Transcript U.S. Budget Issues – Unsustainable Debt Under Current Policies

Taxmageddon or Tax Reform?
The Outlook for U.S. Tax Reform in the Next Congress
Presented by Robert Glennon, Jeff Munk, John Stanton, and Jamie Wickett
September 27, 2012
Why Reform is Likely / Necessary
• U.S. Budget pressures
– Ever-increasing U.S. debt – Now above $16 Trillion
– “Fiscal cliff” (in 2013 and beyond)
• Competitiveness concerns – U.S. corporate rate
• More agreement than many realize
– U.S. corporate rate should be lowered
– Base should be broadened, “loopholes” closed
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U.S. Budget Issues – Unsustainable Debt
• If current policies extended, by 2025 Social
Security, Medicare, and interest on national debt will
consume all federal revenues
• U.S. gross debt = 103% of GDP (2011)*
• Spanish gross debt = 75% of GDP (2011)*
• Greek gross debt = 170% of GDP (2011)*
* Source - OECD
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U.S. Budget Issues – Unsustainable Debt
Under Current Policies
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U.S. Budget Issues – “Fiscal Cliff”
• “Fiscal cliff” – As of January 1, 2013:
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Expiration of 2001/2003/2010 tax cuts
Top individual income tax rate rises from 35% to 39.6%
10% rate for low income earners disappears
Top dividend rate increases from 15% to 43.4% (3.8% ACA)
AMT patch expired 2011– from 4m to 30m AMT taxpayers
Expired “Doc fix” 30% cut in Medicare physician payments
$1.3 Trillion sequester of defense, non-defense programs, $55 Billion
each per year
• U.S. debt ceiling will need increasing around
January ’13
• Business tax extenders
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“Fiscal Cliff” – Fiscal Impact
• 1 year extension of current policy - $500 Billion
• 2 year extension of current policy - $1 Trillion
• Failure to extend any tax cuts
– Up to 4% reduction in GDP
– CBO estimates reduction in employment of 1-2 million
– WSJ piece May 5, 2012: estimates possible 30% decline
in stock market
– Moody’s threatening U.S. debt downgrade
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U.S. Corporate Tax Rate – Competitiveness
• U.S. corporate rate of 35% is world’s highest
statutory corporate rate
• 35% marginal rate disincentive to invest capital in
U.S. as compared to other countries with lower
rates
• Average effective rate for U.S.-based corporate
taxpayers (2008) - 27.1%
• OECD average effective corporate rate – 24.9%
• U.S. collects 1.9% of GDP (2009) in corporate tax
• OECD avg. collection 2.8% (2009) in corporate tax
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Reducing Corporate Rate –
High-Level Conceptual Agreement
• Obama, Romney, Camp, and Simpson-Bowles all
agree U.S. corporate rate should be reduced
• Agreement on concept of broadening base to pay
for reducing rate
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U.S. Tax Reform By End of 2013
• Six-month or one-year extension of 2012 expiring
tax provisions likely to include triggers forcing major
tax reform by end of 2013
• For budget and political reasons, tax reform also
likely to include changes to U.S. entitlement
programs (Medicare and Social Security)
• U.S. tax reform legislation, however, is already
being crafted, and development will continue in
2013
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Challenges of “Broadening the Base”
• Tax reform is fundamentally about taking things
away from people
– In assessing impact of tax reform on your business,
important to look beyond siren call of lower corporate tax
rate
– Tax reform also by necessity means eliminating tax
benefits to fund tax rate reduction – “revenue offsets”
– To get to a 25% corporate and individual tax rate, most
current tax preferences would have to be repealed or
substantially curtailed
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Obama outline: All current industry-specific preferences repealed
Simpson-Bowles: 107 tax expenditures and credits repealed
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Challenges of “Broadening the Base,” cont’d
– Those facing losing a specific tax break historically fight
harder than those trying to take it away to fund rate
reduction.
– Tax reformers’ response: Pain must be widely-shared –
no significant disparity among industry sectors.
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Corporate Tax Reform Outlook
• Reform likely to address taxation of
– U.S. corporate income
– foreign income and transactions between U.S. and foreign
affiliates
– pass-through entities
– individuals, including on investment income
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Corporate Taxes – Limited Revenue Source
• In 1952, corporate taxes generated 32.1% of federal
tax revenue
• In 2010, corporate taxes generated only 8.9% of
federal revenue
• Why?
– Reduction in effective tax rates due to deferral of foreign
income, new credits, and deductions
– More business activity conducted in pass-through entities
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Corporate Reform – Base Broadening
• Almost all tax expenditures on table, depending on
who is in White House
• Largest corporate tax expenditures (2010-14 Total
in $Billions)
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Deferral of overseas earnings
State and local tax-exempt bonds
Sec. 199 domestic production deduction
R&D credit and expensing (approx.)
