Making Tax Reform Deficit Neutral Without a Border Adjustment Tax: Part 2 (article)
As tax reform discussions continue in Congress, much of the debate centers around a means to pay for the cost of proposed tax cuts. In Part I of our series on proposals to generate revenue as part of a tax reform plan, we discussed tariffs and reciprocal taxes, a national profits tax, and a value added tax (VAT). Continuing with our study of potential revenue raisers, in Part II we analyze proposals for a carbon tax and a repatriation tax. But first, we begin with a proposal for corporate integration, which isn't really a revenue generating proposal, but can be viewed as a way to achieve many of the goals mentioned in President Trump's tax outline.
Who is proposing it? Senate Finance Committee
What is it? A proposal to eliminate the current double tax system for C corporations
How does it work? The goal of corporate integration is a more modest change to the tax code than the Border Adjusted Tax (BAT) or any other shift to a territorial tax system. Corporate integration could occur by either eliminating the corporate-level tax while preserving the tax on corporate distributions at the individual level, or by exempting from individual tax a shareholder's corporate distributions. Either of these would result in "full integration." There are also proposals that call for partial integration, which vary the level of tax exemption for either party. Proponents of corporate integration argue that the current system of double taxation discourages economic growth by inhibiting market choices over forms of business and sources of capital, and that integration would remove these constraints while reducing the impetus for multinational corporations to divert earnings overseas. A 2014 report from the staff of the Senate Finance Committee also points out that the current system promotes debt over equity, because interest repayments are deductible while dividend distributions are not.
How much money will it raise? Without eliminating other deductions or credits, most corporate integration proposals would actually decrease revenue, with Congressional Budget Office (CBO) estimates being anywhere from 8% to 102% in reductions from current corporate tax revenue levels. Instead of viewing corporate integration as a way to pay for tax cuts, it is probably better viewed as an alternative compromise in tax reform to achieve lower rates and tax simplification.
Concerns: Corporations that do not pay dividends do not favor integration. Also, projected losses in tax revenues may prevent full integration from being economically feasible, even with a broader tax base. Per the CBO estimates, "most proposals would not have significant effects on the international allocation of capital, repatriation, profit-shifting and inversions."
Who is proposing it? No one, but like the VAT that was discussed in Part I of our series, a Washington Post report indicated that the White House was considering such a tax. The White House quickly disputed the report.
What is it? A tax on the emission of carbon dioxide (CO2), from which the tax gets its name
How does it work? A carbon tax is based upon the amount of CO2 produced through the use of CO2 producing fuel, with the tax proportionate to such use. The carbon tax is framed as an alternative to a "cap and trade system." Under the cap and trade system, emitters of greenhouse gasses are assigned a set amount of emissions that they are allowed to produce. A tax is based on the amount by which emissions exceed this cap, with unused portions made available for sale to other companies. Proponents of a carbon tax argue that a carbon tax is simpler, can be implemented more quickly, and is better at discouraging pollution.
How much money will it raise? As proposed, it will not raise revenues due to rebates, tax cuts, or dividend distributions. However, the amount of rebates, tax cuts, or dividend distributions could be reduced or eliminated, which would in turn raise substantial amounts of tax revenue. With these changes, a CBO report predicted it could raise $977 billion over a ten-year period.
Concerns: Like other consumption taxes, the carbon tax is denounced as being regressive, since the tax arguably will be passed on to consumers disproportionately in the lower income class. Such consumers would then be dependent on a corresponding rebate, tax cut, or dividend to avoid higher energy costs, where critics claim that such incentives may not materialize with governmental tendencies to absorb the tax revenue generated. Critics also argue that the tax will reduce economic output.
Who is proposing it? President Trump, and it is also part of the House Blueprint.
What is it? A one-time tax on profits held overseas by U.S. multinational firms
How does it work? Under the President's Tax Outline, foreign earnings held as assets overseas that remain untaxed for most businesses would be subject to a one-time deemed repatriation tax. While the outline does not specify the tax rate, the President's campaign set out a 10% rate. The House Blueprint proposes a similar measure, but with varying tax rates for cash and cash equivalents and for other investments. Under the House Blueprint, the rate for cash and cash equivalents would be set at 8.75%, while the rate for other investments would be 3.5% and payable in installments over eight years. It should be noted that there is no requirement that current proposals utilize a lower rate. It would be lawful to impose a deemed repatriation tax at normal statutory tax rates.
How much money will it raise? Estimates show that approximately 2.5 trillion dollars of tax-deferred earnings is held overseas, which would generate 2.5 billion dollars of tax revenue at the proposed 10% rate. Tax revenues under the bifurcated tax proposal of the House Blueprint are more difficult to estimate, but the lower rates would yield a lower amount. On the other hand the CBO, which compares proposed legislation to current law, may determine that the proposal actually costs the government revenue over a ten-year window. This would be the case if the CBO estimated that the amount repatriated under current law at higher rates would be enough, over a ten-year period, to generate more revenue than the proposed one-time tax.
Concerns: A one-time repatriation tax at a special tax rate forecloses the possibility of future taxation at the higher traditional tax rates. Furthermore, businesses could make a pre-emptive shift in the type of tax-deferred foreign assets held in order to the minimize tax under the dual-rate proposal. Additionally, data from a similar 5.25% repatriation tax implemented previously under President George W. Bush indicates that businesses did not reinvest the repatriated profits or raise U.S. wages, and instead used the repatriated profits to repurchase stock and pay down debt. A Joint Committee on Taxation study indicated that this previous repatriation tax did not generate additional revenue for the government. With this history in mind, some have argued that the negative effects of the repatriation tax would be mitigated if it were part of a move to a territorial system, as revenue would be generated immediately while removing the incentive to keep foreign profits overseas.
Currently the President's tax plan does not have a specific mechanism for offsetting its tax cuts, and the President has been noncommittal on the BAT, which is a principal source of revenue offsets in the House
Blueprint. This leaves an opening for any of these other revenue generating alternatives. As noted in Part I of our series, a revenue shortfall of about one trillion dollars over 10 years would result if the proposed BAT is eliminated and not replaced with another revenue generator. And the BAT or a substitute revenue would not make the President's plan revenue neutral, so the issue of revenue neutrality remains to be addressed. This may compel Congress to more seriously consider these and further sources of funding. For more information on these revenue generating proposals and tax reform in general, please contact your local CBIZ tax professional.
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