Overview: Senate Finance Committee held a hearing on Tuesday, Sept. 19, 2017, to examine ways to improve the U.S. tax code’s business provisions, create a healthier economic environment, and encourage job creators to invest in the U.S. in order to increase their competitiveness in the global market. The hearing, entitled, “Business Tax Reform” took place at 10 a.m. in Dirksen Senate Office Building, Room 215.
Mr. Scott A. Hodge, President, Tax Foundation
Dr. Donald B. Marron, Ph.D, Institute Fellow, Urban Institute and Urban-Brookings Tax Policy Center
Troy K. Lewis, CPA, CGMA, Immediate Past Chair, Tax Executive Committee of the American Institute of Certified Public Accountants
Mr. Jeffrey D. DeBoer, President and Chief Executive Officer, The Real Estate Roundtable
Chairman Orrin Hatch (R-UT): Members of both parties recognize the need to reform the way we tax businesses in the United States. As former President Obama noted when discussing his own framework for business tax reform, the current system “does too little to encourage job creation and investment in the United States while allowing firms to benefit from incentives to locate production and shift profits overseas.” As we all know, many elements of a particular business’s tax burden depend on the company’s organizational form. For example, C-Corporations are taxed at the corporate tax rate. According to a recent report by the Congressional Budget Office, the top federal statutory corporate income tax rate has been 35 percent since 1993 and, with state taxes added, the United States’ average corporate statutory rate is the highest in the industrialized world, at more than 39.1 percent. We need to lower the corporate tax rate to relieve the burdens the tax imposes on American workers, who, according to many economists, bear a significant part of the corporate tax. We also need to reduce the burden on pass-through businesses, whose earnings are reported and taxed on individual tax returns. We need to fix our international tax system so that American businesses can compete in the global marketplace without facing significant disadvantages simply because they are headquartered in the United States. We know that my friend, Ranking Member Wyden, shares these broad objectives. In fact, he has put forward his own tax reform proposals in the past, likely with these same goals in mind. And, at the end of the day, we should all, at the very least, agree that the current tax system is broken and the current state of our economy should not be accepted as the new normal.
Ranking Member Ron Wyden (D-OR): Last night, the majority announced that the Finance Committee will hold a hearing on the Cassidy-Graham-Heller healthcare bill without consulting the minority. That aside, the Finance Committee cannot adequately examine a proposal this massive in a single hearing and without a full analysis from CBO. The plan for this bill to be discussed in a single hearing on a Monday morning and hit the Senate floor a day or two later makes a mockery of the legislative process. Disagreements on policy aside, this is an abomination to the process. Regarding tax reform, the secretive “Big Six” meetings suggest the plan is a major, unprecedented tax giveaway for the most fortunate and the biggest corporations in the U.S. The centerpiece of the bill could be a major loophole called a pass-through status. A pass-through company should be a small business, like a restaurant. Any law that allows a company to self-declare as a pass-through company would be worse than what is on the books currently in the tax code. It is time for Congress to take the lies out of the corporate tax rate in America. Armies of lawyers and accountants are utilized by corporations to cut their tax rates to teens, sometimes even single digits. It’s time to tackle this very important issue.
Mr. Scott A. Hodge: The most important thing that Congress and the Administration can do is boost economic growth, lift wages, create jobs, and make the U.S. economy more competitive globally to overhaul the business tax system. The Committee should have four priorities in mind:
- provide full expensing for capital investment
- cut the corporate tax rate to a globally competitive level, such as 20%
- move to a competitive territorial system
- make all three of these priorities permanent
Many may see these policies in conflict or competing for space in the tax plan; we see these pieces as complimentary and essential. Cutting the corporate tax rate and moving to a more territorial system are essential for restoring U.S. competitiveness and reducing the incentives for profit shifting and corporate inversions. These measures are also important for refining and reclaiming the U.S. tax base. Currently, the EU and OECD are proposing policies, such as a new turnover tax on digital companies, which are directly aimed at raising taxes on U.S. multinationals. Expensing is the key to reducing the cost of capital, in order to revitalize U.S. capital investment, which, in turn, will boost productivity and wages – thus, a good tax plan should include all three of these policies. They will boost economic growth while leading to higher wages and living standards for working Americans. That said, the gains are not possible if made temporary. Temporary tax cuts deliver temporary results. Permanent reform delivers permanent economic benefits. It’s difficult to sell corporate tax reform to the public, but it can have a powerful effect on spurring economic growth and lifting after-tax incomes and living standards. We simulated the long-term economic effects of cutting the corporate tax rate to 20% and moving to full expensing for corporations. We found that these two policies combined would increase the level of GDP by 3.4%, lift wages by an average of 3.8%, and create more than 860,000 new jobs. We found these two policies, combined, would boost the after-tax incomes of all Americans by an average 5.2%. Finally, expensing eliminates pages and sections from the tax code – saving businesses over 448 million hours of compliance time and over $23 billion in compliance costs each year. Corporate tax reform done right is key to growing the economy, boosting family incomes, and making the U.S. a better place to do business in and from.
