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Topical Focus – US Tax Reform Update

By Editorial
July 8, 2013

A recent survey of senior tax professionals in the United States ranked potential US corporate tax reform alongside tax authorities’ more rigorous pursuit of transfer pricing cases as the top global tax concern facing companies. This feature outlines just why this is the case.

In January 2013, National Taxpayer Advocate Nina E. Olson issued her 2012 Annual Report to the United States Congress, in which she identified the need for tax reform to simplify the tax code as the overriding priority in tax administration. The report states that the tax code imposes a “significant, even unconscionable, burden on taxpayers” and shows that since 2001, Congress has made nearly 5,000 changes to the tax code. This is an average of more than one a day, with the number of words in the code now having reached nearly four million.

In particular, Olson points out that it takes US taxpayers (both individuals and businesses) more than 6.1bn hours to complete tax filings; it was estimated that it cost individual and corporate taxpayers USD168bn to comply with the tax code in 2010; and around nine out of ten Americans rely on paid professionals or commercial software to prepare their tax returns (nearly 60% of taxpayers hire paid preparers; another 30% use software).

It would be difficult to find a member of Congress who thinks this an acceptable state of affairs. Indeed, there is broad bipartisan support for tax reform which makes the tax code simpler. However, since President Obama arrived in the White House in 2009 to a split Congress – and one which has become sharply divided across party lines – the legislative process has been almost paralyzed at times, especially over key fiscal and economic issues. One only has to look how the last minute (quite literally) deal to avert the first “fiscal cliff” was taken to the wire in January 2013 to see how far apart the two sides can be, not only on the fundamental issues posing a threat to the US economy, but also on the finer details of tax legislation.

This in itself has caused much uncertainty for taxpayers and led to calls from business groups for Congress and the Administration to bang their collective heads together for the greater good. Yet it is not entirely true that Democrats and Republicans can’t work together. The verbal jousting on tax between President Obama, House Republican House Speaker John Boehner and other political heavyweights naturally attracts the headlines; but a great deal has actually been accomplished behind the scenes by the leaders of the congressional tax committees – one a Republican and one a Democrat – to prepare the ground for tax reform.

Over the last two years alone, Rep. Dave Camp (R – Michigan), Chairman of the House Ways and Means Committee, and Sen. Max Baucus (D – Montana) have held more than 50 Congressional hearings to gather evidence on how the US tax code can be fixed, and on February 13 this year, Dave Camp and Ways and Means Committee Ranking Member Sandy Levin (D - Michigan) announced the formation of 11 separate Tax Reform Working Groups. The groups were led by one Republican Member serving as Chair and one Democratic Member serving as Vice Chair and covered almost the full gamut of the US tax system including: charitable/exempt organizations; debt, equity and capital; education and family benefits; energy; financial services; income and tax distribution; international; manufacturing; pensions/retirement; real estate; and small business/pass-thrus.

In a similar vein, the Senate Finance Committee is currently in the final stages of releasing a series of ten option papers on tax reform, the ninth of which, dealing with the tax breaks for charitable donations and tax-exempt organizations, was issued on June 13. Other papers released by the Committee recently included one on international competitiveness, and another on housing tax reform.

Significantly, Baucus and Camp are now beginning to pool their efforts, indicating that the Congressional tax reform campaign is moving into a new phase with much of the legwork having been done.

In May, the two men teamed up to launch, a new website dedicated to obtaining input from the American public on United States tax reform. Developed in partnership with the non-partisan congressional Joint Committee on Taxation (JCT), will serve as a platform for the American public to weigh in on tax reform. The idea behind recalls the efforts of former Ways and Means Chairman Dan Rostenkowski to engage the American public in the last successful overhaul of the US tax code in 1985. He encouraged the American public to send letters in support of tax reform in what became known as the "Write Rosty Campaign." As a result, Rostenkowski received more than 75,000 letters and post cards from the American public in support of tax reform, helping lead to the Tax Reform Act of 1986.

During a breakfast meeting in June, Baucus and Camp confirmed that they were planning on a series of joint meetings during the summer across the United States to carry forward the debate on tax reform, giving them an opportunity to meet with, and hear the views of, both local individuals and businessmen on tax reform directly. When asked at the breakfast, Baucus confirmed that concrete proposals would be available shortly, at the end of the program of meetings and hearings in both of the tax writing committees.

However, discussions have since begun to turn towards firing the starting gun for US tax reform. On June 27, Baucus and Finance Committee Ranking Member Orrin Hatch (R – Utah) issued a statement proposing a “blank slate” approach to tax reform and they confirmed that they recently wrote to Senate colleagues to suggest this as a legislative starting point. To end up with a "simpler, more efficient and fairer tax code," they begin by eliminating from the tax base all of its present exclusions, deductions and credits, and then call on other lawmakers to provide justified proposals for those tax expenditures they want to add back into a reformed tax code.

