Nutter's Washington

Corporate Tax Reform: A Primer and Different Approaches

There is a mounting interest in Congress, the business community and the Administration to revise the corporate income tax. The marginal rate is the highest in the world and international competition is driving the possibility of an update. In addition, policy makers are searching for any and all ways to help the lagging economy. However, the issue is very complicated and unlike the individual tax side, the choices are diverse.

 Three broad areas have emerged to form a triangle of reform. The first is the reduction of the corporate income tax rate. In conjunction with lowering the tax rate, the second leg how to minimize the loss of revenue to the government by examining the makeup of income and the associated reduction or eliminating “tax expenditures”. Reduction of such expenditures is also seen as promoting tax simplification and reducing the importance of tax considerations in business decision-making. Lastly, as the third side of the triangle, there is the basis on which the United States taxes multinational corporations.

By way of background, C corporations are taxed at statutory rates ranging from 15 percent to 35 percent.

 Certain domestic production activities are effectively taxed at lower rates by virtue of a deduction equal to a percentage of the income from such activities. The deduction is equal to nine percent of the income from manufacturing, construction, and certain other activities specified by statute Thus, generally the maximum tax rate for a C corporation on its domestic production activities income is effectively 31.85 percent.

The United States employs a worldwide tax system, meaning that American companies are taxed on their U.S. profits, taxed abroad on their foreign profits, and then taxed again when those foreign profits are brought back home. By contrast, virtually all foreign companies are taxed under a territorial system in which they pay taxes on their home country profits in their home country and on their foreign profits in the foreign country. Foreign profits are not taxed a second time when they are brought back home. Thus, the double taxation of foreign profits is avoided.

To offset the advantage of a territorial tax system and to help level the playing field between American worldwide companies and their foreign competitors, the U.S. government employs a system of tax credits and tax deferral. Deferral, which has been in the Internal Revenue Code in various forms since the 1960’s, allows U.S. companies to delay paying tax on foreign earnings until that income is repatriated.

The House Ways and Means Committee under Chairman Dave Camp has held a series of hearing in the past year on corporate tax reform. The Chairman has released a draft outline of revisions.

Link as follows: http://waysandmeans.house.gov/taxreform/

The centerpiece is a reduction of the highest marginal rate to 25 %. The provision maintains the present law 15-percent corporate tax rate for taxable income not in excess of $50,000. For a corporation with taxable income in excess of $100,000, the benefit of the 15-percent rate is eventually recaptured.

This rate reduction would be accomplished without increasing the deficit by broadening the tax base. In typical Washington fashion, the necessary base-broadening provisions are not included in the discussion draft.

 In addition the discussion draft specifics a number of changes in international taxes as follows:

• A deduction equal to 95% of foreign-source dividends received by a 10% U.S. corporate shareholder from a controlled foreign corporation (CFC). In addition, 95% of capital gains from the sale of shares in a CFC by a 10% corporate shareholder would be excluded from income, as long as a one-year holding period requirement is met and at least 70% of the assets in the CFC are used in the active conduct of a trade or business.
• Initiate a transition rule that would apply a 5.25% tax to all existing foreign earnings currently held offshore, whether or not such earnings are repatriated. Taxpayers could use a ratable portion of their foreign tax credit carryovers to further reduce the 5.25% tax.  In addition, they could elect to pay this tax in up to eight annual installments.  Once paid, such earnings would benefit from the 95% exemption if brought back to the United States as a dividend.

In essence the proposals shifts from a worldwide system of taxation to a territorial-based system because as explained above the current high U.S. rates have the effect of penalizing those U.S. corporations that bring their foreign profits back. These changes are designed to free up existing overseas earnings in order to facilitate reinvestment domestically after they are taxed at a low rate

In contrast to Chairman Camp’s outline, the Department of Treasury and the White House released in February a “framework“ of proposals to reform the corporate tax system. The details are not complete but there are a few good suggestions. The centerpiece is a cut in the top corporate rate - now at 35 percent to 28 percent. The proposal suggests broadening the income base, also a good suggestion and, sensitive to the fact budget deficits have been more than $1 trillion a year, the plan crows it will not "add a dime to the deficit."

