Impact of the 2016 Election on Tax Policy
Republican control of the White House and both chambers of Congress after this week’s election is a game-changer for tax policy and greatly increases the odds for tax reform. In particular, synergies between President-elect Donald Trump’s tax reform plan and the House Republican tax reform blueprint, and the potential to use the fast-track reconciliation process to work around the 60-vote threshold in the Senate, make tax reform early in the Trump administration a viable possibility.
Setting the stage for swift action in the first 100 days will most likely focus on – securing revenues to pay for a policy priority (infrastructure) that everyone seems to agree on, concerns about U.S. businesses moving offshore, aggressive global anti-tax avoidance initiatives impacting multinationals, and pleas from U.S. businesses to make the U.S. tax regime fairer, simpler and more competitive.
As of this writing, Republicans will hold a 45-seat majority in the House, with 238 seats in total compared to the Democrats’ 193. Four seats remain undecided. In the Senate, Republicans retain a slim, one-seat majority, with 51 seats total compared to the Democrats’ 46 plus two Independents. One race remains undecided.
Because Senate Republicans will not hold a filibuster proof majority, Senate Democrats will hold considerable leverage in the outcome of legislative action outside of the reconciliation process because Republicans will need some of their votes to meet the 60-vote threshold.
This briefing looks ahead to the impact of the election on the tax policy landscape in the coming Lame Duck session and 115th Congress, followed by an overview of the changes in congressional leadership and the composition of the tax-writing committees.
Looking toward 2017, tax reform is likely to come early to the forefront of the legislative agenda. President-elect Trump, Speaker Paul Ryan (R-WI), Leader McConnell, House Ways & Means Committee Chairman Kevin Brady (R-TX) and Senate Finance Committee Chairman Orrin Hatch (R-UT) share the belief that the tax code needs to be revised to make U.S. businesses more competitive, boost the economy, create jobs, reduce burdens on small businesses, improve fairness and make it simpler to understand and comply. This vision may be bolstered by the desire to find revenues to pay for infrastructure, as President-elect Trump and House and Senate leadership in both parties are on record in support of an infrastructure bill.
Given the demands of setting up a new administration, and the fact that his Republican colleagues in the House and the Senate have fairly well-developed tax reform plans, President-elect Trump could largely defer to the tax writers to push the details of a tax reform agenda, as long as they were generally consistent with his broad principles as listed above. The tax plan outlined by President-elect Trump during his campaign is largely consistent with the House Republican tax reform blueprint.
President-elect Trump proposes to lower the corporate tax rate, eliminate most tax expenditures, allow a choice between full expensing or deducting interest expense, and tax deemed repatriated earnings at a significantly lower tax rate. As a result, under Speaker Ryan, Chairman Brady, and their counterparts in the Senate, the blueprint for tax reform could quickly evolve into a legislative reality.
Chairman Brady has stated he wants to tackle tax reform within the first 100 days of the new Congress; his staff has been drafting the blueprint into legislative language for months in order to have a legislative proposal ready to go when the 115th Congress convenes. This would have the added advantage of providing common ground that could help heal any rifts that arose during the campaign.
The likelihood of tax reform and the speed at which it could occur is significantly increased by the potential use of the fast-track reconciliation process. While normal Senate rules require a 60-vote threshold, the reconciliation process requires only a simple majority vote of 51, exactly the number of Republican members in the Senate (not including the potential addition of one more Republican after the Louisiana Senate race is resolved in December). The Vice President can also cast his vote in event of a tie. While arcane reconciliation rules limit what can be accomplished through this mechanism, it is important to note that the health care bill was adopted in 2010 using the reconciliation process.
The details of President-elect Trump’s tax plan and the House Republican tax reform blueprint are still under construction, as Congressional staff solicit comments from stakeholders and the Trump transition team fleshes out their plan. In addition, other reform ideas, like Chairman Hatch’s corporate integration proposal, Sen. Sanders’ proposal to close “Trump loopholes,” Rep. Jim Renacci’s (R-OH) value-added tax, Sen. Ben Cardin’s (D-MD) consumption tax and others, will likely be part of the mix. As a result of this uncertainty, nearly all deductions, credits, and other tax benefits should be considered at risk – even those tax incentives that have typically been considered “safe.”
