Trump Tax Plan: Billionaire’s Bounty (Aug. 19)

Mike & Co.,
 
As Donald Trump continues the drawn-out process of providing details of his tax agenda, it has become abundantly clear that his plan stands to benefit the rich at the expense of lower- and middle-class Americans.  Even more audacious — he  appears to be running with three Achilles heels: the Trump loophole, whereby pass-through companies qualify for a reduced corporate rate; the repeal of the estate tax; and the combination of business interest deduction and expensing.

The below analyzes each of the three proposals and their impact on Trump and other wealthy Americans.  We can only estimate how many billions of dollars Trump stands to gain from his own tax plan as he has yet to release his tax returns but it’s not chump change. 

I hope this finds you headed for a weekend with at least some time out of the office.

Best,

Dana

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The Trump Loophole

• Pass-Through Relief for the Wealthy

Arguably the largest, Achilles heel in the tax plan is the so-called “Trump Loophole,” his proposal to reduce the top marginal corporate tax rate from 35 percent to 15 percent.  Under the Trump plan, pass-through entities would qualify for the corporate rate, instead of paying a much higher individual rate.  This is a boon for the wealthy who can report large portions, if not all, of their income as “business income” thereby avoid the higher rates faced by average Americans earning wages and salaries. 

This loophole has largely emerged due to the large reduction of the top marginal corporate rate, without a similar decrease of the top individual rate.  Such discrepancies between the individual and corporate tax codes is “practically a recipe for tax avoidance.”  And while many small businesses are pass-through organizations, at present approximately 70 percent of pass-through income goes to the top one percent of earners.   

•  Benefit to Trump Inc.

Trump’s organizations would stand to gain from this proposal,l and his total tax burden, whatever it may be, would likely be cut in half, though it cannot be confirmed without his tax returns.  Nevertheless, Trump himself has stated, “a lot of the rich are benefitting because of the reduced taxes for businesses.”  Under Trump’s plan, the rich would benefit even more, particularly due to this unchecked loophole.  

As this is a problem of the House Republican tax plan as well, some Republican staffers have acknowledged the problematic situation and are looking into ways to address it.  One idea in the works is a prevention of personal service income from receiving the low corporate rate.  However, Trump and his campaign aides are not seeking to change this provision and any changes in the House Republican plan would not necessarily be reflected in the Trump plan.

 The Estate Tax

•  Relief for the Wealthiest

 A second component of Trump’s plan that conspicuously favors the rich is his proposed repeal of the estate tax.  Trump has called the tax, which applies to estates over $5.45 million for individuals and $10.9 million for couples, “just plain wrong.”  It affects the estates of 0.2 percent of Americans who die each year.  

Trump himself would stand to benefit greatly from such a repeal.  Assuming Trump is worth his stated estimate of over $10 billion, it is likely a 40 percent tax would be assessed on his estate upon the death of both Trump and his wife.  As a result, eliminating the estate tax would save the Trump family approximately $4 billion. 

This $4 billion could be used for a plethora of other efforts, to the benefit of lower- and middle-class Americans.  But a repeal of the estate tax would solely benefit the wealthiest, and the $4 billion would instead continue to go towards the “successful” endeavors of the Trump family. 

•   Benefit to Trump Inc.

Unfortunately, without Trump’s tax returns, it is difficult to determine Trump’s exact net worth.  Bloomberg News has estimated his worth to be far less than $10 billion, at approximately $3 billion instead.  This decreased net worth would result in approximately $1.2 billion in estate tax revenue. 

A Poisonous Combination

•  Interest Deduction Plus Expensing

A third weakness of Trump’s plan is in fact a combination of two policies: continuing to allow businesses to deduct interest, and at the same time permitting immediate write-offs, or expensing, for investment in equipment and buildings.  

Under the first policy, businesses can deduct all interest paid on debts from their tax burden each year.  The proposal to allow expensing on investment deviates from current law, which requires businesses to spread deductions on investments in equipment and buildings over multiple years.  By including both policies in the same plan, Trump would provide negative tax rates for investments financed with debt.  

 This practice could incentivize companies to engage in projects that, without these tax breaks, would no longer be economically beneficial in terms of profits. In essence a business could take high losses in the first year of an investment, while creating ongoing interest deductions.  These losses could then be carried forward and used to offset income in the future.  

