On Tuesday morning, Treasury Secretary Jack Lew will appear before the House Ways and Means Committee to discuss President Barack Obama’s budget for the 2016 fiscal year. One policy sure to be a major topic of discussion: corporate tax reform. The hearing will give us our first look to see if corporate tax reform is really possible in the 114th Congress.
Paul Ryan, the chair of the House Ways and Means Committee, offered a sneak peak of his position on NBC’s “Meet the Press” Sunday morning. “We really believe that we should reform the entire tax code for all people,” he said. “The question is, which I don't know the answer to: Is there common ground on aspects of tax reform that we think can help grow the economy? For us, small businesses have to be a part of that puzzle.”
Ryan has frequently argued that reducing the marginal tax rates for small businesses is a vital part of tax reform, since 97 percent of small businesses pay taxes at the individual rate. It’s a fair point, but it’s almost impossible to imagine Democrats and Republicans agreeing on a plan for individual tax reform. Ryan suggested as much in other comments on “Meet the Press.”
Corporate tax reform, on the other hand, is a more likely possibility. Ryan’s comments prompt two questions. First, would he object to any corporate tax reform deal that doesn’t include small businesses? That’s certainly what he has indicated. Second, would President Obama accept a corporate tax reform deal that includes small businesses? If the answers to those questions are yes and no—which they very well might be—then corporate tax reform has no chance. But if either Ryan or Obama is flexible in their positions, then a corporate tax reform deal is possible. There are four key parts of corporate tax reform:
Lowering the statutory corporate tax rate
They both want to lower the statutory corporate rate from 35 percent. Obama has proposed lowering it to 28 percent and 25 percent for manufacturers. Republicans have traditionally wanted to lower it to 25 percent.
Closing tax loopholes
To make up the lost revenue, both sides want to close corporate tax loopholes. Deciding what loopholes to close is always one of the hardest parts of tax reform. Everyone supports broadening the base and closing certain tax break in principle. But every tax break has a favored constituency that will vehemently defend it. For a perfect example of this, see Obama’s quick reversal on his plan to eliminate a tax break for college savings for the upper middle class.
Taxing foreign income
If Obama and Republicans reach an agreement on closing tax breaks, they would then have to agree on how to tax foreign income. Currently, foreign subsidiaries of U.S. corporations must pay taxes at the 35 percent statutory rate, with a credit for any taxes paid to the foreign country. For example, if a company pays taxes at a 10 percent rate to a foreign country, it will have to pay a 25 percent rate when it repatriates that money to the U.S. But that only happens when it repatriates it. That has caused U.S. companies to amass nearly $2 trillion of profits outside of the United States. Any corporate tax reform will have to address that $2 trillion and international taxation.
In his 2016 budget, Obama suggests a one-time, mandatory tax of 14 percent on that $2 trillion, money earmarked for infrastructure investment. He would then impose a minimum 19 percent tax rate on all foreign income, keeping the credit for taxes paid to foreign countries. That tax will be imposed whether or not that income is repatriated, eliminating the incentive for U.S. companies to stash profits abroad.
Republicans generally want to move to a territorial tax system which only taxes income in the country where it originated. Under such a system, foreign profits are taxed in the foreign country—and not in the United States. It might seem hard to see where Obama and Republicans could reach a compromise here, but it’s also hard to imagine that Republicans are OK with companies using complex strategies to avoid the corporate tax. Microsoft, for instance, is currently holding $92.9 billion abroad and would have to pay $29.6 billion in taxes if they repatriated it—a 31.9 percent rate. That’s the same as saying Microsoft managed to pay just a 3.1 percent tax rate on its foreign income (or at least the income it hasn’t repatriated yet). In a territorial tax system, they could bring that income back to the U.S. without paying any other taxes. Do Republicans really support that? I’m skeptical.
Finally, there is the question of revenue neutrality. Republicans want it to be revenue neutral. Obama wants it to be revenue neutral in the long-run, with a one-time gain of $238 billion to use for infrastructure spending. Republicans will object to that provision. But that’s a much smaller disagreement than if Democrats were demanding greater long-term revenue.
When Lew testifies before Congress Tuesday, he’ll likely face an onslaught of criticism from Republicans, some of it not based in fact. Ryan offered a glimpse of that in his “Meet the Press” appearance. He criticized Obama’s plan to eliminate a tax advantage for rich heirs, arguing that it would prevent families from passing down small businesses from one generation to the next. If he had read the White House fact sheet on the proposal, he’d know that’s wrong. “No tax would be due on inherited small, family-owned and operated businesses—unless and until the business was sold,” it says. If Ryan is going to mischaracterize Obama’s proposals, that will make it even harder to reach a compromise on tax reform.
So, is corporate tax reform possible? Technically, yes. In each of the four areas I just dissected, Republicans and Obama could find common ground. But the odds of them finding common ground on all four areas are exceedingly small. We’ll have a better idea of that after Lew’s hearing Tuesday.