Tax cuts

Author: Keith Martin Publication | October 2017

Tax cuts should start to come into clearer focus this month.

Budget resolutions in the House and Senate set a deadline of November 13 for the tax writing committees to have reported tax-cut bills to the full House and Senate. The budget resolutions have not yet cleared Congress.

The Trump administration and House and Senate Republican leaders released a broad outline of a bill that all three groups can support on September 27. The eight-page framework suggests that the “big six,” as the negotiators were called, have had trouble reaching consensus after four months of effort. Martin Sullivan, a respected tax economist read by policymakers in Washington, called the framework “Cheez Doodle tax reform: a lot of puff and color, but mostly air.”

There are nine paragraphs of text about how corporate income taxes will be revised. House leaders needed something to show members who were unwilling to vote on the budget resolution without more detail. The framework is a product of compromise: the carefully chosen words suggest where tensions may remain over details.

The corporate income tax rate will be 20 percent. With the lower rate, tax equity will become a somewhat smaller percentage of the capital stack for US renewable energy projects. Before the rate reduction, tax equity accounted for 40 percent to 50 percent of the capital in a typical solar project and 50 percent to 60 percent in the typical wind farm. Many tax equity investors have been calculating their investments this year by assuming a reduced tax rate and then planning to have a one-time adjustment in the pricing at the end of 2018.

There will be a separate “maximum tax rate” of 25 percent on income received from partnerships, S corporations and other pass-through entities. The NFIB, the politically potent trade group for small business, has been pushing hard to set the pass-through rate at the same level as for corporations.

The framework “aims to eliminate” the corporate alternative minimum tax.

The cost of new investments in equipment—not buildings—made after September 27, 2017 could be written off immediately. This policy will remain in place for “at least five years.” Permanent full expensing would cost more than $2 trillion over 10 years. House Republican leaders are more keen on this than Trump or the Senate.

Until this year, few tax equity investors had been taking the current “depreciation bonus” that allows half the cost of new equipment to be written off immediately. However, many tax equity investors have been claiming it in 2017 as a way of mitigating the potential effects of a tax rate reduction after 2017. Full expensing would have the effect of eliminating the tax bases of most utilities. Most states piggyback on the federal definition of taxable income. Some states could decouple from the federal tax calculations to avoid punching a hole in state budgets, depending on the degree to which Congress eliminates other deductions or tax credits to broaden the tax base.

Interest deductions by C corporations will be “partially limited.” The House tax committee chairman, Kevin Brady (R-Texas), said the plan is to grandfather existing debt and provide exemptions for small business and agriculture. There does not appear to be any effort underway by developers to lock in debt in advance of any vote by the House tax committee later this month. (Under the US constitution, the House must act first on taxes.) Interest may revive in sale-leaseback transactions that allow the financing cost to be deducted as rent.

Tax credits for research and development and low-income housing will be retained. “While the framework envisions repeal of other business credits,” the document says, “the committees may decide to retain some other business credits to the extent budgetary limitations allow.” The expectation is that Congress will not disturb the current phase-out schedules for wind production tax credits and the solar investment tax credit that were negotiated in 2015, but until the tax committees engage fully, it is hard to know for sure. Changes in how inflation adjustments work are possible. The section of the framework on individual income taxes says it “envisions the use of a more accurate measure of inflation for purposes of indexing the tax brackets and other tax parameters.”

US multinational corporations hold more than $2.6 trillion in offshore holding companies. These earnings would be treated as repatriated to the United States, triggering a US income tax at a reduced rate. Earnings held in illiquid assets will be subject to a lower rate than cash and cash equivalents. Payments of the taxes may be spread “over several years.”

The US will move closer to a territorial system of not taxing US companies on their earnings from doing business abroad by exempting dividends from offshore holding companies in which the US taxpayer is at least a 10 percent shareholder, but it will take other unspecified steps to “protect the US tax base by taxing at a reduced rate and on a global basis the foreign profits of US multinational corporations.” There will be rules to “level the playing field between US-headquartered parent companies and foreign-headquartered parent companies.”

Agreement on the budget resolution is central to the prospects for the tax bill in the Senate, as it will allow any tax-cut bill to clear the Senate by a simple majority rather than the 60 votes that would be required otherwise. The Republicans hold 52 Senate seats.

One issue with which Republicans are still wrestling is to what extent tax cuts will be allowed to add to the US debt. The debt stands currently at $20.3 trillion. The Senate budget resolution would allow tax cuts to add another $1.5 trillion to the debt, while the House resolution requires any tax bill be revenue neutral.

The politics of any tax-cut bill are complicated. Senator Bob Corker (R-Tennessee) said he will not support any bill that adds to the US debt. The Senate tax committee chairman, Orrin Hatch (R-Utah), said his committee will not be a “rubber stamp” for the framework agreement. Hatch is interested in corporate integration, or the idea that corporate earnings should only be taxed once, perhaps by allowing corporate shareholders a dividends-received deduction that has the effect of reducing the tax rate on dividends. Corporate integration did not get much traction with House Republicans. The framework said the tax committees “may consider methods to reduce” the double tax on corporate earnings. The big six hoped to make up some lost revenue by eliminating the deduction for state and local income taxes. Republicans from blue states with high income taxes are large enough in number to block the tax bill in the House.

Timing is another issue. The president and House Republican leaders insist the bill will be enacted this year. Congress has only 23 work days remaining after October in the current session and a lot pressing business has already been pushed to year end. The last time, in 1986, that Congress passed a major tax reform bill, the process took 13 months from the first vote in the House tax committee to when the bill became law.

The framework was understandably light on details of “pay fors” to cover the cost of the tax rate reduction. Attention is focused on a bill that Dave Camp, a former House tax committee chairman, introduced in 2014 that was a serious effort to cut tax rates while keeping the books balanced. The bill included more than 200 revenue raisers. A description of the revenue raisers that would have affected the project finance market can be found in “Camp Tax Reform Bill” in the April 2014 NewsWire.


Contacts

Keith Martin

Keith Martin

Washington, DC