• Bipartisan Opposition

NYU law professor and former Obama advisor Lily Batchelder described this policy combination as“insane,” noting that it could “convert the tax code into a direct spending program” for all spending classified as debt-financed business investment. Republican economist Douglas Holtz-Eakin has expressed his confusion over Trump’s reluctance to pair expensing with a termination of interest deductions, calling the union “very weird.”  Alan Viard of the American Enterprise Institute also labeled this generous treatment of businesses as “excessive.”  

• Real Estate Relief

As real estate is one of the sectors that would stand to benefit greatly from such a policy arrangement, Trump would once again be manipulating the tax code to suit his financial interests, and those of his wealthy peers.  As the self-proclaimed “king of debt,” this two policies taken together could allow him to continue to engage in questionable projects and investments. 

While Trump has yet to officially release both policies as part of this tax agenda, he has in the past stated his support for full expensing and his reluctance to eliminate interest deductions.  

 • Benefit to Trump Inc. 

 Estimates for how much Trump would save based on this toxic combination are once again difficult to quantify without information from his tax returns.  But, as those who stand most to benefit in general are those in real estate with high utilization of debt, Trump looks like a prime candidate to reap the rewards.  

Renewed Push for Tax Return Release

Democrats may address Trump’s failure to release his tax to the Senate in September.  Senate Finance Ranking Member Wyden proposed legislation in May requiring major-party presidential nominees to disclose at least three years of tax returns within 15 days of becoming the official nominee.  Should a nominee refuse to release his returns, the Treasury Department would be permitted to disclose them instead.  

Yesterday, Sen. Wyden and Chris Murphy both stated their intention to push for consideration of the bill on the Senate floor. Sen. Wyden also noted that the Finance Committee routinely seeks the view three years of tax returns as part of their confirmation process for executive branch nominees.  It is unlikely as of now that Majority Leader McConnell will allow this bill to receive floor consideration but stranger things have happened this year. 

Counterprogramming Trump on Taxes (July 21)

Mike & Co.,
In a couple of hours, when Donald Trump takes the stage in Cleveland in a couple of hours to accept the GOP presidential nomination, it’s a good bet he won’t say much about his tax plan.  With good reason: he doesn’t have one.

Yesterday, Trump’s campaign announced  that the candidate is preparing a new tax plan, featuring new taxes on the wealthy and no deficits.  Advisors said specifics have yet to be finalized — the plan isn’t expected to be formally released for weeks after Trump is nominated. 

Below we analyze the details of the new plan available, compare it to Trump’s original proposal, and imagine its reception in the next Congress.

Best,

Dana

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Take Two on Taxes

After releasing a tax plan during the primary campaign with tax cuts that dwarf the GHW Bush cuts of 2001 and 2003, loading trillions onto the national debt, Trump is tacking toward fiscal reality.  Per estimates by the Tax Foundation, the next plan will cost at least $3 trillion over the next decade; his original plan cost $10 trillion.  

Trump advisors reportedly made “tough decisions” on which tax breaks to keep in order to reduce the cost by $7 trillion, and a number of deductions presently enjoyed by wealthy Americans have been eliminated.  They have indicated that the plan will resemble House Speaker Paul Ryan’s recent proposal. Says one, there’s “not a heck of a lot of daylight” between the two proposals.  House Ways and Means Chair Kevin Brady described the plans as “kissing cousins.”  Both plans would reduce the corporate rate to 20 percent, as opposed to Trump’s original 15 percent.  The new tax agenda will reportedly feature a top individual rate of between 30 and 33 percent, higher than the original 25 percent, and in line with Ryan’s proposed 33 percent.  

The new plan is expected to be unveiled a few weeks after the Republican Convention in a speech at the Detroit Economic Club, though a date has yet to be officially announced. 

The revision is seen as an effort to attract support from Congressional Republicans, many of whom have been reluctant to endorse the candidate. Allegedly included in the proposal is a tax credit for children and families similar to one supported by Sen. Rubio in his campaign, supposedly part of framing the plan as beneficial for the middle class.  