Dr. Donald B. Marron, Ph.D: America’s business tax system is needlessly complex and economically harmful. Thoughtful reform can make our tax code simpler, boost American competitiveness, create better jobs, and promote shared prosperity. First, thoughtful reform can promote economic growth but we should be realistic about how much. More and better investment boosts economic activity over time – the largest effects will occur beyond the 10-year budget window. If reform is revenue neutral, revenue raisers may temper future growth. If reform turns into tax cuts, deficits may crowd out private investment. Either way, the boost will be modest. Second, the corporate income tax makes our tax system more progressive. It falls on shareholders, investors, and workers – economists debate how much each group bears. The bulk falls on the highest earners. Third, workers would benefit from reforms that encourage more and better investments in the United States. Benefits depend on worker productivity. Reforms that encourage investment and boost productivity would do more to help workers than those that merely increase shareholder profits. Fourth, taxing pass-through business income at preferential rates would inspire new tax avoidance. When taxpayers can switch from a high tax rate to a lower one, they often do so. S-Corporations, for example, are often used to avoid payroll taxes. Congress and the IRS can do its best to limit tax avoidance, but the cost will be new complexities, arbitrary distinctions, and new administrative burdens. Fifth, capping the top tax rate on pass-through business income would benefit only high-income people. To benefit, taxpayers must have qualifying business income and be in a high tax bracket. Creating a complete schedule of pass-through rates could reduce this inequity but would expand the pool of tax payers tempted by tax avoidance. Sixth, taxing pass-through business income at the corporate rate would not be a level playing field. This would favor pass-through over corporations. To get true tax parity, you could apply a higher tax rate on pass-through business income, levy a new tax on pass-through distributions, or you could get rid of shareholder taxes. Seventh, it is difficult to pay for large tax cuts and business tax rates by limiting business tax rates and deductions. To pay for large rate reductions, you would have to raise other taxes or introduce new ones. Options include raising taxes on shareholders, a value-added tax like the destination-based cash flow tax, or a carbon tax. Finally, making business tax cuts retroactive to January 1, 2017 would not promote growth. This would simply give a windfall to profitable businesses that does little or nothing to encourage productive investment. It could actually weaken growth by leaving less budget room for more pro-growth reforms. Additionally, all the benefits would go to shareholders, not workers.
Troy K. Lewis, CPA, CGMA: Provide tax reform to all of America’s businesses. We need a tax system that is fair, stimulates economic growth, has minimal compliance costs, and allows taxpayers to understand their tax obligations. First, we are opposed to any new limitations on the use of the cash method of accounting. It is simpler in application, has fewer compliance costs, and doesn’t require taxpayers to require tax before receiving their income. Second, tax relief should not mean a rate reduction for only C-Corporations. Congress should encourage, or at least not discourage, the formation of pass-through entities. Inequities would also arise from significantly different income tax rates based on an overly simplistic approach, such as one centered solely on the structure, sector, and general nature of business activities. Excluding professional service firms, for example, from the benefit of a lower business rate reflects a view that is not in line with the current global environment. We recommend codifying traditional definitions of reasonable compensation and providing additional guidance from Treasury and the IRS. If Congress moves forward with a fixed percentage split for business income, such as treating 70% of pass-through earnings as employment income and 30% as returned capital, we recommend making the proposal a safe harbor, rather than a fast rule. Another important issue is the ability to deduct interest expense. Businesses rely on equity to survive. We should not take away this critical deduction. Otherwise, businesses may have to rely on debt-financing. Finally, we encourage Congress to enact mobile workforce legislation, such as the bill introduced by Senator Thune. The burden of tracking and complying with all the different state payroll tax laws is complex and costly, particularly for small employers. The mobile workforce legislation provides a uniform, national standard for non-resident state income tax withholding and an exemption from state income tax for non-resident employees.
