Global Tax Alert (News from Washington Council Ernst & Young) | 15 August 2013

US Tax reform: A status update

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A look at what to expect later this year as the US Congressional committees prepare to consider comprehensive tax reform legislation

Executive summary

Despite complex political dynamics and a fundamental partisan dispute over whether tax reform should be a vehicle to raise additional revenue, the chairmen of both congressional tax writing committees are moving forward on the issue of US tax reform and intend to bring reform bills up for committee consideration this fall. The prospect of House Ways and Means Committee Chairman Dave Camp (R-MI) and Senate Finance Committee Chairman Max Baucus (D-MT) unveiling comprehensive tax reform legislation and processing that legislation through their respective committees is significant. The process will require each committee to decide which current tax provisions will be retained, modified, or eliminated.

A “grand bargain” in conjunction with deadlines related to government funding and the debt limit (as well as revisiting the Budget Control Act sequester) provides the best opportunity to bridge this partisan dispute over whether reform should be revenue neutral or raise revenue.

Recognizing that, both chairmen have made clear that it is their intent to mark up legislation in the fall.

Laying the groundwork

In speaking about the timeframe for consideration of reform, both chairmen emphasize the groundwork they have laid in surveying other members. Chairman Camp has met with off-Committee House Republicans and Committee Democrats, and spent considerable time in recent months meeting with Committee Republicans. Chairman Baucus has said he has “had meetings with every single Senator about the Tax Code.” They also cite the combined roughly 50 hearings held between the two panels in this Congress and last. Both Committees also undertook separate but similar processes for examining specific issues under tax reform this past spring – Ways and Means through working groups and Finance through options papers and meetings.

The revenue issue

As was the case in the debt limit negotiations in summer 2011 and heading toward the fiscal cliff at the end of 2012, President Obama and Congressional Democrats insist that any large scale fiscal or tax reform package raise significant net revenue, from tax increases on higher income individuals and possibly corporations. Republicans are adamantly opposed to new net revenue. Senators have become even more entrenched in their positions, and the issue has flared among Senate and Finance Committee leaders.

Finance Committee leaders have had their own public disagreement over revenue. Chairman Baucus assured fellow Democrats during an early July caucus meeting that tax reform would result in additional revenue, prompting Senator Orin Hatch (R-UT) to announce that he and the Chairman had agreed to pursue a revenue-neutral tax reform plan.

In the House, Chairman Camp has stated clearly that tax reform will be revenue neutral. While some have said they would not prejudge the effort, Committee Democrats will likely oppose a bill that does not raise revenue. They could still be active in the markup. Democratic members also continue to doubt the feasibility of the Majority’s tax rate targets, particularly for individuals. On 31 July, they released Joint Committee on Taxation estimates of the revenue effects of lowering the top individual tax rate to 25% and the corporate tax rate to 25%, showing the reductions would cost approximately $5 trillion over the ten-year budget window.

The Administration’s view

President Obama has pushed for tax reform only intermittently, to the frustration of Republican lawmakers who contend that Presidential leadership is necessary to make tax reform a reality, as evidenced by President Reagan’s active role in the run-up to the Tax Reform Act of 1986. The President’s Framework for Business Tax Reform released by the Obama administration in February 2012 called for a 28% top statutory corporate tax rate, or 25% for manufacturers, and an unspecified minimum tax on foreign earnings. The President’s FY2014 budget released this past April for the first time set aside some revenue raising proposals from previous budgets for revenue-neutral business tax reform. The business tax reform reserve was estimated to raise only $95 billion over ten years – a fraction of the roughly $700 billion to $800 billion estimated cost of reducing the rate to 28%.

On 30 July, the President called for a plan consistent with the 2012 Framework but broke from the revenue-neutral principle the Administration had held for business tax reform in calling “one-time revenue” generated in the transition to a reformed system to be used to finance construction jobs through infrastructure investment and fund worker training.