Paying for Infrastructure: International Tax Reform and Beyond
A key driver of the tax reform debate will be President-elect Trump’s pledge to enact a major infrastructure spending package** – perhaps amounting to $1 trillion dollars. Presumptive Senate Minority Leader Chuck Schumer (D-NY) has already signaled interest in negotiating a tax reform package that centers on repatriation and international tax reform to help fund such an initiative.
A one-time “deemed repatriation” tax on U.S. corporate earnings held overseas could help pay for most, if not all, of a multibillion dollar infrastructure package. This presumably would be coupled with broader international tax reform, perhaps moving to a territorial tax system with a minimum tax on offshore earnings.
However, it is important to note that the international tax reforms needed to facilitate repatriation are not easily severable from broader corporate, pass-through and individual tax reforms. While Leader McConnell has expressed interest in infrastructure, repatriation and tax reform, he hasn’t necessarily linked them; instead, he has said he would like to use revenues from tax reform to buy down the tax rates for businesses.
Given the challenges of repatriation, policymakers could look elsewhere for revenue to fund an infrastructure package. Possibilities could include closing the carried interest “loophole,” enacting a financial transactions or bank tax or repealing a series of deductions and credits in the tax code that some characterize as loopholes. Although bipartisan receptivity to such ideas is unclear, it is possible that consensus could emerge as a way to achieve the larger goal of enhanced infrastructure investment. As members look ahead to the 2018 election, touting their role in creating better roads and bridges, and the jobs that come with them, makes for a good campaign message.
If lawmakers can agree on international reform, this could lead to an even broader package incorporating other aspects of the Republican vision for comprehensive tax reform. A primary obstacle to international-only reform, including a lower rate on deemed repatriation, is that it would not reduce corporate tax rates. If the appetite for repatriation and international tax reform is strong enough, particularly if driven by infrastructure, domestic stakeholders could use this as leverage to lower corporate rates. As part of the chain reaction, pass-through taxpayers, owners of partnerships and S-corporations, would then insist that individual rates be reduced to provide tax parity between corporate and pass-through forms of business.
As noted above, these reforms could take several shapes as the “broaden the base, lower the rate” approach of recent years has stalled in the face of opposition from businesses that would have to give up valuable deductions and credits that may not compensate for any viable lower rate. The greater the number of permutations of tax reform pending, the greater the potential risks, and the greater the need to know what those risks are and how they might affect your operations.
Regulations and the IRS
If Congress fails to act on tax reform, the Trump Administration may take a page from its predecessor and actively use regulations and other administrative mechanisms to promulgate tax policy. A recent case in point is the Section 385 anti-inversion, anti-base erosion regulations. The Treasury Department responded to congressional pressure and the failure of Congress to take action itself by quickly issuing sweeping and aggressive final regulations to stem this activity.
Conversely, President-elect Trump and Congress may decide to exert their power and use the Congressional Review Act (CRA) to nullify key regulatory projects which were finalized late in the Obama Administration. Under the CRA, if there are less than 60 remaining legislative days in the House or session days in the Senate when final regulations are issued, the clock resets, giving the new Congress time to override the guidance. Similarly, projects in progress at Treasury and the IRS may be stalled, dropped, or revamped to reflect the policies of the new administration.
The technical corrections legislation under development in Congress may also be affected. Since sign-off is required from Treasury for a provision to be characterized as a technical correction, the Trump Administration could either give or revoke its blessing on pending technical changes. One case in point could be clarification of the new partnership audit rules and whether audit adjustments may be pushed out to upper tiers in the ownership structure.