 The Original Plan

Trump’s original tax plan would have made sweeping changes to the individual and corporate codes.  The seven tax brackets on the individual side would be collapsed into three, with the top bracket cut from 39.6 to 25 percent.  The standard deduction would be raised to $25,000 for single filers and $50,000 for joint filers.  It would repeal the alternative minimum tax and estate tax, reduce the corporate rate to 15 percent, and impose a tax of up to 10 percent on repatriated revenue.  It would eliminate the 3.8 percent net investment income tax on people with incomes over $200,000, a tax  paying for the Affordable Care Act.  

The Trump campaign website describes his original tax plan as “revenue neutral” with numerous pay-fors, including a reduction in loopholes and deductions for the very rich.  The Tax Policy Center has concluded the proposed loopholes are “nowhere near enough” to overcome the tax-rate cuts, hence the significant costs over a decade.  

An analysis of the original plan and overall economic agenda by Moody’s Analytics found it “fiscally unsound,” resulting in “very large deficits and a much higher debt load.”  It predicted a lengthy recession, enormous job losses, higher interest rates, increased unemployment, a plummeting stock market, reduced long-term growth opportunities, and a “diminished” U.S. economy.  

In May, in repeated interviews, Trump stated his belief that taxes on the wealthiest Americans should be increased, albeit slightly.  However, when later pressured for details, he revealed this “increase” pertained not to current rates, but the rates proposed in his original plan, which are far lower than under present law.  If this intention holds true in his new plan, taxes on the wealthy would still be lower under Trump, assuming the candidate doesn’t change his mind again.

 Personal Profit

It would appear that Trump himself stands to gain a large sum of money as a result of his tax plan.  According to one estimate, the Trump family would gain a tax cut of $7.1 billion.  Such an estimate is necessarily speculative — Trump has shown no evidence that he has paid taxes in nearly forty years.

Looking Forward

No matter what the election outcome, it won’t be easy for Congress to pass a major tax bill in 2017.   

Both Trump and House Republican leadership have stressed their intention to prioritize tax reform, with Chairman Brady noting his preparation for a vote on tax reform in 2017.   But the GOP may not control Congress next year and willy-nilly there is nothing close to consensus on comprehensive reform.  Conservatives will insist on paying for it in full; progressives will emphasize increasing taxes on the wealthiest Americans.  On the corporate side, multinational corporations will lobby for a revised system, with a top rate of no higher than 25 percent and favorable terms for dividend repatriation.  Small businesses will push for equal treatment.  Put all of that together, and you have a very expensive bill that probably can’t pass.  

We don’t know what the tax reform landscape like in 2017, but as the primary campaign and this week’s convention show, tax policy though traditionally a headline GOP issue, has been particularly muted this year.  This may reflect not only Trump’s uncertainty about his revised plan but also an abatement of the popular ardor for tax cuts in recent decades.  Americans may have recognized that tax cuts are not an optimal solution, given the devastation of public services, the further crumbling of an unreliable infrastructure, and exacerbated inequality wrought by the recent recession.

House GOP Tax Reform Plan (June 27)

Mike & Co. —

Last week, the House GOP capped off a month of policy events, announcing a new tax reform plan.  The  proposal is aimed not only at getting the fractious caucus on the same page on an issue long a top GOP priority but also at creating some space between Congressional  Republicans and the party’s presidential nominee to insulate the former against the latter.

No official scoring has been offered estimating the cost of the tax plan, though the authors say they are aiming for revenue neutrality.  The plan is part of Speaker Ryan’s A Better Way policy platform, which includes plans to address poverty, security, health care, and the economy.  While many of its proposals are what you’d expect from a GOP tax plan, some new proposals have made the cut this time around.

What’s in it and what should we expect next?

Best,

Dana

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 Business Tax Proposals

  •  Cut corporate tax rate: The corporate tax rate will be lowered from 35 to 20 percentwhile small businesses will pay 25 percent.
  •  Adopt a territorial tax system: Corporations will not pay taxes on income earned overseas.
  •  Move to a “cash flow” based tax system:  A popular idea among conservative circles, the plan embraces taxes against cash flow as opposed to income.
  •  Allow the immediate expensing of capital investment:This will likely come at the cost of the interest payment deduction for businesses.

