Oct 4, 2017
Tax Policy Update
QUOTE OF THE WEEK:
“This unified framework serves as a template for the tax-writing committees that will develop legislation through a transparent and inclusive committee process. The committees will also develop additional reforms to improve the efficiency and effectiveness of tax laws and to effectuate the goals of the framework. The Chairmen welcome and encourage bipartisan support and participation in the process.”
GOP’s Unified Framework for Tax Reform
September 27, 2017
On Sept. 27, the Big Six released the Unified Framework for Fixing Our Broken Tax Code (the “Framework”) — a nine-page document showing where the administration, House, and Senate tax writers have reached consensus in their efforts to overhaul the U.S. tax code. As expected, the Framework contains no groundbreaking details on the GOP’s forthcoming tax reform bill; it only confirms some of the details that have been floating around earlier this year.
For those who have been following tax reform developments closely, the Framework could have been a little more specific given how much time tax writers have had to come to a decision on tough policy questions. Despite the inclusion of specific tax rates for individuals and businesses, the Big Six negotiators are leaving most of the hard work ahead to the House and Senate tax-writing committees. But as the Tax Policy Update team suggested in last week’s preview of the Framework, the lack of details may be intentional: GOP tax writers are keen to shield the details of unpopular provisions from early attacks. The demise of the border adjustment tax provides a cautionary tale of what can happen when controversial provisions are left hanging “out there” for too long.
House Speaker Paul Ryan (R-WI) remains determined to pass a tax reform bill in 2017: The House Ways and Means Committee is aiming to mark up a bill in October, which is to be followed by a Senate Finance Committee markup in November. Such an aggressive timeline is unrealistic as it assumes that GOP lawmakers will fall in line with leadership without question. Members of the GOP conference may be playing nice for now, but knives will come out when lawmakers start talking offsets.
Here Comes Another Chart. McGuireWoods’ tax policy team has put together a concise summary of the Framework below. The chart is intended to serve as a quick, handy reference guide as tax reform progresses this fall.
Summary of the Big Six’s Unified Framework for Tax Reform
Business Tax Provisions
|Corporate Tax Rate
✔ 20% top rate
✔ Eliminates the corporate AMT.
✔ Consideration of unspecified method to reduce the double taxation of corporate earnings.
Our Analysis: The open-ended nature of the Framework will likely allow for the inclusion of Senate Finance Committee Chairman Orrin Hatch’s partial dividends-paid corporate integration proposal to reduce double taxation of corporate earnings and move closer to an effective tax rate of 15%, which President Trump originally proposed.
|Pass-through Tax Rate
✔ 25% rate
✔ Tax-writing committees to adopt measures to prevent the recharacterization of personal income into business income to prevent wealthy individuals from avoiding the top personal tax rate.
Our Analysis: Though pass-throughs will be taxed at a lower rate than the top rate for individuals, pass-through advocacy groups are unlikely to be satisfied with the 25% figure. They will continue to agitate for parity with the corporate income tax rate.
✔ Full and immediate expensing for at least 5 years
Our Analysis: Full and immediate expensing is an expensive provision — this is likely the reason why it is only included on a temporary basis. This is a significant departure from the 2016 House GOP tax blueprint, which made full and immediate expensing permanent. The loss of permanent expensing is the trade-off for the lower 20% corporate tax rate.
The inclusion of a partial dividends-paid deduction and the partial denial of the interest expense deduction will allow policymakers to say they have placed debt and equity on a neutral or equal footing in the tax code.
✔ Partially limits the deduction for net interest expense incurred by corporations.
✔ Tax-writing committees will consider the appropriate treatment of interest paid by non-corporate taxpayers.
