May 2, 2017

Tax Policy Update


A Whole Lot of Nothing. Remember those days in college when you used to mess with the font size and margins to stretch out your essays so that they hit a certain page requirement?

That’s sort of the deal with President Donald Trump’s tax reform plan released on April 26. The one-page document was reportedly typed up on the eve of the release. To call it a tax plan might be overzealous — absent were the details that tax policy observers and lawmakers have been itching to see (e.g., repatriation rate, border adjustment tax, etc.).

If the tax plan looks familiar, that’s because it’s a regurgitation of what Trump proposed on campaign trail and what’s in the House GOP tax reform blueprint, albeit with some slight changes.

Amid all the ridicule for the anti-climactic rollout, Treasury Secretary Steven Mnuchin has defended the one-page proposal, saying that “the only reason we didn’t put out all the details is because we’re determined to work with the House and the Senate to turn this into a bill — and that’s the reason why we didn’t put out the details.”



A Whole Lot of Nothing (cont’d). After having kept the public in suspense since February, the White House has finally unveiled its own tax reform plan on April 26. To the surprise of no one, Trump’s plan is sparse on details. The one pager is a mere outline of high-level principles for tax reform and a plan of action for the administration and congressional Republicans.

To the disappointment of tax nerds in Washington, the plan contains no mention of the controversial border adjustment tax (“BAT”) or any other form of border tax, immediate expensing, and interest expense deductibility.

The talking point circulating amongst Republican leaders at the moment is that Trump’s tax plan is 80 percent aligned with the House GOP tax blueprint. So let’s take a look at how the president’s tax plan compares with the House blueprint:

Proposed Tax Changes on the Business Side

Trump Tax Plan

House GOP Blueprint

  • End worldwide system of taxation
  • Shift to a territorial system
  • End worldwide system of taxation
  • Shift to a territorial system
  • Deemed repatriation of profits held offshore – no details on rate
  • Deemed repatriation of profits held offshore – one-time rate of 8.75%
  • Corporate/Pass-through Tax Rate: 15%
  • Corporate Tax Rate: 20%
  • Pass-through Tax Rate: 25%
  • Eliminate most credits and deductions.
  • Eliminate most credits and deductions.
  • Keep R&D credit (potential modifications)
  • No details on interest deductibility
  • No details on immediate expensing
  • Eliminate net interest deduction
  • Allow for full and immediate expensing
  • Eliminate the Alternative Minimum Tax
  • Eliminate the Alternative Minimum Tax
  • No border adjustment tax
  • No details on border adjustment tax
  • Impose a border adjustment tax


Proposed Tax Changes on the Individual Side

Trump Tax Plan

House GOP Blueprint

  • Individual tax brackets: 10%, 25%, 35%
  • Individual tax brackets: 12%, 25%, 33%
  • 20% capital gains rate
  • Eliminate the 3.8% net investment tax
  • 20% capital gains rate
  • Eliminate the 3.8% net investment tax
  • Provide for a 50% deduction for capital gains, dividends, and interest income
  • Eliminate the 3.8% net investment tax
  • Doubles the Standard Deduction
  • Nearly doubles the Standard Deduction

Eliminate most credits and deductions. Keep the following:

  • Charitable giving deduction
  • Mortgage interest deduction
  • Unspecified tax breaks for child and dependent care expenses

Eliminate most credits and deductions. Keep the following:

  • Child Tax Credit (with increase)
  • EITC
  • Mortgage interest deduction
  • Charitable giving deduction
  • Unspecified incentives for higher education and retirement
  • Repeal estate tax
  • Repeal estate tax
  • Eliminate the Alternative Minimum Tax
  • Eliminate the Alternative Minimum Tax

“We will get back to you with…with definitive answers on all these details.”
This is what NEC Director Gary Cohn said as he struggled to answer some of the reporters’ questions at the tax reform press briefing last week. “You’re going into very micro details on some of these,” Cohn snapped at one point. But details are critical at this juncture, especially if the administration and GOP lawmakers want to enact comprehensive tax reform by the end of the year.

Last week’s tax plan rollout did little to address some of the open questions and concerns with the GOP’s tax reform efforts. For example, the call for a 15 percent corporate tax rate has prompted deficit-conscious folks to wonder how such a dramatic rate reduction will be paid for. By the Tax Policy Center’s estimate, a 15 percent rate coupled with the elimination of the AMT would cost at least $3 trillion.

To be sure, no one seriously thinks the 15 percent corporate rate will be enacted. The administration, itself, conceded that the 15 percent rate is only the starting point for negotiations. Most tax policy observers would say that the corporate tax rate will fall somewhere between 20-28 percent.

The issue of offsets exposes one of the key disagreements between the administration and congressional Republicans on tax reform. Since the release of Trump’s tax plan, Republican leaders have been telling reporters that the White House and Republican tax writers agree on roughly 80 percent of the key issues. So what are the issues that make up the 20 percent?