Individual Tax Proposals

  •  Institute three tax brackets: The top rate of 39.6 percent moves to 33 percent.  Other brackets are 12 and 15 percent.
  •  Increase the standard deduction, child credit, and EITC:  A larger standard deduction takes the place of many itemized deductions and credits, while GOP favorites, like the EITC, charitable contribution credit, and mortgage interest rate deduction will stay.
  • Eliminate the alternative minimum and estate tax: Itwouldn’t be a Republican tax plan without these two taxes on the chopping block.
  •  Cut rates on investment income: Only half of investment income will be included when calculating a person’s taxable income.  That would create a new rate structure of 6 percent, 12.5 percent and 16.5 percent.

New Features

The plan’s top personal income tax rate is set much higher than previous plans, which often contained provisions of 25 percent or less – 33 percent is a major increase from there.  That higher-than-expected rate is likely more than made up for by the plan’s treatment of investment income

Investment income receives a significant boost in the plan. The ability to deduct 50  percent of all investment income from taxable income is meant to encourage Americans to invest and save but will also certainly be a boon to wealthy taxpayers.

On the corporate side, including a consumption-based tax on businesses is novel.  This type of tax most recently made a splash when a number of GOP presidential hopefuls included them in their plans last year, but they have been gaining support in conservative think tanks for some time now.  The same goes for creating a territorial tax system, whereby international earnings are not taxed against American businesses.

Old Chestnuts

The plan’s more favorable treatment of investment income could more than make up for the plan’s 33 percent income tax on the wealthy.  While that top tax bracket is higher than is usually seen in conservative plans, the ability to discount one-half of all investment income is a major benefit for the most affluent.

Conservatives in general, and Ryan specifically, have long called for an increase in the EITC and the child tax credit.  They also defend the home mortgage interest rate deduction and the charitable contribution deduction.  As such it’s not surprising that these tax incentives were singled out for special mention in their tax plan.  What’s missing is a list of all the other bits of tax code that are supposedly being cut to make room for income tax cuts.

Ending the alternative minimum tax and the estate tax are long-standing goals of the GOP and as such are standard in plans like this.  So is the promise to cut out the many itemized deductions and credits available to individuals and businesses alike – a major pillar in the conservative argument for simplifying the tax code.

Corporate vs. Individual Reform

It’s not surprising that the corporate tax system sees more radical changes in this plan.  Proposals to institute a consumption tax, a territorial taxation system, and to eliminate the corporate alternative minimum tax should make many in the business community happy.  One notable exception: corporate real estate companies and asset managers, who stand to lose money if the interest rate deduction is killed.

Despite lacking the bells and whistles of the corporate side of things, individual rate payers haven’t been neglected.  High Investment income treatment and an end to estate taxes are big benefits for them, not to mention a reduction in income taxes (though it’s not as steep a reduction as we’re used to seeing).

The Plan’s Purpose and Prospects

GOP lawmakers say that they’ve learned from the failure of Dave Camp’s 2014 tax plan.  That experience was the impetus behind this much more radical proposal, which likely won’t be fully fleshed out until 2017.  The plan as it stands today amounts to House Republicans’ opening bid in any tax reform effort.

While no scoring has been released yet, the plan reflects familiar GOP imperatives: no tax increases and no deficit increase.  That means it will rely heavily on optimistic dynamic revenue estimates.  On top of these considerations, any plan to “simplify and flatten” the tax code will require a greater level of enforcement to make sure that taxable income is properly collected.  Creating zero new taxes on exports and profits earned overseas will tempt companies to come up with ways to make their income fit either description.  That goes against the plan’s promise to effectively neuter the IRS.

Moving Forward

Republicans have announced this tax plan late in the game for 2016.  And it’s as much a matter of policy as it is of the political reality facing them.  House leadership may be itching to set out a plan that is seen as more reasonable compared to Donald Trump’s $9.5 trillion slash-and-burn proposal. Additionally, they may be trying to set up a gentle glide path toward a compromise on tax reform with Democrats.  Because of that, don’t expect to see much further development on this plan – a scoring should come in the near future, but real legislation probably won’t come with it.

