In our last article we looked at the distributional effects of the Former House Ways and Means Chairman Dave Camp’s tax reform plan, and noted that there was approximately $580 billion in individual income tax cuts proposed. The Camp Plan proposes to offset these cuts by a corresponding increase in tax revenues generated from businesses. These revenue raisers would primarily come from so-called “base-broadening” measures that are designed to eliminate or reduce deductions or credits, functioning to broaden the scope of the tax base. While base broadening is a staple of most tax reform discussions, few explore the specific items that must be sacrificed in sufficient detail. An analysis of the deductions and credits that would be affected under the Camp Plan will provide context on the real cost of its tax reform vision.
Individual and Business Tax Distinctions under the JCT Score
First, it should be noted that the division of cuts and revenue raisers in the Camp Plan is not a simple showing of business versus individual targets. This is a result of the Joint Committee on Taxation (JCT) approach to score the bill. Part of the tax cuts on the individual side would be accomplished by lowering the individual income tax rate, which also lowers the rate and tax that pass-through businesses pay. This is especially true for manufacturing businesses that would not be subject to the Camp Plan’s additional 10 percent surcharge. Hence, the nexus of cuts that ostensibly benefit individuals will reach businesses as well. Likewise, certain business tax increases are not attributed to individuals, even as such increases are borne by individual owners of pass-through entities. With these overlaps duly noted, we will maintain the conventions articulated by the JCT.
Base Broadeners to Cover Individual Cuts
Perhaps the base-broadening change with the widest effect on business taxation under the Camp Plan would be for depreciation deductions. The Camp Plan calls for a switch from MACRS depreciation to a system that more closely resembles the ADS depreciation method. This would extend the recovery period for most assets, drastically reducing the yearly deductions available to business that hold depreciable assets. An election would be made available to claim additional depreciation to account for the effects of inflation; however, the net result would still be higher taxable income for businesses and higher tax revenue for the government. How much higher? The JCT estimates that it would raise $270 billion over 10 years, or nearly half of the cost of the individual income tax cuts.
Other changes proposed under the Camp Plan that would have widespread consequences are those related to the treatment of Research and Development (R&D) expenses and certain advertising expenses. The Camp Plan would require five-year amortization of R&D costs instead of the immediately deductible treatment under current law. Furthermore, the full deduction for certain advertising expenses under current law would be curtailed to 50 percent in the first year, with the remainder being spread out over 10 years. The JCT projected that these two provisions would generate an additional $362 billion in tax revenues. Taken together with the proposed depreciation changes, these additional revenues would finance the revenue losses stemming from the individual income tax changes in the Camp Plan.
Other Business Tax Cuts and Offsets
With these proposals for business tax increases under the Camp Plan comes other large-scale cuts that will also benefit certain businesses. One such proposed cut would be moving to a flat tax system with a 25 percent rate, which for high-income businesses would result in a cut from the current 35 percent rate. The additional 2.3 percent tax on the sale of certain medical devices also would be repealed. Combined with other business tax cuts, these proposals mean that the Camp Plan will require an estimated $819 billion in additional tax revenue from other sources in order to be deficit neutral. This would be accomplished with further base-broadening measures on businesses, and the establishment of a new tax on large financial institutions.
Among the additional base-broadening measures is a proposal to curtail usage of the net operating loss (NOL) deduction, and a proposal to eliminate the tax benefits from like-kind exchanges. Under the Camp Plan, a corporation’s NOL deduction would be limited to 90 percent of its taxable income, similar to existing rules for alternative minimum tax (AMT) purposes. The favorable tax treatment of like-kind exchanges essentially would be eliminated immediately, with a limited exception for transactions under binding written contracts.
Another such measure that would have dramatic effects on certain businesses would be a repeal of the last-in, first-out (LIFO) inventory rules, as well as the lower of cost or market (LCM) inventory provisions. Instead, businesses would be required to use the first-in, first-out (FIFO) method. Taxpayers who currently use the LIFO or LCM methods could elect to transition to FIFO over a four-year period, with transitional effects (generally additional income) captured 10 percent in the first year, 15 percent in the second year, 25 percent in the third year, and 50 percent in the final year. To accommodate certain small businesses (generally corporations or partnerships with 100 or fewer shareholders or partners), only 20 percent (28 percent in the case of corporations) of the additional income resulting from the change to FIFO would be required to be recognized.
Furthermore, the Camp Plan proposes a change from the current worldwide tax system to a territorial system. Unlike the Border Adjustment Tax championed by House Speaker Paul Ryan (R-WI) and House Ways and Means Committee Chairman Kevin Brady (R-TX), the Camp Plan envisions three elements of its territorial tax design. The first would be a retroactive 8.75 percent tax on profits held overseas in cash and cash equivalents, with a 3.5 percent rate on profits reinvested in non-cash assets. The second would provide a 95 percent exemption for all foreign income earned from active business, together with exemptions for certain transactions between foreign subsidiaries. The final element would call for the creation of a special 15 percent rate applicable to certain intangible income (such as royalties). This rate would apply to qualifying income earned domestically or abroad, and is designed to spur innovation.
Turning to the tax on financial institutions, the Camp Plan proposes a new bank excise tax on very large financial institutions. A .035 percent excise tax rate would be imposed on the value of assets in excess of $500 billion held by financial institutions. The bank excise tax would be targeted at “important” financial institutions, thereby limiting its footprint, but would still generate a substantial amount of tax revenue to offset the other business tax cuts proposed under the Camp Plan. Separately, but in a similar vein, corporations would no longer be allowed to deduct the value of bonuses to executives that are paid in stock.
These changes along with some other additional technical adjustments, changes to the taxation of exempt organizations, and other adjustments, including the elimination of many of the energy related credits, would raise the additional $819 billion in taxes required to pay for the other corporate tax cuts under the Camp Plan.
Takeaway
As is evident from the Camp Plan’s proposals, the sheer scope of all the adjustments it endorses is a necessary extreme to pay for something that rises to the level of tax reform. The Camp Plan confronts many of the hard choices that will face the current Administration and Congress, as they each contemplate their own tax reform ideals. Any revival of the Camp Plan would likely face opposition from almost all directions, similar to the widespread opposition involving the Border Adjustment Tax. Thus, it may be that political will underscores the most significant element of successful tax reform, as opposed to any specific tax policy proposal.
For more information on the Camp Plan’s relevance to the current tax reform agenda, please contact your local CBIZ MHM tax professional.
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