The disagreement over the need for pay-fors has also led to disagreements on revenue neutrality and permanency between the administration and congressional Republicans. Treasury Secretary Mnuchin has argued that the proposed tax cuts will pay for themselves in the long run through the economic growth that is expected to be generated from the rate reductions. This line of hopeful thinking on tax cuts is contrary to what the Congressional Budget Office and other outside budget experts believe. Sure, it’s plausible that economic growth will pay for some of the proposed tax cuts but definitely not all of them.

The potential cost of the administration’s tax plan has some Republicans like Rep. Tom Reed (R-NY) worried about the plan’s impact on the deficit. A tax reform plan that increases the deficit would put Republicans in a tough spot when it comes time to vote on a bill and threatens the permanency of any rate reductions. As a refresher, the GOP’s plan to use the budget reconciliation process to pass tax reform means that the legislation cannot increase the deficit outside the 10-year budget window.

Unlike Mnuchin, House Speaker Paul Ryan and House Ways and Means Chairman Kevin Brady remain committed to revenue-neutral tax reform. “The greatest growth for the greatest years comes about when tax reform is bold, when it balances in the budget, and when it’s […] permanent,” Brady said.

Ryan and Brady’s commitment to revenue neutrality makes it hard for them to completely give up on the border adjustment tax — a provision that could raise an estimated $1 trillion — which has been left out of Trump’s tax plan. Its absence has led Sen. John Cornyn to suspect that the BAT is dead. Ryan simply conceded that the provision needs to be modified.

Getting Carried Away. While Trump’s tax plan does not explicitly call for the repeal of carried interest, White House Chief of Staff Reince Priebus confirmed in an interview that the president does want to get rid of it.

Investment managers are generally compensated under a “2-and-20” fee structure – a 2 percent fee for assets under management, which is currently taxed at the ordinary rate and a 20 percent fee for profits interest (the carried interest), which is currently taxed at the capital gains rate.

Eliminating the current capital gains treatment of carried interest might actually represent a tax cut for some investment managers, unless proper guardrails are in place.

Consider this : Partnerships currently do not pay any federal income tax — rather, partners are allocated their share of the partnership profits and pay tax on those profits. Individual partners may be subject to a maximum rate of 39.6 percent on ordinary income, while paying 23.8 percent on capital gains and carried interest.

Trump has proposed to tax pass-through entities at a rate of 15 percent and to lower the maximum individual top rate from 39.6 percent to 35 percent. Trump’s tax plan would also eliminate the 3.8 percent net investment income tax and capital gains would be subject to a 20 percent rate.

Here’s the plot twist : A repeal of the carried interest tax break would mean that carried interest would no longer be subject to the 20 percent capital gains rate. But thanks to Trump’s proposed 15 percent pass-through rate, investment managers organized as partnerships (and those that would soon follow suit) would have carried interest subject to the pass-through rate of 15 percent. This would represent a tax cut without any caveats.

Interesting huh? However, Mnuchin did say at the tax reform plan briefing that the administration will “make sure that there are rules in place so that wealthy people can’t create pass-throughs and use that as a mechanism to avoid paying the tax rate that they should be on the personal side.”

Deal! Agreement on FY2017 Spending Bill. House and Senate negotiators have reached a deal on a $1.1 trillion omnibus spending package to fund the rest of fiscal year 2017. Of note, the spending deal does not include funding for the president’s border wall but does provide $1.5 billion towards border security. The spending measure steers clear of the controversial political issues that would have doomed the bill (e.g., Planned Parenthood, sanctuary cities, etc.).

In the package is also a $25 billion boost for defense spending and an additional $2 billion for the National Institute of Health. Funding for some agencies like the IRS and the SEC will remain the same. The IRS’s budget will be frozen at $11.2 billion and the SEC’s funding will remain at $1.6 billion.

Both the House and Senate are expected to pass the spending package by May 5, when last week’s short-term patch expires.

Tick Tock. The GOP is once again racing against the clock to repeal and replace Obamacare. With the House slated to go on recess again next week, Republicans are eager to hold a vote before they lose the momentum they picked up after the Freedom Caucus endorsed the latest version of the American Health Care Act (“AHCA”)

Last week, GOP leadership unveiled the text of the MacArthur-Meadows amendment, a compromise authored by the chair of the Freedom Caucus and one of the co-chairs of the Moderate Tuesday Group. For those who need a refresher, the amendment would permit states to waive Obamacare’s Essential Health Benefits (EHB) standards and community rating requirements, as long as the state is participating in a high-risk pool. The amendment would also allow states to receive automatic approval for waivers within 60 days as long as they attested that the waiver would lower premiums, increase enrollment, stabilize the market, stabilize premiums for people with pre-existing conditions, or increase the choice of health plans in the state.

Since releasing the text of the amendment, the GOP has been frantically counting votes to see if they have enough to pass the AHCA: Republicans will need to muster up 216 votes. Unfortunately, for the GOP, moderates and even some staunch conservatives are refusing to support the latest version of the bill.