Export source rule for inventory
Accelerated depreciation
Low income housing tax credit
LIFO accounting
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Corporate Reform – Base Broadening, cont’d
• Other Potential Revenue Offsets
– Limit U.S. interest expense deduction to reduce tax bias toward debt
financing
– Significant new “earnings stripping” restrictions on deduction of
outbound payments by U.S. affiliate to foreign multinational parent
– U.S. multinationals pay tax on overseas earnings from IP (base
erosion v. minimum tax)
– Repeal industry specific tax preferences (e.g., oil/gas and alternative
energy)
– Large businesses operated in pass-through form (partnership, LLC, S,
MLP)
• Entity level tax on business income
• Partner loss of passed-through corporate tax deductions (e.g.,
accelerated depreciation)
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Industry Sectors Pitted Against Each Other
• Revenue target
– Revenue neutral: balance of winners and losers
– Revenue positive/deficit reduction: more losers than
winners
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Industry Sectors Pitted Against Each
Other, cont’d
“Bricks & Mortar” retail
(accelerated
depreciation)
High tech and pharma
(territorial system for
overseas earnings)
U.S. manufacturing
(accelerated
depreciation; sec. 199)
Services businesses
(rate cut)
Leveraged businesses
(full interest deduction)
Non-leveraged
businesses
(rate cut)
Industry specific
preferences
(e.g., oil & gas)
High effective tax rate
industry
(e.g., retail)
Pass-throughs
(loss of tax preferences;
no benefit from
Regular corporations
corporate rate cut)
Foreign-owned
multinationals
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(rate cut in exchange for
repeal of preferences)
No help from U.S.
industry to fight new
outbound earnings
stripping rules
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Individual Tax Reform
• Why corporate reform is linked to individual reform
– If rate disparity too large, choice of entity become key
consideration
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Resurrect Irving Berlin and his incorporated pocketbook
– Pass-throughs hurt by repeal of preferences, no benefit
from corporate rate cut
– Individual side drives huge industry impacts
•
e.g., mortgage deduction limits affect real estate, construction
industries via consumer demand
– Linkage of individual reform to corporate reform
underscores enormity of challenge of tax reform
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Individual Tax Reform, cont’d
• Largest Tax Expenditures for Individuals (2010-14
Total in $Billions)
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Exclusion of employer contributions to health care
Exclusion of pension contributions and earnings
Mortgage interest deduction
Capital gains/dividends – reduced rates
Earned income credit
State/local income, property tax deduction
Exclusion of capital gains at death
Charitable deduction (other than health, education)
Exclusion of Social Security benefits
Child credit
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Roundtable – Observations
• Observations regarding tax reform regardless of who is
POTUS. E.g., does tax reform drive deficit reduction or vice
versa?
• Pass-through entities and the relationship between individual
and corporate tax reform
• Transition relief may lessen the pain but arithmetically,
reduces “the good news” on rates
• Deferred tax assets – transition relief?
• Is there a “miracle cure” on the sidelines; i.e., a very low
additional tax on a very large base?
– VAT
– Carbon tax
– Financial transaction tax
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Q&A
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Appendix
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Tax Reform Proposals - Obama
• Lower U.S. corporate tax rate to 28%
• Eliminate “loopholes and subsidies”
– Eliminate LIFO tax accounting
– Eliminate tax benefits of COLI
– Tax carried interests as ordinary income
• Eliminate “distortions”
– Decelerate accelerated depreciation
– Reduce corporate deductibility of interest on debt
– Eliminate tax advantage for large pass-through entities
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Tax Reform Proposals – Obama, cont’d
• Encourage U.S. manufacturing
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25% Corporate rate for U.S. manufacturing
Lower rate (22%) for “advanced technology property manufacturing”
Increase and make permanent simple R&E credit to 17%
Extend and consolidate clean energy tax incentives
• Encourage domestic investment
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Apply minimum tax to overseas profits
Remove deductions for moving production overseas
20% credit for expense of ‘insourcing’ production to U.S.
Tax excess profits of shifting intangibles to low-tax areas
No deduction on U.S. interest expense on debt invested abroad until
foreign income taxed in U.S.
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Tax Reform Proposals - Romney
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Permanent extension of Bush tax rates
Repeal Affordable Care Act Medicare tax
Broaden tax base by “eliminating preferences”
Reduce corporate tax rate to 25%
Move to territorial U.S. tax system
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Tax Reform Proposals – Romney, cont’d
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Make R&E credit permanent
Extend 100% bonus depreciation through 2013
Repatriation tax holiday
Broaden corporate base and “reduce preferences”
Repeal corporate AMT
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Tax Reform Proposals - Camp
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Reduce corporate tax rate to 25%
Broaden the corporate tax base
Move to territorial U.S. tax system
DRD of 95% of CFC dividends to parent
Exclude 95% of capital gains from sale of CFC in
active trade or business
• Transition rule would apply 5.25% tax on all existing
foreign earnings held offshore
• Passive, highly mobile foreign income subject to
U.S. tax under Subpart F rules
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Tax Reform Proposals – Camp, cont’d
• Reduce risk of income shifting – particularly related
to intangibles – to lower tax jurisdictions; 3 options:
– Obama “excess returns” proposal - new subpart F
category: income from transferred intangible property
earning high return in low tax jurisdiction
– CFC income subject to a foreign effective tax rate of 10%
or less treated as subpart F income, with exception for
same-country active income
– Income for low-taxed worldwide income derived by a CFC
from intangibles is Subpart F; and domestic corporation
gets 40% deduction for income attributable solely to the
foreign exploitation of intangibles
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Tax Reform Proposals – Simpson-Bowles
• Reduce corporate tax rate to between 23% and
29%
• Eliminate all but a few tax preferences
• Move to territorial U.S. tax system
• Maintain U.S. tax on passive foreign source income
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Contact
• Robert Glennon, Partner
Email: [email protected]
• Jeff Munk, Partner
Email: [email protected]
• John Stanton, Partner
Email: [email protected]
• Jamie Wickett, Partner
Email: [email protected]
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