international analysis and commentary

Tax reform and the potential for bipartisan compromise


With the 2014 elections now behind them and the 2016 elections already looming, both the recently victorious Republicans and their defeated democratic opponents must already start thinking about what kind of image they want to present to the voters in two years, as part of their bid for the White House and Congress. Neither wants to be cast as the party of “No”, especially  the Republicans, who have been carrying this label for the last six years and are somehow looking to shed it.

Therefore, for the first time since President Barack Obama took office, it is now in the best interest of both parties to find at least a few areas where compromise is possible and get to work on legislative agreements there, which they can then sell to their constituencies as a success story. International trade certainly has the potential for it. For a long time, immigration reform was thought to hold some promise, though Obama’s recent decision to go ahead with a series of executive actions combined with deep internal divisions within the GOP might undermine prospects in this area. Finally, the new Congress, the 114th, could possibly produce some results with regard to tax reform, though experts warn not to hold one’s breath for it.

“I don’t think the outcome of the midterm elections had any effect on the chances for individual tax reform, which remains highly unlikely,” says Chuck Marr, Director of Federal Tax Policy at the liberal-leaning Center on Budget and Policy Priorities in Washington, D.C. “But it may have marginally increased the small probability for corporate tax reform, in that Republicans are now in charge of both houses of Congress and there is more pressure on them to do something.” The US has an outdated and arcane corporate tax code, whose top rate is, at 35%, one of the highest in the world, but whose many loopholes allow large corporations equipped with smart lawyers to pay very little, if any taxes at all. Therefore, corporate tax reform should be a no-brainer. In recent months, much has been said of the process of tax inversions, whereby American multinationals acquire or merge with foreign companies only in order to move their tax base to a more favorable location. And of the fact that companies such as Apple keep their foreign-earned profits abroad in order to avoid paying taxes on their repatriation.    

At least nominally, then, corporate tax reform is not only a high priority for Congressional Republicans, but is also at the top of the White House’s list, and has the support of the business community. Speaking before the Business Roundtable, the lobby of the biggest American companies, at the beginning of December, the President said that there is “definitely a deal to be done.” Yet, when push comes to shove, it suddenly becomes incredibly hard to hatch out the details of a plan and compromise drifts even further from reach. “Tax reform is generally very difficult because it always produces winners and losers, and losers get much more unhappy than winners get happy,” says Marr. “Human beings, corporations, lobbyists are all very loss averse.”

So while in theory there is some consensus on the need to lower corporate tax rates in exchange for eliminating some exemptions and deductions – in hope of creating a system that is simpler and fairer – once it comes time to decide how much to lower taxes and which exemptions and deductions to do away with, they all head for the hills. Especially since different industries are competing against each other in a race to protect their favorite loopholes.

“There is broad disagreement about key features of the reform: How should it affect revenue, should it raise or lower taxes on overseas profits of US-chartered companies?” says Alan Viard, Resident Scholar at the conservative-leaning American Enterprise Institute in Washington, D.C. “And even if agreement can be reached on those issues, you still have the obstacles of agreeing on exactly which provisions should be changed, for example, you can’t get significant revenue-neutral corporate rate reduction without slowing down depreciation schedules or curbing the interest deduction.” Both parties worry about how reform would impact the US’s fiscal position, with Republicans more focused on the size of the tax cuts, regardless of how these would affect the budget in the long run, while Democrats wouldn’t mind raising some revenue in the process.

Another major point of contention is how the government should tax the foreign profits of American corporations, whether it should move to a territorial system, whereby these profits would go untaxed in the US but companies would also not be allowed to deduct related costs from their American tax bill, or whether it should tax all their worldwide profits (currently Washington employs a mix of the two, which further complicates the picture). A repatriation tax holiday is also under discussion, to encourage American multinationals to reinvest their overseas earnings in the US.

The experience of David Camp, Representative from Michigan and the outgoing Chairman of the House Ways and Means Committee (which is tasked with tax-writing responsibilities,) illustrates how complicated it is, because of all the above reasons, to pass any kind of tax reform. Earlier this year, Camp presented the outlines of a plan, which he then only introduced formally as the Tax Reform Act of 2014 on December 11th, to cut the top corporate tax rate to 25% while eliminating some 150 tax breaks to keep the reform revenue-neutral (Camp also included a significant revamp of the individual tax code). But so far, his proposal has failed to rally even his fellow Republicans and the business community has been critical of some of its elements.

Camp’s mantle now passes to Paul Ryan, Representative from Wisconsin and former vice-presidential candidate, who is scheduled to take over the House Ways and Means Committee in January. Ryan has already said he is eager to get going on tax reform and believes a deal is within reach and could be sealed by the end of 2015. According to Chuck Marr, a first indication of whether this is true will come from how Republicans go about it, considering that the two sides are further apart on individual tax reform. “If they go for individual and corporate at the same time, it is very unlikely than anything will come of it,” Marr says. “If they go only for corporate tax reform, there might be a way.”