The Three Tax Buckets for 2017 (May 18)

Mike & Co. — 

Defying a tradition dating back to 1976, presumptive GOP presidential nominee Trump has continuously flipped his answer about whether will or won’t release his tax documents, saying at times absolutely yes.  Or would never dream of it.  Or really wants to but really can’t just yet. 

While we wait, we have a moment to survey tax policy issues and proposals currently under discussion in Congress and assess the Trump factor on the Hill through the prism of tax legislation. 

Best,

Dana 

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Policy Asymmetry or Vacuum

Typically in an election year, tax policy stands as a major pillar of the candidates’ and parties’ platforms.  But that’s not been the case in 2016.  In fact, this Congress has been a rather active tax policy laboratory.  This year the Hill has rapidly become a testing ground and showcase for future initiatives.

This cycle is unusual in that the party in control of Congress does not have any solid indication of where its nominee will end up on major tax issues.  Of late, Trump has begun trying to mix a message of populist anger with pro-Wall Street financial reform promises, leading to a muddied and confused tax platform.  Such basic tax policy positions as he has taken he has taken back. Other positions come with such sketchy detail that large unanswered questions remain.

Consequently, down-ballot candidates still don’t know if they will be running with or away from their nominee’s tax policy. That lack of predictability has led lawmakers to seek shelter in a safe harbor: preparing for 2017.  By fixing their sights on the next Congress, legislators today can spare themselves the risks involved in trying to predict the policies of an unpredictable politician.

Three tax approaches

Members from both sides have focused on developing policy in three major tax areas, all of which have seen proposals, from the comprehensive and bipartisan to the narrow and ideologically tilted.

  •  Corporate tax reform

Senior members of the tax-writing committees in Congress are doing their best this spring to generate buzz around promised bipartisan broad-based corporate tax reform initiatives.  This annual ritual looks like it will come up short again.  But the debate is prologue.

Senate Finance Chair Hatch has said that his own corporate integration plan will be released in the “next several” weeks, and the plan had its own hearing yesterday in Finance.   It enjoyed the support of most of the witness panel, though Ranking Member Wyden did point out with one witness that corporate integration may cause a dip in investment from savers.  Concerns were raised about the impact on Americans’ retirement security.

House Ways and Means Chair Brady has promised to release his own comprehensive tax reform plan by June, a substantial portion of which is expected to address corporate tax issues.  His office has stated that no ideas are off the table: “consumption tax, cash flow tax, reformed income tax, and any other approach that will be pro-growth.”

  •  International tax reform

The name of the game in international tax reform is this: inversions.  Finding a way to curb the corporate maneuver which takes American companies overseas to avoid U.S. taxes has been a major priority of Congress for some time now.

Rep. Sander Levin, Ranking on Ways and Means, recently released his third measure this Congress to address the issue.  Yesterday, he announced a plan that would address “de-controlling” and “hopscotching.”  The former allows foreign companies to reduce the U.S. ownership level of a company to just under the minimum requirement for an inversion to take place; the latter enables a foreign parent company to use overseas earnings of the foreign subsidiaries of a U.S. company without paying tax.

GOP plans focus on solving inversions by drastically reducing the corporate income tax rate and switching to a territorial tax system — which would forego taxing the income earned by companies abroad.  So far no proposal has surfaced this Congress to codify these ideas.

  •  Financial reform through taxes

This is a part of tax reform which is firmly in the hands of progressive members.  A number of proposals seek to close tax loopholes which benefit the wealthy (such as carried interest, below) or to add a surcharge (the Buffett Rule), in particular for those who gained wealth through work in financial services.

Sen. Baldwin’s Carried Interest Fairness Act of 2015 aims to close the loophole allowing hedge fund managers to claim their income as capital gains.  Sen. Warren aims to fund one-time emergency social security payments by eliminating tax deductions for “performance-based” wages at America’s biggest companies.

Yesterday, Sen. Wyden released a proposal aimed at preventing “sophisticated” taxpayers from avoiding paying taxes on investments by streamlining the rules for taxing derivatives.  Some taxpayers have been able to take advantage of the complexity of rules in this area to reduce the amount of taxes they have to pay.

Under the proposal, derivative contracts would be treated as if they had been sold and bought again at the end of each year, and the gains and losses would be taxed as ordinary income.  The discussion draft is targeted toward those trying to avoid taxes and not toward those hedging business risks, employee stock options or derivatives in pension funds. JCT estimates that the proposal would raise $16.5 billion over a decade.