Mr. Jeffrey D. DeBoer: Tax reform’s impact on the commercial real estate industry will have wide-ranging effects on the economy and job creation, as well as the overall GDP. In 1981, Congress provided our industry with very aggressive tax incentives. These incentives spawned a robust tax shelter industry that resulted in the development of millions of buildings that had no tenants. In 1986, Congress rightly eliminated these provisions, but the combination of these actions caused severe dislocation in real estate markets nationwide, caused great numbers of lost jobs, resulted in countless bankruptcies, and many believe, led to the demise of the savings and loan industry. It took years for the economic pain to work through the system. The first step of tax reform should be to reduce the tax on all job-creating businesses, not limited to corporate income, but also include income from pass-through businesses. Pledged to Senator Wyden that his industry and organization will work very hard to make sure there are no games played on compensation earned. Pro-growth tax reform should also reward risk through capital gain. Expensing structures would obviously encourage a lot of development, but we are concerned that this development would not be supported by underlying demand and such uneconomic development is a false indicator of economic strength, badly distorting markets. The deduction for federal, state, and local property tax payments should continue. The like-kind exchange rules are a positive part of the economy and should be continued. In 2015, Congress took a very positive step in the PATH Act, regarding the taxation of foreign investment in U.S. real property – we urge you to repeal that. Finally, we urge you to consider an infrastructure initiative of some type in tax reform. Action in this area is badly needed and would create jobs.
Senator Orrin Hatch (R-UT): Asked Lewis and DeBoer to discuss how the current tax treatment of debt and equity financing leads to overleveraging of businesses, and how limiting the deductibility of business expenses brings the tax treatment of the two more in sync. Lewis responded that equity financing for many startups and small to mid-sized businesses is not available. While the points Senator Hatch made are valid, Lewis conceded, taking away an interest expense deduction will put more burden on these businesses. Tax laws shouldn’t discourage the formation of new businesses – it’s one of the best parts of the tax code and should be continued. DeBoer responded that overleveraging should be examined on an individual basis. If there is overleverage, it’s a problem with the regulators that were supposed to be determining whether someone had too much leverage. We would prefer that the issue be dealt with there, not through the tax code. The use of debt is very important for all businesses, not just startups and small businesses. Debt allows entrepreneurs to retain more control of their business operation; if they give up their equity, they lose control.
Senator Chuck Grassley (R-IA): Asked about the restrictions imposed on the ability to deduct interest. The House Blueprint generally eliminates interest as a business expense in exchange for going to a full expensing on capital assets. Sen. Grassley asked the panel if any restriction on the deductibility of interest should be considered to finance lower rates or faster depreciation. Marron responded that we have a system that has accelerated depreciation but allows interest deductibility. The challenge there is that you can over-encourage investment. He is open to reducing interest deductibility if it’s paired with making depreciation more favorable that moves in the direction of a consumption tax. Hodge agreed saying that his models show that when you eliminate interest deductibility, it raises about $1.2 trillion. When paired with a corporate rate cut or full expensing, you can get the most benefits with the least amount of harm. Another advantage in eliminating interest deductibility is in the reduction in the amount of earnings stripping.
Senator Carper (D-DE): Noted that we’ve been down this road in early 1981 with tax cuts for the higher income people: it didn’t work. We tried it again in 2001 and ended up with no debt and not the economic growth we’d hoped for. Now we’re trying it again and it doesn’t make much sense. Asked Marron to lay out what the largely deficit-financed tax cut would have on long-term economic growth for the U.S. and our deficits. Marron responded that if you look at the CBO forecast for the next decade, we’re on track to spend around $50 trillion and to bring in by tax revenue about $40 trillion. So we’ll have about a $10 trillion deficit increase over the next decade which will build the debt from about 70% of GDP today to about 90% of GDP by the end of the budget window. That’s a standalone problem but if you deficit-financed tax cuts today, you’d have more of that. So you could have another $1 or $2 trillion of additional debt over the decade depending on the scenario we took. The financing of that would have to come from somewhere. One way is by reducing the amount of private investing in the United States, which would weaken the amount of growth you get from a tax reform. Foreign capital could offset this, but then you’re left with more benefits going overseas. Carper then asked what the evidence shows regarding who bears the cost of corporate tax and his assessment of the assumptions that a rate cut would help workers. Marron noted that workers clearly pay some of the corporate income tax. Workers will have less capital to work with, are less productive, and wages are lower. The ranges of that are around 20-25%, but that differs depending on the tax reform model you look at. Carper is in favor of reducing the corporate tax rate because we are not competitive globally but he wants to remember four considerations regarding comprehensive tax reform: is it fair, does it foster or impede economic growth, does it make the tax code more or less complex, and what is the fiscal impact? We are six years into the longest running economic expansion in the history of our country. We should address the corporate tax problem in a way that is fiscally responsible.