Our Analysis: The partial retention of the net interest expense deduction is a compromise among the Big Six negotiators. The 2016 House GOP tax blueprint originally called for eliminating the deduction. However, Republican senators, including Sen. Hatch, have criticized this idea. Though President Trump’s tax plan was silent on interest deductibility, Treasury Secretary Steven Mnuchin has noted that the president would prefer to keep the deduction. The limitation on the deduction is likely to be met with continued opposition from many sectors, including the real estate industry.
|Deductions & Credits
||✔ The Framework calls for the elimination of most deductions and credits but explicitly:
- Eliminates the current Section 199 domestic production deduction
- Maintains the R&D tax credit
- Maintains the low-income housing tax credit
✔ Tax-writing committees to make the decision on which other business deductions and credits to keep, modify, and eliminate.
Our Analysis: While the Framework currently retains only two credits, the list is likely to grow due to pressure from various industries and special interest groups.
|Territorial System of Taxation
||✔ Shifts the U.S. to a territorial system of taxation.
✔ 100% dividend deduction for foreign subsidiaries – allows free flow of earnings back to the U.S.
✔ Deemed repatriation with bifurcated rate – payment spread out over several years.
Our Analysis: Similar to the 2016 House GOP tax blueprint, the Framework proposes a two-tier repatriation system, but does not propose a rate. The blueprint specified an 8.75% tax on cash and a 3.5% tax on other assets, payable over eight years. Given that Trump’s campaign tax plan called for a one-time tax on repatriated assets and a 10% rate on offshore earnings, it remains to be seen how the final tax legislation will handle this issue.
||✔ Calls for a global minimum tax in vague terms.
✔ Tax-writing committee to write rules to level playing field between U.S. headquartered parent companies and foreign-headquartered parent companies.
Our Analysis: The Framework calls for a global minimum tax to prevent companies from shifting profits to low-tax or no-tax jurisdictions, though a rate has not yet been specified. The final deal will likely include a rate above proposals by former Ways and Means Chairman Dave Camp, President Trump, and the 2016 House GOP Blueprint – perhaps to 12.5%.
|Individual Tax Provisions
|Zero Tax Bracket
✔ Nearly doubles the standard deduction:
- $24,000 for joint filers
- $12,000 for single filers
✔ Eliminates personal exemptions
Our Analysis: The Framework eliminates most personal exemptions and deductions, consolidating these items into the increased standard deduction. Doubling the standard deduction will increase the number of individuals in the 0% tax bracket.
✔ Reduces the current 7 income tax brackets to 3:
✔ Considers establishing an additional top rate for the highest-income taxpayers.
✔ Repeals the AMT.
✔ Calls for the elimination of most itemized deductions but explicitly maintains:
- Mortgage interest deduction
- Charitable contributions deduction
✔ Tax-writing committees to determine what other deductions, exemptions, and credits to preserve, modify, and eliminate.
Our Analysis: Due to the increased standard deduction, the Framework assumes that most individuals in the lowest bracket will see major reductions in their tax liability. Though the Framework currently proposes a reduction in the top rate, by the time the bill moves through Congress, the final product is likely to be a tax cut primarily for the middle class. The current 39.6% top rate will likely remain.
|Child Tax Credit
✔ Repeals personal exemptions for dependents.
✔ Frist $1,000 of the tax credit remains refundable as under current law.
✔ Increases the income levels at which the Child Tax Credit begins to phase out
✔ Provides an additional non-refundable $500 credit for non-child dependents.
Our Analysis: The Framework assumes that the increased standard deduction will offset the loss of the current $4,050 per person personal exemption for dependents. While the Framework does not increase the amount of the refundable Child Tax Credit, it does expand it so that people with higher incomes can take advantage of the credit.
|Work, Education, and Retirement
✔Retains tax benefits that encourage work, higher education, and retirement security, without specifying specific reform measures.
Our Analysis: Though President Trump’s tax plan and the 2016 House GOP tax blueprint previously maintained current incentives for retirement, in recent weeks the tax-writing committees have been looking at a partial “Rothification” approach – taxing retirement savings upfront – as a pay-for. The absence of this provision is significant and indicates that the GOP is either yet to reach a consensus on this issue or does not want to announce this provision at this juncture so as to prevent industry pushback.
