Washington Tax Insight April 2017
Politics and Congressional Activity
Congress and the White House continue to manage a full legislative agenda including health care reform, budget deadlines, tax reform, House and Senate intelligence committee hearings on Russian involvement in the 2016 election, and confirmation of a Supreme Court nominee.
Health Care reform: On March 24th, the President and House Speaker Ryan decided to delay indefinitely a final vote on the GOP legislation to repeal and replace the Affordable Care Act (ACA) signaling that Republican leadership in the House did not have majority support for the bill. Leadership had worked throughout the week to make changes to the bill to address concerns of conservatives in the House Freedom Caucus and Republican moderates, but more than 30 Republican members still opposed the bill, and the Speaker could only afford 22 defectors from the GOP caucus as there was no Democratic support. The Speaker and other members of the Republican caucus have indicated that Republicans will continue to work on health care legislation, while they move on to other agenda items, but it seems unlikely that the budget reconciliation process would be used again, which means that they will need to advance bipartisan legislation. The White House has stated that they will leave the ACA in place with their expectation that the program will have problems, which they hope will lead Democrats to work with them on changing the system.
The Continuing Resolution and Funding the Government: The current Continuing Resolution (CR) expires on April 28th, and Congress will have to address extension of the CR which funds the government at current spending levels or risk a partial government shutdown. Congress will be on recess for 2 weeks prior to this deadline, returning to work on April 24th. In the past, members of the House Freedom Caucus have supported adding policy riders to the bill to secure their support of the CR with the result that House leadership has often looked to support from some Democrats to replace votes from conservatives.
The White House has requested $1.4 billion in border wall funding (with a final price tag of more than $20 billion) as part of a package that increases defense spending by $30 billion and decreases domestic spending by $18 billion with a plan to attach this to the CR legislation. House Minority Leader Pelosi has stated that Democrats will not support the funding legislation if controversial riders are added such as funding the border wall between Mexico and the US. In the Senate, Majority Leader McConnell will need Democrats to support the funding bill, so it is expected that Minority Leader Schumer will have some leverage with respect to what is included in the bill, and he has also stated that Democrats will oppose the CR if the border wall funding is included.
President Trump’s FY 2018 budget: President Trump released a preliminary FY 2018 budget on March 16th, which covered discretionary funding levels but did not include tax policy proposals. The budget document stated “The full Budget that will be released later this spring will include our specific mandatory and tax proposals, as well as a full fiscal path.” FY 2018 begins on October 1, 2017.
Confirmation of Supreme Court nominee Neil Gorsuch: The nomination of Neil Gorsuch to the Supreme Court is expected to be brought to the Senate Floor in the next few weeks after he clears the Senate Judiciary Committee vote. Senate Minority Leader Schumer (D-NY) has stated that Senate Democrats will filibuster this nomination due to the fact that the Senate refused to consider the nomination of Merrick Garland in 2016. Senate Republicans will need 60 votes to break that filibuster or be faced with the decision of whether to change the Senate rules to allow confirmation by majority vote. Majority Leader McConnell has stated that he will invoke the so-called “nuclear option” in order to get Gorsuch confirmed.
Federal Government Debt limit: Congress will also likely have to address raising the debt limit by the August/September timeframe when the Treasury Department is likely to have exhausted its ability to use “extraordinary measures” to avoid violating the current debt limit, which would result in the government not being able to pay its bills. Congress could take different approaches to the debt limit issue including stand alone legislation, attaching the legislation to another bill that is likely to pass or not act to raise or suspend the debt limit, which has never been done.
The Joint Committee on Taxation (JCT) issued its annual report summarizing the US system of federal taxation as currently in effect. The report covers income taxes and alternative minimum taxes on individuals and corporations; payroll taxes on the wages of employees and the self-employed that finance social insurance programs; estate, gift, and generation-skipping taxes; and excise taxes on selected goods and services.
The Congressional Budget Office (CBO) sent a report to the Senate Finance Committee documenting the statutory and effective tax rates on US corporations and the “factors that affect them for the US and other G20 member countries in 2012.” The report estimated that the combined (federal and state) corporate tax rate was 39.1%, with an average corporate tax rate of 29% and an effective marginal corporate tax rate of 19%.
Treasury and the IRS
The IRS announced that it would resume issuing “subregulatory” guidance, which includes such routine guidance as revenue procedures, announcements, informal Q&As and similar pronouncements. This announcement came from Commissioner Koskinen because of the Executive Order issued on January 30, 2017, that ordered federal agencies to remove two regulations for each new regulation promulgated. This order had raised questions about how the IRS would interpret the directive with respect to routine taxpayer advice and compliance publications.
