sufficient funding to pay its obligations through the fall; (3) Nominations: The Senate will be tasked with confirming President Trump’s nominees – including, in particular, Neil Gorsuch to be a Supreme Court Justice; and (4) Appropriations: Lawmakers in both Chambers will continue working to finalize Congressional appropriations for both FY 2017 and FY 2018.

In sum, key policymakers remain committed to seeing tax reform across the finish line this year. However, with many consequential issues that need to, the path to tax reform grows more perilous with each passing day. In particular, if proponents of tax reform let too much time slip away, they will soon find themselves running up against the 2018 Election, which makes potentially politically difficult votes all that much harder to take. As such, Republican tax-writers must decide whether to Chairman Brady’s advice and “seize the moment,” or risk losing the opportunity to deliver “a better way” for U.S. tax policy.


[1] The income levels associated with individual tax rates would also apply to the respective investment tax rates.

 

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