Let a Thousand Tax Plans Bloom (May 17)

Mike & Co.,

Word this afternoon is that Senate Banking will take another shot at a conformations votes for five regulatory nominees, including two for SEC commissioner, perhaps as soon as this week.  This follows an aborted April 7 vote, in which four Democrats (Schumer, Menendez, Warren, and Merkeley) withheld support for their own party’s nominee at the last minute.  While a new vote hasn’t been scheduled yet, it is now expected in the coming days.

Should the nominees clear the Committee, it’s unclear they can get any floor time in the Senate.  Observers have predicted that they will need to pass by unanimous consent — meaning that just one Senator can block their confirmation.

Meanwhile, once again, the main legislative developments of note are on the tax front. We try to bring you up to date below. 

Best,

Dana

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Today marks the beginning of a series of tax hearings in Congress as Democrats begin to position themselves for what could be a power swap in 2017.  Per Todd Metcalf, minority chief tax counsel for Senate Finance:  “We are putting together the building blocks hopefully so that we will be ready when in 2017 or whenever the opportunity arises, we are ready.”

Democrats in Congress  are using 2016 as a staging area to gauge reaction to their plans for next year – drafts are being  circulated and released so offices and gather feedback and make the necessary changes to improve the odds of pet projects’ passage in 2017, where circumstances are likely to improve, possibly markedly.

The GOP is up to the same thing. The corporate integration plan to end double taxes on corporate income from Senate Finance Chair Hatch and the tax blueprint by House Ways and Means Chair Brady are being developed to carry forward priorities while awaiting the right moment.

What’s Been Released, What’s Ahead

Senate Finance ranking member Wyden has been busy this year, releasing a number of proposals.  On April 26, he released a proposal changing the rules on capital depreciation, simplifying the schedules currently in use; earlier in the year he proposed changing the minimum ownership stake require for a company to invert.

Wyden is expected to introduce draft legislation to revise taxes on financial products like derivatives in short order. The draft is said likely to resemble, at least partly, proposals offered in early 2013 by former Ways and Means Chair Dave Camp, while incorporating some of the changes sought to Camp’s bill.

Sen. Wyden and other Democrats have also talked regularly about legislation to tackle inversions and related cross-border income issues.   Last year, Wyden published a report saying legislation to mark all derivative instruments to market and tax the resulting gains or losses as ordinary income would end the manipulation of timing and income character that derivatives allow.  On wash sales, the Wyden report said rules could be updated to apply to forward contracts, swaps and derivatives involving commodities and currencies, and additional legislation could address immediately replacing a loss position.

Sen. Schumer is focused on achieving some sort of tax overhaul that would be linked to infrastructure investment.  His plan for 2016 —  “Let people know how great the need is on both sides to straighten out the international system, for the inversions and everything, but also how demanding our need for infrastructure is and to marry the two.”

In a moment of bipartisan success, and perhaps a view of what we stand to lose as we wait for 2017, the Senate passed a bill on May 10 allowing tariff relief for goods that domestic manufacturers cannot find inside the United States.  The bill took longer than expected, but has been hailed as a way to allow American manufacturers to remain competitive.

The Landscape for 2016

Congress is on an abbreviated schedule for this election year and it’s sloped heavily toward the spring side of 2016.  Legislative days are in short supply already and whatever time for compromise existed in 2016 is fast disappearing.  It is likely that we will have to wait even for a hint of bipartisan agreement on tax reform issues until after the November election.  Even if 2016 turns out to be a year for preparing and showcasing legislative ideas in Congress, but that doesn’t mean it will be a boring one for legislation.

Section 162(m): the Bonus Break (May 10)

Mike & Co. —

April showers in May provides an excuse for a tax focus this week.  How many know that the federal tax code had a provision allowing large firms to write off the bulk of their executives’ wages?  Section 162(m) of the Code has a loophole letting “performance-based” compensation to be claimed as business expenses, costing U.S. taxpayers $5 billion per year (per the JCT).

Half the Senate Democratic caucus has now supported a legislative effort to close the “Bonus Break,” which is easier to grasp than the carried interest loophole and twice as expensive.  