The IRS released instructions for the draft Form 8975 and related Schedule A, for use by US multinationals with $850 million or more in annual consolidated gross income. The draft form is based on the OECD’s guidance for country-by-country reporting, which was finalized in 2015. According to the instructions, companies that are the ultimate parent of a global group must report the amounts of revenue, profit or loss, capital, and accumulated earnings for each country of operation.
The IRS issued Notice 2017-20, which suspends the March 13, 2017 deadline for employers to issue an initial notice to employees covered by a qualified small employer health reimbursement arrangement (QSEHRA) as provided for in Code section 9831(d). The IRS stated that the current reporting deadline presents compliance difficulties for employers without additional guidance, and the reporting deadline will remain suspended until the IRS issues new guidance, which it expects to do in the near future. A new deadline will be set in the forthcoming guidance that provides at least 90 days to comply.
The European Council reached a compromise on rules designed to target “hybrid mismatches,” which allow multinational enterprises to exploit disparities between two or more tax jurisdictions in order to reduce their overall tax liability. The compromise updates EU Directive 2016/1164 issued in October 2016, which provided a framework to address hybrid mismatch arrangements. The Council agreed to a temporary carve-out from the rules for the banking sector; an approach similar to that used by the OECD for financial traders, and a longer implementation timeline.
Tax Reform Update
The President’s legislative agenda had envisioned 3 key legislative initiatives: repeal and replace the ACA, enact comprehensive tax reform, and pass a $1 trillion infrastructure bill. The failure of the ACA repeal legislation complicates the process for the other two initiatives amid challenging political obstacles. Tax reform is no less complex than health care reform – arguably more complicated without passage of the health care legislation which included key tax cuts. Tax cuts in the ACA legislation were intended to assist with the challenge of paying for tax reform.
It has been suggested that the failure of the ACA repeal legislation to advance will impact the momentum of the President’s legislative agenda, including tax reform, which the President has now said is his next priority. Speaker Ryan said that the failure of the GOP health care bill would make tax reform “more difficult but not impossible.” The Republican agenda for this year had called for action on health care to come first using the reconciliation instructions in the FY 2017 budget resolution approved in January to then be followed by tax reform legislation also using the budget reconciliation process with instructions from a budget resolution for FY 2018 that the House has not yet approved. Budget reconciliation instructions establish a fast-track process which protects legislation from a filibuster in the Senate by allowing legislation to pass with only 51 votes, rather than the 60 votes normally needed to clear procedural obstacles such as a filibuster, which is necessary for Republicans in the Senate, who hold only 52 seats.
Who will be in charge of leading on tax reform – the White House or House Republicans?
It is not clear at this point whether the tax reform legislative process will be led by the Administration or Congress and what document will be used as a starting point for the process.
White House representatives have indicated that tax reform will be led by Secretary Mnuchin and National Economic Council Director Gary Cohn with input from Commerce Secretary Wilbur Ross and chief strategist Steve Bannon. A Trump tax proposal is reportedly forthcoming, although there continue to be reports of disagreements with the Administration economic team on some of the key issues. After the health care bill was pulled from the House Floor, Secretary Mnuchin commented that his work on a comprehensive reform proposal for the Administration was nearly complete. He said that drafting the tax reform plan took longer than expected because “we are designing it from scratch.”
At Treasury, Justin Muzinich was named as a counselor for tax reform, but the office of Assistant Secretary for Tax Policy remains vacant – a key position to be filled with respect to advancing tax reform legislation. Although Secretary Mnuchin continues to state a goal of completing tax reform by August, he has suggested that date might slip, while other Administration officials have been more cautious about the timeline, and arguably more realistic. There are less than 60 legislative days until the August recess, making the promise of a signed tax reform bill by that date appear unlikely.
W&M Chair Brady continues to state publicly with support from Speaker Ryan that he believes the best course is to start with the GOP Tax Reform Blueprint. Chair Brady issued a statement that said “We have fought hard for this repeal – but I’m not discouraged. Ways and Means Republicans are moving full speed ahead with President Trump on the first pro-growth tax reform in a generation.”
One of the key provisions and revenue raisers in the GOP Blueprint — the border adjustment tax — remains controversial with opposition in Congress growing. Other areas of potential disagreement between the Administration and Congress and within the Republican party include whether they should attempt comprehensive tax reform or limit their efforts to corporate tax reform and whether tax reform legislation should be revenue neutral, which is a goal of Chair Brady but no clear signal on this issue has come from the White House. Should they move forward with tax reform for individuals and businesses, President Trump and Speaker Ryan have also taken different approaches toward middle-class relief, which is not key in the House GOP blueprint but has been included by the President in his comments about tax cuts.