✔ Repeals the estate tax and the generation-skipping transfer tax
Our Analysis: The final bill will likely call for a reduction of the estate tax, not a full repeal.
Tax Rules Get Honorable Mention. Although the administration’s April tax reform outline did not address existing tax rules, the Framework, surprisingly, offers two sentences on the need to modernize the rules that govern the tax treatment of certain industries and sectors. Without providing specifics, the Framework articulates the tax writers’ intention to update these rules to minimize tax avoidance.
The Things They Left Behind. Unlike the House GOP tax reform blueprint and the House FY 2018 budget resolution, the Framework makes no mention of revenue neutrality as a goal of comprehensive tax reform. This may be an indication that the GOP is backing away from revenue-neutral tax reform given the reality of how difficult it will be to find enough offsets. Interestingly, the Senate’s FY 2018 budget resolution contains reconciliation language allowing the Senate Finance Committee to deliver up $1.5 trillion in tax cuts even if that means increasing the deficit. Ways and Means Chairman Kevin Brady (R-TX) has recently conceded that some provisions in the tax reform legislation may have to be temporary.
In addition to leaving out talks of revenue neutrality, the Framework is also silent on the following topics:
- Obamacare Taxes. The Framework makes no mention of the 3.8% net investment income tax or the additional 0.9% Medicare tax — nor does it give any indication that the tax-writing committees are planning to address healthcare taxes in the forthcoming tax bill.
- State and Local Tax Deduction. The Framework does not explicitly eliminate the state and local tax (SALT) deduction, despite statements from ranking GOP officials hinting that this tax preference would be removed. This shows that lawmakers from hard-hit states — California, New York, New Jersey, Illinois, Texas, and Pennsylvania — continue to fiercely oppose the removal of the SALT deduction. This also indicates that the GOP is still struggling to agree on tax reform pay-fors.
- Carried Interest. Despite President Trump’s previous calls on the campaign trail to end the preferential tax treatment of carried interest, the Framework remains silent on the topic because members of the Big Six have yet to come to an agreement on whether to modify or repeal it.
Happy New Fiscal Year. Congress is ushering in the 2018 fiscal year with House and Senate action this week on the FY 2018 budget resolutions. After the ultra-conservative House Freedom Caucus threw its support behind the Framework, House GOP leaders are finally ready to take a vote on their budget resolution (H.Con.Res. 71). As a refresher, the House budget sets discretionary spending at $1.1 trillion and balances the budget within 10 years via a combination of spending cuts and projected economic growth. Most importantly, the House budget contains reconciliation instructions for 11 committees to produce at least $203 billion in mandatory savings and reforms. Specifically, the House Ways and Means Committee will use those instructions to pursue deficit-neutral tax reform. Below is a review of the House reconciliation instructions by committee:
With the House Freedom Caucus on board, the House is expected to pass its budget this week. Meanwhile, the Senate Budget Committee is set to hold a two-day markup for its own budget resolution, which was unveiled on Sept. 29. The Senate budget contains reconciliation language that would allow the Senate Finance Committee to deliver up to $1.5 trillion in tax cuts, and it directs the Senate Energy Committee to produce $1 billion in savings. The energy panel is expected to use the instructions to end the drilling ban in the Arctic National Wildlife Refuge. The Senate Budget Committee is expected to approve its budget by the end of the week, and the full Senate will likely take up the resolution during the week of Oct. 16.
According to Ways and Means Chairman Kevin Brady, a committee markup of the tax reform bill will take place only after the budget process is completed. Given the differences between the House and Senate budget resolutions, tax policy watchers may have to wait until November to see an actual bill out of Ways and Means.
Market Stabilization Encore. Senate negotiators are still trying to craft a bipartisan Obamacare market stabilization bill. The general blueprint being negotiated by Senate HELP Committee Chairman Lamar Alexander (R-TN) and Ranking Member Patty Murray (D-WA) has not changed significantly since discussions ceased two weeks ago, when GOP leadership decided to pursue partisan legislation to repeal Obamacare. The bipartisan deal would still include the following:
- Fund the cost-sharing reduction (CSR) subsidies that reduce out-of-pocket (OOP) costs for two years.