More below.  More on carried interest tomorrow. 

Best,

Dana

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Performance Incentive or Tax Dodge?

Large companies able to take advantage of Section 162(m) and deduct all “performance-based” compensation packages from a business’ tax liability as a business expense.  That same section of the Code limits the tax deductions for regular salaries to $1 million, but only for the CEO and the next four highest paid officers.  These are the “covered” employees comprising the beneficiaries of the loophole.

Instead of putting an end to galloping CEO salaries, as it was intended to do, Section 162(m) set a floor for executive compensation at $1 million annually, plus any and all bonuses, stock options, or other “performance based” payments a CEO could desire.  While 162(m) does contain four statutory requirements for compensation to qualify as performance based, Congress has already declared that any stock option given to a CEO must be performance based per se.

The massive increase in executive pay seen in the past two decades is probably not a coincidence.   Between 1978 and 2013 CEO compensation has increased by 937 percent; in 1995 the CEO-to-worker compensation ratio was 122.6-to-1 (up from 30-to-1 in 1978) and by 2013 was 296-to-1.

The Current Criteria

A performance-based compensation package needs to meet four criteria to qualify for 162(m) treatment:

•   Performance Goals:  the compensation must be contingent on meeting one of more “pre-established” and quantifiable performance goals

•   Compensation Committee:  the goals must be set by the corporation’s compensation committee

•   Shareholder approval:  shareholders must hold a separate vote to approve the compensation terms, including the applicable goals and the total maximum amount payable to a covered employee, before the compensation package is paid

•   Committee Certification:  before any payment, the compensation committee must certify, in writing, that the performance goals were met

In theory, these requirements set out a minimum level of due diligence for companies to follow when assigning CEOs a performance-based compensation package, but in practice little of it matters.  Since stock options are considered performance-based per se, the simplest solution is to make a sizable amount of any executive’s performance-based pay based on that form — a loophole built into a loophole.

Ending the Corporate Bonus Break

The break had faced criticism from both sides of the aisle.  Sens. Reed and Blumenthal introduced the Stop Subsidizing Multimillion Dollar Corporate Bonuses Act in 2013.  Rep. Lloyd Doggett introduced the companion House bill the next year.  These bills would have recovered the full $50 billion which is lost over 10 years to the loophole.  Former GOP Ways and Means chairman Dave Camp targeted the break in his 2014 tax reform proposal, indicating Section 162(m)’s legislative vulnerability.

The loophole has long been a point of contention in government.  In 2007 the SEC announced it would issue a rule concerning executive pay disclosure, pay if an attempt to shame companies into lowering pay packages. Some expected a democratic surge after Bush left office to take care of the matter once and for all, but 162(m) has survived, due to defense by beneficiary firms.

Criticisms Fall Flat

Lobbyists for these firms have long said that the government has no right to dictate how much firms pay their executives. This argument is not a serious one.  The proposals to deal with the performance-based pay loophole don’t limit firms’ ability to pay CEOs, or any other covered executives.

Will the best executives have less incentive to work if companies lower their pay in the face of higher taxes?   This relies on the (idle) speculation that companies will punish executives for the closing of the bonus loophole.

Chances in Congress Today

Not high.  But the proposal scores many pinball points, hitting on several of the most resonant issues in the political campaign — big corporations (sounds kinda like Wall Street) profiting off a special bonus break for rewarding their top bosses…. Voters oppose this section of the Code by nearly 2 to 1 (63-34) when asked about it.  Corporations should be free to pay their CEOs whatever they choose but asking taxpayers to subsidize those salaries is a non-starter in 2016.  It may be history by next year.

Corporate Tax Reform Proposals (Apr. 25)

Mike & Co. —

It’s April, tax time, and tax reform is in the air in DC again this spring as Senate Finance and House Ways and Means both hold hearings on the topic this week.  Additionally, the Joint Committee on Taxation released a comprehensive background report on corporate income tax (CIT) reform Friday which outlines and analyzes the principle reform proposals from Treasury and the Hill. 