The tax provisions in the ACA repeal bill in large part were written by Speaker Ryan’s policy staff and W&M Committee Chair Brady with input from Health and Human Services Secretary Tom Price. The bill included several provisions that conservatives did not support including a refundable tax credit. Some White House officials have suggested that one of the lessons learned was that the President and his staff must drive the process of legislating on key issues from the beginning – which suggests an approach of starting with a Trump tax plan rather than the House GOP Blueprint written by Ryan and Brady. In any case, the White House is being encouraged by many Republicans to take more ownership of the tax reform issue and the legislation that advances.
Should the White House and Congressional Republicans Proceed with Comprehensive Tax Reform, Corporate Tax Reform or an Infrastructure bill?
Considering the challenges with moving forward on tax reform, some Republicans have argued that the White House should turn next to advancing an infrastructure bill, which potentially could draw support from Democrats. The White House has not, however, suggested how it would pay for its infrastructure bill, so any certainty of a political coalition that could move this legislation forward isn’t necessarily there.
Secretary Mnuchin has suggested that the money would come from a combination of public and private money, which may not align with the Democratic position of using direct government spending. In addition, there is a real question as to whether bipartisan legislation is possible on any issue in light of the contentious issues that have already been addressed by Congress, such as the ACA repeal bill, and the ongoing intelligence committees Russia investigations and the Supreme Court nominee confirmation process.
If the White House wants to succeed quickly on tax reform, they may consider doing corporate tax reform first and address tax rates for individuals later. An alternative approach would be to package an infrastructure bill with corporate tax reform in order to attract support from moderate Democrats.
Will success on tax reform legislation be the result of bipartisan agreement or Republican unity?
The White House will need to consider in the months ahead how to form alliances with members of Congress to advance priorities such as tax reform – will they reach out to Democrats by proposing a middle-class tax cut or infrastructure legislation or will they work to address the concerns of the conservative Republicans of the Freedom Caucus or the moderate Republicans who did not support the ACA repeal legislation? In the immediate aftermath of the failure of the health care reform legislation, the Administration gave an indication that they would reach out to Democrats in an effort to work together. Whether this approach will work may be affected by the other political issues ongoing in Washington including the outcome of the work on the CR and the process used to achieve confirmation of Gorsuch to the Supreme Court.
Even if Democrats are on board with the substance and goals of legislation dealing with infrastructure and tax reform, it may be challenging to overcome the politics. In addition, Democrats may be looking forward to the 2018 elections with the hope of picking up seats especially in the House, leading them to be less inclined to support Republican initiatives.
If the White House does believe that working with Democrats to achieve bipartisan tax reform is the approach to take, that likely means that tax reform will take much longer to accomplish since there would appear to be huge disagreements between the two parties on how to overhaul the tax code.
Does the failure of the ACA repeal bill make it harder to do tax reform?
The ACA repeal legislation that failed to advance in the House included $1 trillion in tax cuts over 10 years that, if enacted, would have resulted in a lower revenue baseline making it easier for Republicans to achieve a goal of revenue-neutral tax reform. The tax cuts in the ACA repeal bill included the repeal of the 3.8% tax on investment income and the 0.9% tax on wages. Speaker Ryan stated that these taxes would stay in place and would not be included in a broader tax reform package, but many Congressional Republicans are very opposed to these taxes and may not be content to leave them in the tax code. Including them in comprehensive tax reform arguably increases the price tag for that legislation.
The opposition to the border adjustment tax proposal in the Republican blueprint, which would tax imports and exempt exports, has not abated, and in fact continues to grow in the Senate, potentially creating a $1 trillion deficit in the House GOP blueprint should that proposal be dropped. Chair Brady has stated that he is making “significant changes” to the border adjustment tax but no specifics have been released.
Congressional leaders plan to use the budget reconciliation process to advance tax reform legislation. There are procedural and budgetary rules that govern the reconciliation process, called the Byrd Rules, including a rule that prohibits legislation that would increase the deficit in any year beyond the budget window, which is typically 10 years. Another rule is designed to block provisions that are deemed to have no effect on the federal budget or whose effect is “merely incidental” to the underlying policy. These rules apply on a provision-by-provision basis and are enforced through points of order, which can be waived in the Senate by a 3/5 majority vote (which is generally 60 votes). Since Republicans only hold 52 seats in the Senate, these rules effectively must be complied with when budget reconciliation legislation which includes tax reform proposals advances through the process.
Eliminating the $1 trillion of ACA taxes and the federal spending associated with that law would have arguably made it easier to design a tax reform package that would comply with the budget reconciliation rules. It will now be more challenging to cut corporate tax rates without adding to the federal deficit. There is also a question as to whether Republican fiscal conservatives who oppose adding to the deficit will support tax reform legislation that is not offset by new spending cuts or new streams of revenue, like the border adjustment tax although House Freedom Caucus Chair Meadows has stated that he does not think the tax reform bill must be fully offset.