- Make “copper” plans available for people those over the age of 29
- Allow for increased state flexibility on an existing Obamacare Section 1332 state innovation waivers — essential health benefit (EHB) protections are likely to remain the same as under current law.
According to GOP staffers, a deal is far from final, though they hope to release something by the end of this week.
Average Domestic Airfare, $352. Resignation After Private Jet Scandal, Priceless. On Sept. 29, Dr. Tom Price resigned from his position as secretary of the Department of Health and Human Services (HHS) due to a controversy involving his use of chartered flights. Don Wright, the current Deputy Assistant Secretary for Health, Director Office of Disease Prevention and Health Promotion, will be replacing Price temporarily as acting secretary. HHS is now on its fourth secretary in just eight months (Sylvia Mathews Burwell, Norris Cochran, Price, and Don Wright.) It remains unclear whether the Trump administration will name a permanent replacement for Price before the end of the year.
The departure of Price leaves the agency’s agenda in flux. Prior to leaving HHS, Price was working on a “Reimagine HHS Initiative,” a massive agency-wide reorganization effort. Price was also laser-focused the opioid crisis and restructuring the bundled payments program. It is unclear whether the acting secretary or his permanent replacement will continue these priorities.
The following is a list of candidates the administration is rumored to be considering to replace Price:
- Seema Verma. Verma is the head of the Centers for Medicare and Medicaid Services (CMS). A close ally of Vice President Mike Pence, Verma helped design the waiver used by Indiana to accept a more conservative version of the Affordable Care Act's Medicaid expansion. During the GOP’s repeal-and-replace efforts, Verma helped explain the specifics of various plans to Republican lawmakers. Additionally, she was confirmed by the Senate for her current position by a 55-43 vote. Verma appears to be a frontrunner for the position.
- Scott Gottlieb. Gottlieb is currently the commissioner of the Food and Drug Administration (FDA). Gottlieb has extensive experience in the healthcare space. As a medical doctor, he has taken a strong stance on fighting the opioid epidemic and speeding the approval process for generic drugs. Gottlieb previous worked at CMS on the implementation of the Medicare drug benefit under President George W. Bush.
- Don Wright. Wright has been named acting secretary of HHS following Price's resignation. Wright is expected to remain in this role for some time, and could potentially replace Price permanently. Wright was previously deputy assistant secretary for health and the director of the Office of Disease Prevention and Health Promotion. He has a 10-year career in the federal government.
- Bobby Jindal. Former Louisiana governor is another potential pick to replace Price. However, statements he made against President Trump during the Republican primaries may rule him out as a viable candidate.
- Sen. John Barrasso. Barrasso is a doctor who is perceived by Trump to be one of the strongest voices on the Hill to repeal and replace Obamacare. However, it is unlikely that he is a frontrunner for the position and has indicated that he is not interested in the position.
Oversight Subcommittee Announces Hearing on IRS Information Technology Modernization Efforts. House Ways and Means Oversight Subcommittee Chairman Vern Buchanan (R-FL) announced a hearing entitled “IRS Reform: Challenges to Modernizing IT Infrastructure” for Oct. 4 at 10:00 AM. Members will examine the current state of the agency’s information technology (IT) systems, the challenges the IRS faces as it seeks to modernize its IT infrastructure, and areas where the IRS could further improve its efforts.
This hearing was prompted, in part, by the number of legacy IT systems the agency maintains, some of which date back to the 1960s. In Fiscal Year 2016, the agency spent nearly $2.7 billion on IT, 70 percent of which was spent on the operations and maintenance of existing IT systems. The remaining 30 percent was spent on development, modernization, and enhancement efforts. The IRS anticipates the percentage spent on operations and maintenance will increase to 86 percent of the IT budget for FY 2018, leaving little room for development and modernization efforts. The agency’s watchdogs, including Treasury Inspector General for Tax Administration (TIGTA) and the Government Accountability Office (GAO), have raised concerns about the IRS’s technological systems and its failure to sufficiently invest in new and more efficient systems.