It is unclear how the Trump Administration will want to treat the IRS. President-elect Trump’s perceptions of the IRS may be shaped, in part, from his experience of being under long-term audit. The ongoing debate over IRS funding will continue to have an effect on the efficient and effective administration of tax policy and relieving the burden on taxpayers. As the IRS copes with the impact of budget constraints on priorities like tax filing, collection and enforcement, the IRS may shift resources away from services like private letter rulings, advance pricing agreements and the compliance audit program. Further, the secure and appropriate processing of an influx of new reports resulting from the OECD-recommended country-by-country reporting and other global tax policy initiatives could be affected.
Finally, it is also unclear how President-elect Trump and his team will perceive and react to the aggressive actions taken by the EU and the OECD directed at base erosion, profit-shifting and transparency. Campaign remarks suggest President-elect Trump may give less credence to global efforts to improve tax compliance than the Obama Administration, particularly since they seem to disproportionately harm U.S. taxpayers. Alternatively, President-elect Trump has often expressed his concerns about U.S. companies offshoring and taking U.S. jobs with them, so he may be supportive of global efforts that would make the U.S. a more attractive place to do business comparatively speaking, especially if he and Congress are successful in enacting tax reform that lowers rates and allows repatriation of foreign earnings at preferential rates.
Leadership and Committee Changes
Leadership in the 115th Congress will undergo a significant change, as Senate Majority Leader McConnell will have a new counterpart in Minority Leader Schumer, who is next in line to lead his caucus following the retirement of Minority Leader Reid. Notably, Minority Leader Schumer will be defending 23 Democrats and two Independents caucusing with the Democrats in the 2018 election, including a significant number of Senate Finance Committee Democrats. With the 2018 election looming, Minority Leader Schumer and Senate Finance Committee Ranking Member Ron Wyden (D-OR) will be inclined to negotiate deals that help provide wins for Senators who are campaigning for re-election.
The increased skew in the House of conservative Republican members could potentially impact Speaker Ryan’s fate in the House. Speaker Ryan has publicly stated that he intends to run again for the position. However, conservative Republicans may attempt to replace him out of retribution for his lukewarm support for President-elect Trump’s candidacy. Even so, it is unclear whether another candidate could muster the requisite 218 votes to become Speaker. Alternatively, the conservative wing of the caucus might use their leverage to gain a position in House leadership. Under any scenario, House Democratic votes may be necessary to advance legislation, giving House Minority Leader Nancy Pelosi (D-CA) and her caucus some influence over what legislation comes out of the House.
*Federal Tax Reform & the Impact on the State Level
Major changes at the federal level have a direct impact on state tax collection, because most state tax codes are connected to the federal tax system in one way or the other. Any changes to deductions or the tax credit would trickle down to a majority of states and directly affect their revenue. With CA’s economic and political climate and lack of its own tax reform, it will be interesting to see how leaders will determine how they react to federal changes.
**Donald Trumps Infrastructure Proposal
Donald Trump’s proposal for $1 trillion worth of new infrastructure construction relies entirely on private financing, which industry experts say is likely to fall far short of adequately funding improvements to roads, bridges and airports. The president-elect’s infrastructure plan largely boils down to a tax break in the hopes of luring capital to projects. He wants investors to put money into projects in exchange for tax credits totaling 82 percent of the equity amount. His plan anticipates that lost tax revenue would be recouped through new income-tax revenue from construction workers and business-tax revenue from contractors, making the proposal essentially cost-free to the government. Experts and industry officials, though, say there are limits to how much can be done with private financing. Because privately funded projects need to turn a profit, they are better suited for major projects such as toll roads, airports or water systems and less appropriate for routine maintenance, such as repaving a public street, they say. Officials also doubt that the nation’s aging infrastructure can be updated without a significant infusion of public dollars. According to the McKinsey Global Institute, the U.S. needs to boost infrastructure spending by 0.7% of gross domestic product between now and 2030 to meet the demands of a growing economy.
Further reading: If you want to learn more about the myths and realities of infrastructure investment I recommend the following article by Edward L. Glaeser: http://city-journal.org/html/if-you-build-it-14606.html