A Link to the plan is as follows: http://www.treasury.gov/resource-center/tax-policy/Documents/The-Presidents-Framework-for-Business-Tax-Reform-02-22-2012.pdf

The proposal provides special tax treatment for manufacturing - cutting that tax rate to 25 percent - and a minimum tax on profits earned in abroad.

The plan calls for the elimination dozens of business tax preference and tax expenditures starting with “a presumption (to)..eliminate(s) all tax expenditures for specific industries, with the few exceptions that are critical to broader growth or fairness.”

Here are the examples of specific reductions in tax expenditures and loophole closers:

• Eliminate “last in first out” accounting
• Eliminate oil and gas tax preferences
• Reform treatment of insurance industry and products-
• Taxing carried (profits) interests as ordinary income for financial managers (not a corporate issue)
• Eliminate special depreciation rules for corporate purchases of aircraft

While details are incomplete, the framework also focuses on manufacturing, however that is defined, by giving a preferential tax rate, pouring more subsidies for research and development and the production of clean energy. This would seem to be in direct conflict with the stated principals stated in the framework of “eliminating significant distortions that can result in a less efficient allocation of capital, reducing the productive capacity of the economy and U.S. living standards.”

Finally, the framework goes after multinational corporations. No doubt, the taxation of these behemoths deserves review. As stated, the current U.S. tax system subjects foreign subsidiaries of U.S.-based multinationals to taxes on their overseas income offset by foreign tax credits. However, corporations are not required to pay taxes in the United States on that income until repatriated back to the U.S., a principal called a deferral (since it defers taxation of the income). Under the President’s proposal, income earned abroad would be subject to a minimum rate of tax and the benefits of deferral curtailed, if not eliminated. 

The approach conflicts with many business leaders, economists and House Ways and Means Chairman Dave Camp that favor revamping the system from a worldwide tax system to a territorial one. The Administration opposes any shift to a territorial based system and this issue will be strongly debated and contested.

There are other items of interest such as a proposal to deny deductibility of interest, the differing treatment of debt and equity and the use of depreciation. 

Corporate income taxes are only the third largest source of revenue for the government. Increasingly businesses have been organizing into pass-through entities such as partnerships Limited Liability Companies (LLC) and Subchapter S. Even so in corporate tax reform, the stakes are very high; the impact enormous, will be hotly contested and will have a huge financial impact on many organizations.

The current focus on taxes is the year-end expiring tax provisions, affectionately referred to in a lump fashion as the “fiscal cliff”. While there are provisions effecting corporations, the bulk involves individual taxation and rates and there will not be any fundamental changes in the tax structure in the short term. Until the situation clears up it is unlikely corporate tax reform will proceed in any meaningful fashion. Because of the complexity and different approaches of the Republican controlled House and the Administration and the Senate, it is difficult to see individual and the corporate taxes being linked into one giant revision. However, it is also clear that anything is possible given the state of the economy and the political landscape.

 

 

 

Liberals equal Grover Norquist: Perhaps, even worse

I know some people who think Grover Norquist is the devil. He is a national impediment to fiscal sanity and standing in the way of prosperity due to his beliefs taxes are too high, should not be increased and government is too pervasive. 

I do not personally know Mr. Norquist. I have heard him speak a few times, seen him at political events. He seems like a sincere person, steeped perhaps in his own self-importance.

It seems Mr. Norquist runs an organization called Americans for Tax Reform where he is known as the promoter of the "Taxpayer Protection Pledge", basically a promise by politicians to not increase taxes.  If they violate the pledge they have signed, he lets those that pay attention to such things know about it. Seems to me a fairly shrewd way to run a political operation.

Bored of the Fiscal Cliff? Some other things to watch

There has been so much written about the “fiscal cliff” that it has become almost a cottage industry. I think there is a cadre of people in Washington who spend all day staring over the edge. I am kind of bored with it; it will be resolved as the politicians are too scared not to act. The resolution will not be particularly good tax or economic policy but each side will declare some sort of victory

 

The President can boast that he has stuck it to the dreaded wealthy and exaggerate the effect of all of the taxes on the deficit by saying something inane like “this is a good down payment of our financial future.” Republicans will crow they are doing everything they can to work on a bipartisan basis. Nonsense, of course.