Contrary to initial reports, Administration officials denied a repatriation tax associated with a switch to a territorial system was the source of the funding, although later said foreign earnings could be one source for the revenue, in addition to changes to the current system of accelerated depreciation and the last-in/first-out (LIFO) method of accounting.

Fiscal grand bargain

Regardless of whether a tax reform package ultimately raises revenue, it is likely to be swept into a larger fiscal package that will be negotiated in conjunction with deadlines this fall involving government funding and the debt limit, with the weight of those issues potentially providing momentum for a grand bargain to be enacted. On the one hand, tax reform could be used to raise revenue to contribute to deficit reduction or partial replacement of the sequester. Alternatively, a revenue-neutral bill would be viewed as a boost to the prospects for economic growth over the next few years.

With regard to government funding, Congress is unlikely to resolve differences in FY2014 appropriation bills prior to the start of fiscal year 1 October due to differences in how the sequester is addressed by the two parties. Senate appropriators are marking up bills with a total target of $1.058 trillion, reflected in President Obama’s FY2014 Budget and assuming the sequester will be replaced with a separate package of tax increases and spending cuts.

Their House counterparts are following the $966 billion spending target reflected in the Budget Resolution approved earlier this year by the House, which assumes sequestration will go forward.

With this government funding issue unresolved, a “continuing resolution” to extend funding at current levels for at least several months is likely to be pursued in order to avoid a government shutdown, setting up an omnibus appropriations process in the fall that could be combined with some approach to win Republican support for an increase in the debt limit. The increase will be necessary sometime in October or November (or possibly later). The Administration maintains that it is the job of Congress to increase the limit and to do so without causing a crisis in financial markets, while Congressional Republicans have said they will not agree to an increase without accompanying spending cuts. The debt limit and appropriations process combined will put significant pressure on a fiscal deal this fall. It remains to be seen whether a tax reform bill could be used as a means to help make a deal happen.

What to expect in the near term

House. Ways and Means Chairman Camp has already laid down some markers on tax reform through three discussion drafts: the October 2011 international tax discussion draft, which outlined moving the United States closer to a territorial system, including three much-talked about options for addressing concerns about base erosion; and drafts on the tax treatment of financial products and reforming the tax rules affecting small businesses. No additional isolated reform elements are expected to be issued by the Ways and Means Committee, with the next release likely to be H.R. 1, the bill number set aside for comprehensive tax reform legislation by House GOP leadership and presumably the starting point for a markup. Camp will likely unveil the bill after discussions with Republican members of his Committee when they return to Washington in September.

Senate. Senate Finance Committee Chairman Baucus has not released any draft elements related to tax reform. Unlike the House Ways and Means Committee effort – in which ranking Democrat Sandy Levin (D-MI) is not playing a role in Chairman Camp’s formulation of a reform plan – Chairman Baucus and ranking Republican Hatch have been in cooperation on tax reform thus far. That cooperation has already been tested on the issue of revenue, and it is unclear how Baucus and Hatch will remain aligned and see a bipartisan bill reported out of the Committee unless the revenue issue is resolved.

Senate Finance Committee staff have said tax reform drafts on specific issues will likely be issued following the August recess. The goal would be to get feedback from Senators and stakeholders and keep the tax reform process in the Senate moving forward until a Committee markup becomes feasible. Taxation of foreign earnings could be one of the issues previewed if isolated drafts are circulated, given the business community’s strong interest in the subject and the highly technical nature of the issue. The Finance Committee has traditionally marked up legislation “in concept” rather than working from and then amending statutory language; it remains to be seen whether the tradition will be followed.

For additional information with respect to this Alert, please contact the following:

Washington Council Ernst & Young, Washington DC
  • Gary Gasper
    +1 202 467 4302
    gary.gasper@wc.ey.com
  • Nick Giordano
    202 467 4316
    nick.giordano@wc.ey.com

EYG no. CM3733