The JCT and Finance Committee staff have determined that every USD2 trillion of individual tax expenditures that are added back would, on average, raise each of the seven individual income tax brackets by between 1.3 percent and 2.2 percent from what they would be under the blank slate. Likewise, every USD200bn of corporate tax expenditures that are added back would, on average, raise the top corporate income tax rate by 1.5 percent from what it would be under the blank slate. The JCT report therefore attempts to demonstrate that the more tax expenditures are allowed in the tax code, the less revenue will be available to reduce tax rates or reduce the deficit.

All Senators were asked to submit legislative language or detailed proposals for what tax expenditures and other provisions should be added back to a reformed code. However, Baucus and Hatch stressed that tax expenditures and other provisions should be added back "only if they: help grow the economy, make the tax code fairer, or effectively promote other important policy objectives." Senators have until July 26 to submit their proposals, and special attention will be given to proposals that are “bipartisan.”

Baucus and Hatch are also encouraging Senators to examine other aspects of the tax code, as they believe that many provisions of the income tax code that are not considered tax expenditures could be greatly simplified. “In addition,” they wrote, “with almost half of federal tax revenues coming from sources other than income taxes, the tax reform process will therefore involve much more than just income tax expenditures.”

Camp’s response to these proposals suggests that the blank page approach would be one that he is amenable to, and it is therefore quite likely that this will form the basis of discussions about the content of a tax reform legislative bill. He commented: "[This] announcement by Chairman Baucus and Senator Hatch is welcome news for Americans who deserve a simpler, flatter, fairer tax code that leads to more jobs and higher wages. This significant step forward underscores that the Senate and House are on the same page as they work in a bicameral, bipartisan manner to fix our broken tax code."

The chances of a tax reform bill emerging from Congress now appear higher than they’ve been for a number of years, and as Baucus and Hatch declared in their letter to fellow Senators: "We're now entering the home stretch.” Nevertheless, these could prove to be the hardest yards of the journey. While most lawmakers support tax reform in principle, it is inevitable that there will be disagreement on the details. More fundamentally though, the ideological divide is likely to re-emerge as the debate begins on what a comprehensive tax reform bill should achieve. This was acknowledged by the Finance Committee leaders, who observed that lawmakers are likely to have different views on whether the revenue raised from eliminating tax expenditures or other reforms should be used to lower tax rates, reduce the deficit, or some combination of the two.

The arguments will as usual boil down to how progressive and “fair” the tax code should be, and Camp’s mention of a “flatter” tax code is likely to raise the hackles of some Democrats.

In the area of business taxation, President Obama is in tune with the Republicans when he says that the top US corporate tax rate should be lower to give America a competitive boost, but the two camps are far apart on other areas of corporate tax reform. The President has frequently attacked the international aspects of the tax code which he says allow multinationals to avoid US income tax on a large scale, and has proposed more taxation of these companies rather than less. Conversely, many in the Republican Party believe that the answer is a move towards a territorial system of tax, whereby foreign income won’t be heavily taxed when remitted back to the US, but this is something completely anathema to the Obama administration given its track record on expanding the jurisdictional reach of the IRS with laws such as FATCA.

Both sides are also likely to agree that the time is ripe for a cut in individual tax rates. But will this benefit all taxpayers, or just the middle class? The Republicans will take the view that tax cuts should be across the board. However the President and most Democrats have argued vociferously that individual tax cuts should not benefit high income households and the wealthy. Further complicating the matter is the fact that there are several tax expenditures in the tax code that allow wealthy taxpayers to reduce their exposure to income tax.

Earlier in the year, House Speaker Boehner announced that he is holding back legislative bill H.R.1 to form the basis of a tax reform bill, declaring at the time that fixing the tax code “is one of my highest legislative priorities for this Congress.” This, and all of the work done by Baucus, Camp and others in Congress, shows how seriously tax reform is now being treated, and the first widespread sweep of US tax law since 1986 is perhaps nearer than it’s ever been in recent years. Unfortunately, until the deed is actually done, doubts about the future shape of the US tax code will persist, and it is therefore probable that this issue will continue to top the uncertainty polls. Given Congress’s recent track record, it cannot be stated with any certainty when the wait for tax reform will finally be over.


Tags: tax | tax reform | business | law | United States | Finance | tax rates | FATCA | professionals | individuals | retirement | legislation | pensions | transfer pricing | education | individual income tax | financial services | tax breaks | manufacturing | energy | services



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