Donald Trump’s radical tax reform is far from done deal

Simple maths and likely political opposition are likely to impede the US’s tax cut pledges

The White House unveils U.S. President Donald Trump's tax plan which would slash the U.S. tax rate on business profits to 15 percent, while also offering tax cuts to average Americans.

 

This Saturday evening, US president Donald Trump will return to the Pennsylvanian heartland that helped get him elected, holding a rally in the small rural town of Harrisburg to mark his 100th day in office.

Having repeatedly chastised the media for their “obsession” with the 100-day mark, Trump and his administration have been racing to push through a range of legislative proposals and executive orders ahead of Saturday’s symbolically important milestone. This week witnessed a frenetic pace of activity – a last-minute bid to revive Republicans’ failed healthcare repeal Bill, a threat by the president to withdraw from Nafta, the free trade agreement governing relations between America, Canada and Mexico, and the signing of a raft of executive orders.

It is within this political context that Wednesday’s tax announcement was made.

Tax reform was one of the many campaign promises made by Trump. But the president took his advisers by surprise late last week when he signalled that a major tax reform announcement was due on Wednesday. Almost immediately, the administration tried to manage expectations, stressing that the announcement would be a statement of broad principles rather than specific details.

This is effectively what transpired on Wednesday when US treasury secretary Steve Mnuchin and chief economic adviser and former Goldman Sachs number-two Gary Cohn presented a one-page outline of Trump’s tax reform package at the White House. Cohn himself described the proposal as a “broad-based overview”, rather than a detailed proposal. But while many questions were left unanswered – most obviously, how trillions of dollars worth of tax cuts would be paid for – the proposal set the stage for one of the most significant shake-ups of the US tax system in decades and months of discussion in Congress.

Among the key elements of the proposal are:

Corporate tax This is perhaps the most significant element of the proposal. The White House followed through on its promise to cut the notoriously high US corporate tax, now 35 per cent, to 15 per cent – a 20 per cent rate is favoured by leading Republicans on Congress such as House Speaker Paul Ryan. It also pledged that small businesses – so-called “pass-through” entities which are currently taxed at individual rates – could be eligible for this rate. There are concerns that other parties like hedge funds, law firms and real estate companies – such as Trump’s own property empire – could piggy-back on the new rules, allowing wealthy individuals to incorporate using this mechanism and benefit from lower tax rates.

Repatriation of foreign profits held overseas Currently it makes sense for US companies to harbour profits overseas, as repatriating the cash would incur a 35 per cent tax rate. Both Democrats and Republicans have long wanted to reform that system and incentivise companies to repatriate the estimated $1.2 trillion in profits sitting offshore. While the White House confirmed its preference to impose a one-off tax, crucially it did not specify a rate. Trump had previously mentioned a 10 per cent levy, while House Republicans had mooted 8.75 per cent. Politically, the issue is difficult – Republicans cannot be seen to reward companies that have made millions in profits, with some arguing that a compulsory tax is the best way to go.

Reform of the personal tax code For most Americans watching the announcement on Thursday, it was the Trump administration’s promise to simplify the tax code and reduce the tax burden on ordinary Americans that was of most relevance. The White House promised to double the personal tax deduction (essentially the individual tax credit), reduce the number of tax brackets from seven to three, and abolish all tax breaks except mortgage interest relief, retirement savings and charitable contributions. It also wants to cut capital gains tax and eliminate the federal tax deduction for state and local income tax.

From Ireland’s perspective, one of the most important aspects of Wednesday’s announcement was the omission of a border-adjustment tax. The proposed tax on imports had been championed by House speaker Paul Ryan and budget director Mick Mulvaney and had been actively discussed among Republicans for months on Capitol Hill. But it was dropped in the White House plan, reflecting the president’s own scepticism about the proposal as well as broader Republican concerns about its impact on consumers and importers.

Multinationals in Ireland

It is worth noting, however, that Ryan and senior Republicans including Mick Mulvaney were still insisting that some form of a border tax was still on the table – Steve Mnuchin said “we don’t think it works in its current form” – but its removal at this stage was welcomed by the Irish Government. Such a tax would likely affect Irish exports to the United States, including pharmaceutical and medical device products made by US multinationals in Ireland and shipped back to America.

However, its omission opens up a gaping hole for the US – depriving it of a revenue stream that would have offset some of the losses that will be generated by the enormous corporate tax cut proposal.

At the heart of the White House tax proposal is a conundrum: though Republican orthodoxy is to slash taxes on businesses, Republicans are also wary of increasing the deficit.

The Washington-based Committee for a Responsible Federal Budget estimates that the loss could equate to between $3 trillion and $7 trillion over a 10-year period, with the corporate tax alone resulting in a $2.2 trillion shortfall.

It’s not just a question of ideology – senate rules mean that, if the proposal is not revenue-neutral, Republicans, who have 52 seats in the senate, will need a 60-40 rather than simple majority to pass the rules. If this majority cannot be achieved, then any changes to the tax code will expire in 10 years.

Republican support

Adam Looney, a senior fellow at the Brookings Institution, believes that securing Republican support for tax reform will be even more difficult than securing congressional support for repealing and replacing Obamacare. While everyone agrees that the US corporate tax rate needs to be reduced, “it’s really hard to do”, he says.

The US is different to other low corporate-tax countries because it does not have a value-added tax system and has lower shareholder taxes, he says. “If Trump wants a 15 per cent corporate rate, he can consider solutions used elsewhere, like imposing new consumption taxes or raising taxes on shareholders – including those currently exempt from tax.”

Brian Keegan, of Chartered Accountants Ireland, who was meeting with companies in New York this week, said that while the White House proposal is likely to “change the conversation” about tax and investment in Ireland, crucially Ireland will still retain a lower corporate tax rate than the United States.

As the debate looks set to intensify over a viable plan to reform the US tax system, the battles ahead in the US Congress could have a profound long-term impact on Ireland’s role as a location for top foreign direct investment.

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