However, the purpose here is not to wax and wane about the expiring so-called Bush tax cuts or to discuss why companies have curtailed their investment plans or even to comment on end of the year extraordinary dividend payouts and profit taking to avoid higher taxes now underway to avoid higher taxes.  These topics are, of course, interesting at least to me but there are other matters on the horizon too.

Itemized Tax Deductions: Bad Idea to Limit Them without Examination

Now that the policy makers realize taxes are going to rise unless Congress acts in the next 50 days or so, there are lots in bad ideas out there. That is the usual course of events.

The goal of the liberals lead by a re-elected President is to increase taxes on the wealthy and about anything else that exudes of success.  For the last two years, at least, that has meant to let the 2001 tax rates for those with income over $200,000 go back into effect. Plus raise the rate on capital gains and a few other things such as attack corporate jets, oil companies and carried interests.

 I am not even going to debate the issue. The election is over and most in Washington accepts the notion that taxes-particularly for the upper income taxpayers- will increase. This tax raising mantra will not solve the deficit issue, it will not create any jobs and it will not foster economic growth.

This in not about economics, it is about politics. That does not mean to imply I support the current tax regime. Indeed, I believe the current system is almost irretrievably broken and must be viewed and reviewed in totality.  The revenue side is part of the equation but so is excessive regulation and federal spending.

No Surprise from Obama on Taxes: I won, you lost and so what?

There are things in life that are never a surprising.  Among them, the earth will rotate bringing the sun into view every day, the Cubs will not win a World’s Series and Barrack Obama will call for large tax increases and bigger government.

 If anyone is surprised the re-elected President would not try to reach some middle ground on the “fiscal cliff”, would modify his view of our former capitalistic economy or try to stop the growth of the federal government then there is a description for you but not polite here.

His re-election is not going to reduce the size of government. It will not curb the growth of federal spending and it will not ask for any national sacrifice to try to reduce the federal deficit, which was $120 billion in October. Yes, 31 days for $120 billion. 

Mr. Obama will meet on Friday with Congressional Leaders in a pow-wow to discuss how to address all the expiring tax provisions, the budget sequester and a whole lot of other things, pressing national business.  He plans to open talks using his 2013 budget proposal, which wanted to raise taxes on corporations and the wealthy by $1.6 trillion over the next decade, a budget that did not garner a single vote in Congress. Not one.

The 2013 budget was a joke, an illusion, and a deception. Mr. Obama who touted the need to reduce the deficit during the campaign now must have second thoughts. He was never and is not now serious about reducing the size of government or the deficit.

If you believe he does then explain it to me. I have looked at his proposal calling for reducing projected deficits over the next 10 years by  $4 trillion. It is not a real number, since it counted $1.1 trillion in cuts already in force and $1 trillion in savings from ending the wars in Iraq and Afghanistan. In essence, saving that were never going to be spent in the first place. It is Lucy Ricardoesque.  The rest, of course, is made up  is taxes.

So, do not be surprised. This is what the country chose.

The goal of the liberals lead by the President is to increase taxes on the wealthy and demonize out-of-favored industries, such as oil and gas. This concept will not solve the deficit issue, it will not create any jobs and it will not foster, well much of anything. This in not about economics, it is about politics. I won, you lost.

This will all work out in the end, I think, but not the way you may have thought. I will be anxious to see the details of the plan, until then it is all and nothing.  

 

 

November 2016: The Economy and the Election, an Alternative Scenario

It is Friday and time for some speculation and fun. It would be great if all goes right in the next four years. Employment increases, peace and prosperity, and joy and the rule of law returns for all.

 

I once made a comment to a colleague of mine that things could not get worse. He replied, "oh yes, they can." In that instance he was right. So have a bit of fun and skip ahead four years. It is now November 2016.

 The unemployment rate in the country towards the end of 2016 hovers around 16.6 percent. The United States has undergone two major recessions. Interest rates for short-term obligations of the United States are 19 per cent; inflation is about 1.5 percent per month. The credit agencies have down graded the sovereign debt 5 times in the last 4 years. The national debt has passed $24 trillion dollars; the deficit is projected to be an additional 2-½ trillion dollars in fiscal year 2017.

After the Election: Now What?

