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Post-election report: Where does this leave US tax reform and what will Obama do next?

20 November 2012

Matthew Gilleard

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The dust has settled on the US election, and President Obama begins his second term in office. Pre-election politicking and points-scoring can take a back seat and issues such as comprehensive reform of the tax code can return to the forefront of discussion.

However, the question remains as to whether bipartisan agreement on tax reform can be reached now, as it last was in 1986.

House speaker John Boehner has referred back to that bipartisan Tax Reform Act 1986 as a model for how Democrats and Republicans can work together to address the national debt and spur economic growth through reform.

"By working together and creating a fairer, simpler, cleaner tax code, we can give our country a stronger, healthier economy," he said. "There is a model for tax reform that supports economic growth; it happened in 1986 with a Democratic House run by Tip O’Neill and a Republican President named Ronald Reagan."

The Business Roundtable (BRT) has gone to the extent of outlining a to-do list for the White House and Congress in the wake of the election outcome, including a plea for the adoption of a competitive US corporate tax rate, comparable to the OECD average, and a competitive market-based tax system similar to the rest of the world.

"This year has witnessed policy gridlock and economic stagnation," said a BRT spokesperson. "Now the election is behind us, America’s business leaders are focused on making 2013 a better year for the US economy."

"Lack of political will by our leadership in Washington is immobilising us," said Scott Davis, chairman and CEO of UPS. "Our national debt increases about $3 million every minute. Our leadership needs to adapt to the economic realities, take a disciplined approach, and most importantly, ACT."

The CEOs – who want, as a minimum, expired and expiring provisions to be extended until comprehensive tax reform can be enacted - among other measures – are urging action through a series of advertising campaigns directed at Washington policymakers. The first of these has already been released.

"If the last debt ceiling discussion was playing with fire, this time they’re playing with nitro-glycerine. It’s important to recognise the stakes have gone up across the board when you combine the debt ceiling with the fiscal cliff," said David Cote, chairman and CEO of Honeywell International, a technology company.

As in 1986, there are certain issues which have garnered bipartisan support already.

"The good news is there is bipartisan consensus on some of the key issues – President Obama and Congressional leaders generally agree the corporate tax rate is too high and our international tax system is in need of reform," said Pam Olson, PwC’s Washington National Tax Services Leader & US Deputy Tax Leader.

Dealing with tax preferences

At the Wall Street Journal CEO Council last week, former chairman of Obama’s council of economic advisers, Austan Goolsbee, warned that a corporate tax rate reduction would probably necessitate the removal of accelerated depreciation.

The ability to expense initial investment is a highly favoured tax break among taxpayers, particularly those in the manufacturing sector. Such a move would therefore be unpopular, but Goolsbee says it may be required to offset a tax rate cut.

While certain lawmakers have asserted that nothing is off the table when it comes to the consideration of which tax breaks to remove, Obama has previously said he believes the manufacturing sector is vital to the US’ economic recovery, so he may be averse to remove one of the industry’s most-loved tax credits.

Obama is not the only one to have recognised the importance of the manufacturing sector, and this too may lessen the chances of Goolsbee’s warning coming to fruition.

"When it comes to our tax code, Governor Romney and I both agree that our corporate tax rate is too high. So I want to lower it, particularly for manufacturing," said Obama.

"Manufacturing is not only a key part of our economy but moving forward, it will remain critical to our nation’s economic vitality," said Heather Boushey, senior economist at the Center for American Progress. "Without a vibrant and innovative manufacturing base, we will not be a global leader for long."

Boushey testified in front of the House Ways and Means Committee in July and said that last year, manufacturing contributed more than $1.8 trillion to US GDP, or about 12% of the economy. From an employment point of view, manufacturing jobs also have the highest multiplier effect.

"To put this in perspective, each job in motor vehicle manufacturing creates 8.6 indirect jobs, each job in computer manufacturing creates 5.6 indirect jobs, and each job in steel manufacturing creates 10.3 indirect jobs," said Boushey.

However, Treasury Secretary Timothy Geithner, also speaking at the WSJ’s Washington event, said limiting tax breaks will not be a sufficient revenue-raiser. This comes in the wake of Obama’s proclamation that he wants $1.6 trillion in additional tax revenue in the next 10 years.

But a KPMG report, released on Friday, has shown that business leaders are recognising they must give up certain tax preferences to allow for a reduction in the corporate tax rate.

"In a survey of more than 680 business executives, almost 80% of respondents from both US domestic and multinational companies said they would be willing to accept the repeal of certain tax incentives in exchange for the lower overall tax rate," said a KPMG press notice that accompanied the survey release.

According to KPMG, among reform supporters: 68% said they would be willing to give up accelerated depreciation, 66% said they would give up the manufacturing deduction, and 52% said they would give up research and experimentation tax incentives.

These figures are somewhat surprising, but Hank Gutman, principal with KPMG and former chief-of-staff of the US Congress Joint Committee on Taxation, said the statistics show recognition that all preferences must be considered as on the table if a lower rate is to be achieved.

"Business leaders understand the fiscal challenges of the US and are increasingly recognising that a hard stance on incentives, with respect to corporate tax reform, will not work," said Hank Gutman, principal with KPMG and former chief of staff of the US Congress Joint Committee on Taxation. "They know that for effective reformation of business taxation to take place, incentives once considered untouchable need to be up for debate."

The survey also revealed that only 16% of respondents expect fundamental tax reform in 2013. This indicates that few have confidence in the comments of, for instance, House Ways & Means chairman Dave Camp, who has vowed action in 2013.

In addition, 25% expected reform by 2014, while 29% expected it by 2015 or beyond. 30% said they were unsure when any reform would be enacted.

Next steps

Despite the lack of faith business leaders seemingly have in action before the end of the year, Olson said a framework for reform could well be in place pre-2013, enabling expedited reform next year.

"The most immediate next step is for the Obama Administration and Congress to reach an agreement on US fiscal cliff issues before the end of 2012. That has to happen before Obama and the next Congress can address the details of comprehensive tax reform legislation," said Olson. "A fiscal cliff agreement could set forth a specific tax reform framework for the next Congress that would speed up the process."

Olson said there is also a possibility that further action could be taken this year, but that this hinges on whether Obama and Congress can agree on legislation addressing the expired and expiring individual tax provisions. However, she remains hopeful.

"If no compromise can be reached in the lame duck session on individual rates, it is highly likely legislation on expired and expiring business tax provisions will be delayed until 2013. Comments from both Republicans and Democrats provide some reason for optimism that a deal is attainable before year’s end."

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