The JCT report raises some questions underlying the debate such as: is the business side of the tax functioning as intended in fiscal terms?   The basic structure of the CIT has not changed in decades.  Yet the reports shows the share of revenue it contributes has fallen over the last 60-plus years to the point where individuals are paying over $300 billion a year more in 2017 dollars to make up the difference. 

More on this and the proposals that will be considered this week below. 

Best,

Dana

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Proposals on the Table

Senate Finance will hold a full committee hearing tomorrow on “navigating business tax reform.”  Ranking member Sen. Wyden is also rumored to be releasing a proposal tomorrow that will rewrite corporate depreciation schedules for the first time since 1986.

Sen. Wyden’s proposal would implement changes to a relatively small component of the business tax code, but it’s one which gets to the heart of the matter – it change would slow down and “simplify” deductions, which likely means that there will be one or just a few standard rates of depreciation, a benefit for manufacturing firms.

Meanwhile, despite the broad-based reform efforts toward the end of the last Congress, the bold talk has remained just that: talk.  One option was put forth by Rep. Bob Goodlatte, chair of the House Judiciary committee.   His Tax Code Termination Act would abolish the entire tax code, save for payroll taxes, on December 31, 2019.    Goodlatte says that a hard deadline would help to “focus the mind” of lawmakers on fixing the issue of an unworkable tax code.  The bill boasts 130 cosponsors, only one of which is a Democrat, and like faces an uphill battle even within its own party.  It will be difficult to get support for such a radical proposal, especially considering how little momentum has been built for comprehensive reform so far.

Comprehensive Options

The JCT’s newest report covers four or the more serious and comprehensive CIT reform proposals, as follows:

Obama’s Framework

  • Repeal a number of corporate tax expenditures, including credits for energy companies and repealing methods of accounting for inventories
  • Allowing the repatriation of foreign profits at a special tax rate of 14 percent with a rate of 19 percent thereafter for all foreign-earned profits
  • Reducing the maximum corporate tax rate from 35 percent to 28 percent
  • Repealing the corporate AMT

Reforms Maintaining Current Income Tax Structure

  • See: Dave Camp and Max Baucus plans for broadening the base in order to lower rates
  • Change the manner in which property depreciation is calculated by businesses
  • Repeal of certain tax credits to create a more level tax field
  • Provide relief for certain types of income, particularly for income derived from intellectual property or for passthroughs by harmonizing the top individual and corporate income rates

Reforms Altering the Income Tax Structure — Proposals that consider equalizing the tax treatment on debt vs. equity by repealing the interest payment deduction for corporations:

  • Allow for corporations to take a deduction on the payment of dividends in order to prevent the double-taxation of income
  • Abolish the corporate income tax entirely in order to prevent double-taxation of income, and rely on the use of individual income taxes from dividend payments

Consumption Tax — These have been particularly popular in the Republican race, with Rubio and Cruz both promoting plans that use some variation of the below:

  • Institute a Value-Added Tax (VAT) to replace the corporate income tax or sales tax
  • Institute a cash-flow tax, this is often taxed at the business level and would prohibit the taxation of dividends and capital gains

Impact and Rationale 

The share of federal tax revenue that comes from the CIT has dropped from a high of 39.8 percent in 1943 to just 10.8 percent in 2015 (which was actually the highest it had been since 2008).   The remainder of federal tax revenue comes from a combination of payroll taxes (about 30 percent) and excise taxes (under 10 percent).  Both of these are regressive and weighted toward consumers or individual earners, meaning that the real share of tax revenue from individuals is higher than indicated through the income tax — but it has become more over the decades.

Shifting Burdens

To put this into hard numbers, in 2014 individual taxpayers foot a bill of roughly $1.03 trillion in income taxes alone, compared to a corporate income tax payment of $138 billion.  If the relative tax burden had stayed the same between 1943 and today, businesses would have paid $471 billion.  Accordingly, individuals, including S and C corp filers, solo proprietors, and most small business owners and farmers are paying $333 billion more per year to make up the shortfall and tax nonpayment by corporations.

The slowly shifting tax burden in the U.S. away from the CIT represents a regressive and significant form of transfer payment to corporations that has been largely overlooked or at least unremarked on.  The impact of this shift on ordinary citizens, small business owners, and millions of others cannot be understated and neither can the importance of politicians at least sparking discussion about it.