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The future of tax reform

In early December, I was able to attend a Bloomberg Government panel discussion on tax reform on behalf of NCRA. Robert Litan, Jennifer Blouin, William Gale, and Doug Holtz-Eakin were speakers on the panel, all providing insightful perspectives from their fields.  Tax reform remains one of the most discussed issues on Capitol Hill and understanding the issue is important with potential changes coming in the near future.

When the tax code was created, 100 years ago, it was less than 500 pages. Today the tax code is more than 70,000 pages, creating confusion and providing thousands of specific exemptions. Tax reform remains a key issue for several reasons, mainly that American corporations are unable to stay competitive in today’s market and the increasingly complex code needs to be simplified. The United States has not seen a major overhaul to the tax code since 1986, when President Ronald Reagan was able to work with House Speaker Tip O’Neil and achieve a major legislative victory simplifying the tax code.

Finance Committee Chairman Max Baucus, D-Mont., released a new plan to fix our country’s corporate taxes, especially uncollected offshore income, in an effort to move along tax reform legislation. Baucus suggests a one-time minimum tax on offshore profits to bring revenue back into the country.  He took major heat from Republicans because of the timing of his plan which was introduced when both sides were focused on getting a budget done before the government shutdown that would occur in January, if nothing is passed. With a rough political climate right now and a president with weak political capital after a failed rollout of the Affordable Care Act, Republicans are worried about conceding too much in any potential deal with primaries early next year. Political pundits point to 2015 as the year tax reform would be more likely since the 2014 elections will give both the House Ways and Means Committee and the Senate Finance Committee new chairmen. The president will also be looking for a second term legislative victory to put his name on, something that looks gloomy until after midterm elections.

During the last several years, both parties have agreed that tax reform is a critical issue for the country to address. However, Republicans have been wary of agreeing to more tax increases while Democrats have been insistent that revenues be raised somehow. It seems unlikely that a tax reform bill will pass this year, but many businesses are hopeful that the tax code will be simplified. While economists continue to note that the U.S. is losing money every year because of our tax code, money is not being reinvested back in the U.S. because of the high tax rates.  Each side has their own policy that they believe will be best for the country.

Baucus and the White House are pushing to keep one of our current policies known as the international tax, a tax that is only used by the United States. As an example of our current system: Starbucks, an international company, is taxed in the United States and then must pay taxes on certain gains after it pays a territorial tax (income tax in the country the business is located) in another country. Oftentimes, most companies never pay the tax or hide gains in tax loopholes because companies are not taxed upfront under current tax code. Under the Democrats’ proposal, Baucus would keep the current international tax system while providing a tax holiday and lower overall tax rates for business.

On the Republican side, David Camp, R-Mich., chairman of the House Ways and Means committee, has floated a proposal that would change two major parts of the current tax policy. First, Camp suggests changing the top tax bracket for high income earners and businesses to 25%, which is lower than Baucus’ proposal. This would make the U.S. more competitive on the business front, as the U.S. currently has one of the highest corporate tax rates. The second part of the plan would move the country to a territorial tax system from an international tax system. Most other developed nations run their tax system on a territorial system. A territorial system is believed to help change how companies operate outside the U.S.

Both sides seem willing to allow an exemption of a low tax or no tax if companies bring back the money from overseas by a certain date. This was last used by President George Bush. Under the “Tax Holiday,” Bush allowed companies to use offshore income to reinvest in America under a lower tax rate, bringing back $360 billion. This would be something both sides seem willing to do again in the future to try to get the economy moving again. Scholars have different opinions on the amount of money that would be reinvested this time around but believe it to be a significant amount, as many companies have significant amounts of capital housed in overseas accounts.

Despite these proposals and some positive overtures by both parties, tax reform seems to be unlikely this year. If tax reform happens, 2015 seems to be the most likely opportunity.