For moderates, though the amendment preserves Obamacare's guarantee of coverage for people with preexisting conditions, it still allows states to relax the prohibition on insurers increasing premiums for sick people. To offset this risk, the bill includes a $130 billion fund to help lower premiums for people with preexisting conditions. However, various professional medical associations and industry groups note that high-risk pools intended to treat patients affected by these patients are underfunded by nearly $20 billion per year.

The GOP’s job has been made more difficult by President Trump who has promised affordable coverage “every bit as good on pre-existing conditions as Obamacare.” The latest alteration to the AHCA does not keep the president’s promise. Over the weekend, Trump admitted that the bill was not “in its final form.” Some have interpreted the president’s latest comments as reopening negotiations. Though prominent Republicans, including Rep. Patrick Meehan (R-PA), seemed skeptical that there will be any further changes to the bill. Meehan and 20 other representatives are currently planning to vote against the bill.

One defection in particular, Rep. Billy Long (R-MO), a long-time Trump ally, has been a major blow to the GOP. Long comes from a conservative district that voted for Trump, but he will not vote for his version of the AHCA— despite his previous support for earlier versions of the healthcare bill. Long recently indicated that affordable coverage for people with pre-existing conditions is one of the few things about Obamacare that should be preserved. Many in the GOP wonder if Long’s defection is a harbinger — if a red-state Republican can’t support this version of the AHCA, does the bill have any chance of passing?

GOP leaders remain hopeful, with rumors of a vote swirling around Capitol Hill. In an effort to whip votes, Vice President Mike Pence was on the Hill on Monday. House leaders have vowed to only move the AHCA once they can guarantee the 216 votes necessary for passage.

While the GOP is busy counting to 216, the exchanges continue to hemorrhage insurers, with companies like Aetna pulling out of all but four states. Democrats and insurance companies hoped for some certainty by securing funding for cost-sharing subsidies in the FY2017 omnibus spending bill. Cost-sharing subsidies help insurers cover low-income enrollees’ deductibles and co-pays. However, Democrats were ultimately unable to secure funding for these payments. Instead, the Trump Administration has promised to continue payments indefinitely, forcing insurers to rely on their word as the 2018 rate-setting deadlines loom ahead. For many insurers, this lack of certainty may cause them to exit the exchanges leaving millions uninsured.


Show Me the Money (or Not). Infrastructure investment advocates waited with great anticipation last week for the rollout of President Trump’s plan for tax reform, hoping to find some buried treasure in the one-page document released on April 26. While the plan did call for repatriation, there was no discussion of whether the revenue would be used for infrastructure investment — an idea that has previously been floated by Republicans and Democrats.

Trump Talks Gas Tax. Instead of rolling his plans for infrastructure investment into a tax reform proposal, President Trump hit the interview circuit this week and professed his “support” for a gas tax increase to pay for infrastructure projects. That position may have failed to make its way back to the White House because later that day, White House Press Secretary Sean Spicer claimed that his boss was not actually expressing support but rather expressing his consideration of a gas tax increase, which has been suggested to him by a group that supported the concept.

Secretary Chao Provides Greater Detail on Infrastructure Plan. While Trump is talking gas tax, Transportation Secretary Elaine Chao said the administration's pending infrastructure proposal could be paid for with "other programs such as, perhaps, the sale of government assets," through tax overhaul, or "allowing the private sector to invest in public infrastructure.” Regardless of how it’s paid for, the secretary also revealed that the plan would include $200 billion in direct federal funding and that details would be unveiled early this summer.


President Trump’s thoughts on the FY2017 spending package released by House and Senate negotiators:


Congressional Activity

Tuesday, 5/2

House Financial Services Committee
Full committee markup of the Financial CHOICE Act.

Senate Banking Committee
Full committee hearing: "Examining the U.S. -- EU Covered Agreements."

Agency Activity

Tuesday, 5/2

Federal Reserve
The Federal Open Market Committee (FOMC) holds a closed meeting, beginning at 9 a.m. The FOMC is the policy-making arm of the Federal Reserve, May 2-3.

Thursday, 5/4

Internal Revenue Service holds a meeting by teleconference of the Taxpayer Advocacy Panel Taxpayer Communications Project Committee on improving customer service at the Internal Revenue Service.

Other Activity

Wednesday, 5/3

American Enterprise Institute
AEI holds an event, “Hard lessons in education reform.”

Thursday, 5/4

Tax Council
Legislative luncheon discussion with special guest Rep. John Larson (D-CT).

National Economists Club
Luncheon discussion on “Currency Conflict and U.S. Trade Policy.”

Friday, 5/5

Brookings Institution
Discussion on "The Quest for Financial Stability a Decade After the Onset of the Global Financial Crisis.

Economic Club of Washington
Discussion with Adena Friedman, president and CEO of NASDAQ.