Senator Pat Toomey (R-PA): Asked if there is anyone on the panel who believes that there is any part of economic growth and output that is completely unaffected or independent by all incentives and penalties in the tax code. No one on the panel holds that view. Toomey responded that if you have better incentives, fewer penalties, and a tax code that creates growth, you have growth. The question becomes how much growth, not is there growth, in the economy. Asked Hodge if there was a fundamental, unavoidable logic that if you get the incentives right, you will have more growth and if you have more growth, you can generate more revenue. Hodge responded that it was correct. Hodge continued that it is true that tax cuts don’t pay for themselves, but that there are macroeconomic effects that minimize their long-term costs.
Senator Maria Cantwell (D-WA): Is interested in the needs and opportunities with regards to housing as it relates to the tax code. DeBoer responded that there is a tremendous shortage of ‘workforce housing,’ for middle-American citizens who are being priced out of America’s urban areas. We need ways to incentivize affordable housing, not just low-income housing which is obviously needed, but housing for our firemen, teachers, etc. Cantwell asked if just cutting the corporate tax rate gets us affordable housing. He responded that it would probably not do anything specific to the issue aside from putting more people to work and put more money in peoples’ paychecks to buy workforce housing. Cantwell asked if affordable housing is a crisis in America. DeBoer didn’t want to define it as a crisis because housing is being built to meet demand but the costs aren’t reasonable.
Senator Tim Scott (R-SC): Asked the panel to discuss the compliance cost borne by small businesses under the current code and what that means long-term for our competitive position and ability to grow jobs and make future investments. Hodge responded that depreciation schedules are costing U.S. businesses around $23 billion per year out of compliance costs. It’s wasted energy, time, and money. Lewis responded that the tax code will probably never be simple, but we should do our best to make it a bit more reasonable.
Senator Ben Cardin (D-MD): Pass-through companies do not have to pay double taxation but when you look at global competition, they’re still paying a much higher rate than their global competitors. As we look for reform to make our code more competitive, how do we ensure we don’t have the unintended consequence of hurting the companies with current status as pass-through companies if we are only considering C-Corp cuts. DeBoer responded that pass-through companies, especially in the real estate industry, are incredibly popular. Real estate companies consist of almost half of all partnerships in America so it’s very important to achieve a lower tax rate for those entities. There should definitely be a break given to pass-through companies if C-Corps are also being given breaks; they are the main drivers of the economy after all. Cardin then asked how we get to competitive rates globally if we continue to use only income revenues, to the exclusion of consumption revenues. Marron responded that he agrees if you want to get to below the high-20s rate, you need to find a new revenue source. The destination-based cash flow tax was a species of consumption tax that has gone by the wayside. He is personally a fan of the carbon tax. Finally, you can look towards the taxable shareholders to partly offset the gain that they get. Hodge commends Cardin’s progressive tax reform plan. He modelled Cardin’s plan and found it to be both pro-growth and revenue positive. It is possible to use a value-added tax to lower the corporate tax rate to 17%.
Senator Sherrod Brown (D-OH): Asked for suggestions from Marron for ways to safeguard against corporate tax reform that overwhelmingly helps corporate America at the expense of American workers. Marron responded that a big question that must be asked is if the reform will encourage more investment domestically – this will directly support the American workers. Additionally, there could be a discussion, outside of the business tax code, about worker credits, expanding the Earned Income Tax Credit, and other programs that could support and encourage a broader array of workers, boost take-home pay, and make them more attractive to employers.
Senator Thune (R-SD): Asked Hodge to elaborate on the connection between business tax reform and tax relief for middle class workers and families. Hodge responded that the OECD studied which taxes were most hurtful to growth and found that the corporate income tax is the most harmful tax to economic growth because capital is the most mobile factor in the economy. When you lower the tax on capital, the economy becomes much more productive. This brings peoples’ standards of living up, which should be the priority of tax reform. Thune asked DeBoer if shortening the recovery period for commercial buildings from 39 years and rental housing from 27.5 years be a reasonable alternative to immediate expensing. Deboer said that it would. He doesn’t want to disparage the power of expensing, he just believes that, in his industry, he sees no benefit to building buildings that are ahead of the demand in the economy. It puts stress on the local markets, stress on lenders’ balance sheets, and ultimately is not good for the long-term economy.
Senator Ron Wyden (D-OR): Asked Marron how much of the benefit goes to the top-1% in President Trump’s proposal? Marron responded that if you do a maximum rate like he did, all the benefit must go to a higher tax bracket. An overwhelming majority would go to the top 20% and a huge portion of that majority, would go to the top 1%. Wyden then asked what Marron thought about the possibility of using this as a massive tax loophole. Marron responded that he’s an honest guy, but he would LLC himself if he could enjoy a tax gap that size. The IRS and legislators should write rules to try and mitigate that, but it is an ongoing game.