Additionally, reports that the agency’s inadequate technological systems are hindering taxpayer experience and creating major inefficiencies have also prompted the subcommittee to hold this hearing.
Lawmakers Introduce Bipartisan Income Verification Legislation. On Sept. 28, Rep. Patrick McHenry (R, NC), the vice chairman of the House Financial Services Committee and Rep. Earl Blumenauer (D-OR), a senior member of the House Ways and Means Committee, and Sen. Cory Booker (D-NJ) introduced the IRS Data Verification Modernization Act of 2017. This bill will require the IRS to automate the Income Verification Express Services (IVES) process by creating an Application Programming Interface (API) that will allow small businesses and consumers to access accurate credit assessments more efficiently.
The introduction of the legislation is, in part, a response to the Equifax data breach. The IRS currently provides a similar service based on fax-image data. Lenders rely on the system to verify a borrower’s income. However, the system has a history of crashing and encountering other technical difficulties.
The API would allow third parties to access the information faster and in a more secure way since the IRS would be able to control and distribute it more quickly than the current system.
President Donald Trump’s reaction to the loss of Sen. Luther Strange (R-AL) in the Sept. 26 Republican Senate primary:
- Sens. Claire McCaskill (D-MO) and David Perdue (R-GA) introduced a bipartisan bill that would ease the Federal Reserve’s regulations on regional banks. Under the measure, banks with over $50 billion in assets but are not designated as G-SIBs would be exempt from several Dodd-Frank era rules, if the Federal Reserve decides the institution does not pose a systemic risk.
IN THE QUEUE
Senate Banking Committee
Full committee hearing on “Wells Fargo: One Year Later.”
Senate Finance Committee
Full committee hearing on international tax reform.
Joint Economic Committee
Hearing on tax reform and how it can revive American Entrepreneurship.
House Energy and Commerce Committee
Subcommittee hearing on “Oversight of the Equifax Data Breach: Answers for Consumers.”
House Financial Services Committee
Full committee hearing on “Sustainable Housing Finance: An Update from the Director of the FHFA.”
Senate Budget Committee
Markup of the FY 2018 budget resolution, Oct. 4-5.
Senate Judiciary Committee
Subcommittee hearing on “Equifax: Continuing to Monitor Data-Broker Cybersecurity.”
Senate Banking Hearing
Full committee hearing to examine the Equifax cybersecurity breach.
House Ways and Means Committee
Oversight Subcommittee hearing on the IRS’s IT modernization efforts.
House Financial Services Committee
Full committee hearing on the oversight of the SEC.
House Small Business Committee
Hearing on "Small Business Tax Reform: Modernizing the Code for the Nation's Job Creators," focusing on H.R. 3717 (115), the "Small Business Owners' Tax Simplification Act of 2017."
Senate Finance Committee
Hearing to consider the nomination of Jeffrey Gerrish to be a deputy USTR; Gregory Doud to be chief agriculture negotiator; and Jason Kearns to be a member of the US International Trade Commission.
House Financial Services Committee
Full committee on “Examining the Equifax Data Breach.”
Discussion with former Federal Reserve Governor Daniel Tarullo
The Daily 202 with OMB Director Mick Mulvaney. The one-on-one talk will cover tax reform and deregulation.
Committee for a Responsible Federal Budget
Discussion on “Paying for Tax Reform.” This event will be held at 2020 Rayburn.
Tax Policy Center
Distinguished Speaker Series with Kevin Hassett, Chairman of the Council of Economic Advisers – topics include fiscal outlook for the U.S. and the prospects for tax reform.
Discussion on the future of FINRA with President and CEO Robert Cook.
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