Obama and Camp tax plans show distance left to travel on US tax reform
Reform of the US tax system is still a long way off judging by the differences between the proposals in the 2015 Budget which President Obama released this week and the plan of Dave Camp, the House Ways and Means Committee chairman, which came out a week earlier.
The Obama FY 2015 Budget largely carries forward previous tax proposals outlined by the Administration, though new revenue raising proposals include a limit on corporate interest deductibility and restrictions on hybrid arrangements.
The Budget shares some features with the Camp discussion draft. There is agreement on the need for a lower corporate tax rate, for example, and proposals that are similar on the treatment of intangibles and taxation of the financial sector.
“I recognise there is some area of agreement between us,” said Camp, commenting on the tax aspects of the Administration’s FY15 Budget. “Clearly, we can all agree that the tax code is a wet blanket on the economy and makes it harder for employers to create new jobs and invest in the US.”
Jonathan Traub, managing principal, tax policy at Deloitte and former staff director for the House Ways & Means Committee, also acknowledges there are similarities, but says insurmountable differences remain.
“There are some similarities between elements of the Camp discussion draft and the President’s Budget, but the differences are large and in some case more significant than the similarities,” said Traub. “Notably, there still is no agreement on whether tax reform should reduce the deficit or whether all of the revenue raised as part of tax reform should be used to reduce tax rates on businesses and individuals. Until that question is settled, it is hard to see tax reform being enacted.”
The divergent views on whether tax reform revenue should be ploughed into deficit reduction or devoted to tax rate reductions remain the largest barrier to bipartisan progress.
Camp is adamant that a revenue rise should not lead to additional government spending, and that raising taxes on business to the extent Obama wants is not a route that should be followed.
“The differences are clear; while your plan raises taxes by $1.8 trillion, my tax reform plan would create 1.8 million new jobs,” he said.
“A key difference between Chairman Camp’s draft and the president’s Budget is the circumstances under which these provisions might be enacted,” said Traub. “While the President does wall off some of the items, designating them for a revenue-neutral business tax reform, most of his proposed tax changes are not tied to tax reform.”
“By contrast,” he adds, “Chairman Camp has made clear that the provisions in his discussion draft – including many items that are similar to items in the president’s Budget – are changes that he would support only in the context of rate-reducing tax reform and not as part of a package of additional spending or deficit reduction.”
The business community naturally agrees with this summary. The Business Roundtable (BRT), an influential group of chief executive officers from America’s largest companies, said the Obama Budget moves in the direction of economic growth and job creation – specifically on lowering the corporate tax rate – but that more needs to be done. It disagrees with Obama’s international tax reform proposals, while concurring with Camp on the need for additional revenue to be targeted on tax code improvements.
“The President’s international tax proposals would move the US economy in the wrong direction, placing US companies in a worse competitive position than they face today,” said BRT President John Engler. “Further, we believe that any corporate revenue generated by tax reform base broadening should be dedicated to creating a more modern and competitive tax system – not used on unrelated spending.”
Achieving a lower rate
To achieve a lower corporate tax rate, there is a consensus among politicians that certain business tax preferences would need to be eliminated. However, agreeing on which preferences to remove has been far more troublesome.
Accelerated cost recovery is the biggest tax preference and would create the most room for rate reduction if repealed, followed by the manufacturing credit and the R&D credit. The Administration wants to keep both of these, while Camp also wants to make permanent the R&D credit.
Ken Kies, managing director of KPMG’s tax policy group, formerly the chief-of-staff of the Congressional Joint Committee on Taxation (JCT) and Republican chief tax counsel to the House Ways & Means Committee, is surprised that section 199 manufacturing deduction has not come under more scrutiny.
“The manufacturing deduction – section 199 – we all know was really intended as a lower corporate rate for manufacturing. And it was amazing to me that the service sector wasn’t more outraged when that was done, because really it’s kind of hard to argue why one sector should get a lower corporate rate than another,” said Kies.
Camp would repeal it, or rather, phase it out, while Obama would repeal it for oil and natural gas production. The manufacturing sector has not reacted well.
“The President’s Budget delivers damaging tax increases for manufacturers in every industry sector,” said Aric Newhouse, senior vice president of policy and government relations at the National Association of Manufacturers. “In addition, this Budget, like previous incarnations, takes aim at energy producers with provisions that would only increase energy costs in the US and significantly undermine our potential for growth.”
The proposed retention (and making permanent) of the R&D credit was well received, but it also limits breathing space for lowering the corporate tax rate.
“The way in which you can get the rate lower is you go outside of tax expenditures, and there’s a couple of big ones that have been in the discussion, one of which is limiting interest deductibility,” said Kies.
This is another area of difference – interest deductibility limits are included in the Obama Budget proposal, but not in Camp’s draft.
Dogs that didn’t bark
There are other revenue sources that were widely touted as likely to feature in one or both of the tax reform proposals, while others that were mentioned were never likely to gain traction.
“There’s a carbon tax, folks have been talking about a financial services tax, many have said that “if we really want to look like the rest of the world, let’s look like the rest of the world with our territorial system and let’s also look like the rest of the world with the rest of our tax system, and have a national consumption tax – which is how these other guys have paid for it,” said Hank Gutman, principal at KPMG and former chief-of-staff of the JCT.
Kies said the only people he knows that are in favour of a VAT are former members of Congress, who no longer plan to run for re-election, and academic economists who “have never been elected dog-catcher”.
Gutman said the reason a VAT would be such a heavy lift in the US is that both the right and the left have reasons to not like it. The left because it is a tax on consumption, meaning it hits low and middle income disproportionately, and the right is concerned that if you give Congress another revenue machine, they will spend more money.
“If you study the VATs in Europe as they have evolved over time, they all started low and went up. In every country, as VAT went up, spending went up faster. And so it never did what economists here are arguing it could do, which is address our fiscal situation,” said Gutman.
Distance left to travel
Despite both Democrats and Republicans producing plenty of ideas on their desired direction of reform, the latest tax plans from Obama and Camp show that many of those ideas remain far apart.
While the two tax plans of the past fortnight will provide plenty of food for thought for taxpayers and policymakers, concrete action looks set to be delayed once more.
“The stars do not appear to be aligned to allow tax to be enacted this year,” said Traub. “That is unfortunate, as reform of the code is badly overdue. Hopefully, the work that has been done to this point and will continue to be done before the end of the year helps form the basis of future action.”