The election is over. No more commercials. No more yards signs. The President has been re-elected for a final four years. Divided government continues. In a sense it was a status quo event.

 

A year ago, the outlook was different. A President with low approvals and in full campaign mode, not bothering much at all to even try to lead the country or address any of the pressing issues. Republicans balking at most everything, thwarted to get anything done but very hopeful the election would bring different results.

The majority has now made it choice. There are many different reasons why it turned out the way it did. However, for the time being, I leave the analysis to the campaign experts, the demographers and the policy experts. I thought going into the election the President would prevail but raised the possibility an unknown anti-Obama swell would manifest itself. It did not happen, was not there. 

Ready to Vote? Observations and Predictions

The political campaign is over. The candidates will be jetting around to important states trying to gin up the believers. Supporters will be trying to get people to the polls to vote tomorrow. The respective campaigns are confident of victory, (as they have to be) but I suspect one camp already knows the outcome.

Opinion polls are varied, divergent and inconsistent. The electoral map-looking at the polls-suggests Mr. Obama will be re-elected. I cannot dispute that notion. However, I am not sure it is right. Here is why.

A friend of mine yesterday asked a really good question. He said, he did not understand why anyone would vote for Mr. Obama. This friend is not politically schooled in the ways of Washington. He was merely asking why the country would continue with a person who has failed in so many areas and who seems nasty and blames any and everyone else for the condition of the country. As I said, it is a good question. It is this kind of question that leads me to think there is a real Obama fatigue and frustration that might manifest itself tomorrow. If it does not, then Mr. Romney will lose.

Sandy, Fiscal Cliff, and the Election: One Common Quality--Disaster

It is the Friday before the election and there are so many things to write. Let’s keep it to three, all deserve more attention than I shall give them but all have one quality in common. 

Like most of people living in the area, the dreaded Sandy, such a great name but what a horrible storm, impacted me. I was prepared for her arrival and all-in-all escaped what others are still enduring. I lost power for only 16 hours as compared to the 6 days of lost electricity last July in the 140-degree heat. I also lost a big tree limb but not like the down trees that covered property last time.

When the winds were howling on Monday night, I was satisfied I had done everything I could to survive. Buckets and 10 6-gallon containers of water, 3 lanterns, batteries, ice in the freezer, cooler for the fridge perishable, gas camping stove with extra containers, cars gassed up, extra cash, snacks and food, radio, firewood inside and a handy pillow case to put Mr. Giant, (the cat) in case of emergency, were all in place. The house shook and creaked, the rain came but Sandy passed. 

Storms and events like Sandy are humbling. They demonstrate our total reliance on modern technology and comforts. They also show the resilience of the human spirit while at the same time can unfortunately bring out the worst in people. Sandy did not devastate my home; I was lucky the brunt went further north. However, I feel for those whose lives have been turn upside down and wish them the strength to pick up the pieces.

The second item that deserves attention is the “fiscal cliff”, that wondrous event of political failure. It is about 60 days from happening. Dealing with this set of circumstances will depend on the election. Congress must act before the end of the year to keep the current tax rates in effect and to prevent the budget sequester from happening.

More about this in the coming weeks but after talking to people on the Hill, (DC speak for Congress) I am not sure anything will be done. Maybe a few things here and there but there will not be any “grand bargain”, no major tax revisions, maybe not anything at all. It is truly a mess with profound consequences.

Finally, the election. The polls are mixed on who wins the Presidential election; they are close. Mr. Romney leads in some but the real battle is in the Electoral College.

Mr. Obama has a strategy to win it and it may prove the right formula. As I said last before, I think if Mr. Obama wins, it will be by a narrow electoral margin but if Mr. Romney wins the margin will be larger. I have the feeling there is considerable and perhaps hidden frustration about the President and these voters are highly motivated. That frustration was obvious and manifested in 2010. It is less visible now but I think it is still there. If that is the case, there will be a different President come 2013. 

The respective organizations have been waiting for November 6 for some time. Get the vote out. Mobilize the troops. There are still lots of maneuvering going one. However, I suspect the campaigns will know by Sunday night their fate. I await the results. Prediction to come! 

What do all of these have in common? Disaster. Sandy is a known disaster, the fiscal cliff is a coming but avoidable disaster and the election is an unknown disaster.