After failing to pass health care legislation in late July, GOP congressional leadership has signaled a move to their next legislative priority—tax reform.
Tax reform involves closing loopholes and rewriting tax laws in order to ensure enough money is collected to fund the government. An effective tax system, according to Brookings Senior Fellow Bill Gale, can also induce economic growth and promote fairness.
Though it may be easily misconstrued, tax reform is not synonymous with tax cuts. Cutting tax rates for individuals and corporations would only shrink the overall tax base and thus the amount of money generated for the government operations or deficit reduction. True tax reform is accompanied by hard decisions and trade-offs, which is why comprehensive reform hasn’t happened since 1986, and why many observers and Brookings experts are skeptical that sweeping reforms will be passed this year.
With control of both chambers of Congress and the White House, Republicans have the opportunity to pass new tax policies without any bipartisan support. There are, however, many political and procedural factors the congressional majority will have to overcome. Here are some things to consider as we prepare for the upcoming debate over tax policy:
What’s on the GOP wish list?
During the 2016 presidential election, Donald Trump campaigned on the promise of eliminating the estate tax while also cutting corporate and business tax rates by more than half. In April, President Trump released a short list of his legislative priorities that included cutting the top tax rate on business income from 35 to 15 percent, cutting individual income tax rates, raising the standard deduction, and abolishing both the estate tax and the alternative minimum tax. Senior Fellow Bill Gale, calling the administration’s approach “flawed,” offered more details on each of Trump’s priorities and the effects they may have.
During the presidential campaign, the Tax Policy Center, a joint project of the Urban Institute and Brookings, estimated that Trump’s corporate tax cut alone would cost the U.S. Treasury $2.3 trillion over ten years and $3.5 trillion in the ten years after 2027. Gale and the Tax Policy Center also analyzed the potential repercussions of paying for Trump’s tax cuts. They concluded that the plan would be incredibly regressive, and that using either an equal costs per household or an equal proportion of each household’s income to finance the cuts would leave the vast majority of households worse off than they would be if the tax cuts were not implemented in the first place.
In the House, Speaker Paul Ryan (R-Wis.) has advocated for completely overhauling the tax system. He has also, along with House Ways and Means Chairman Kevin Brady, lobbied for the “Better Way” reform plan which includes a border-adjustment tax (BAT) on imports with exceptions on exports. The BAT was criticized by both the Trump administration and House Freedom Caucus, deemed a political non-starter by Bill Gale, and was set aside in a joint statement from congressional leaders and administration officials in late July.
Rep. Mark Meadows (R-NC), chair of the House Freedom Caucus, not only voiced opposition to Speaker Ryan’s border-adjustment proposal, but also threatened to obstruct any 2018 fiscal budget unless Republicans “slash” corporate taxes and double standard deductions for individuals.
The procedural hurdles to tax reform
Republican leadership has sent mixed signals regarding whether or not they intend to use normal Senate rules to introduce their pending tax legislation. Assuming they will not win over at least eight Democratic votes to achieve a filibuster-proof 60 vote super-majority, Senate Majority Leader Mitch McConnell (R-Ky.) may pursue the reconciliation process as he did in the recent health care debate. With reconciliation, Republicans would need only 50 votes to pass legislation in the Senate (where they currently hold 52 seats) with Vice President Mike Pence as a tiebreaker.
In order to use the reconciliation process, Republicans will first have to pass a budget to set spending levels for 2018. Even this step, according to Gale, will be politically difficult to navigate as the more conservative members of the Republican-controlled House have withheld early support from the leadership’s proposals.
Governance Studies Fellow Molly Reynolds adds that to be in accordance with the Senate’s Byrd Rule, any proposal passed under the reconciliation process cannot increase the deficit after the ten-year budget window closes. This will limit Republican ability to cut taxes without shifting the burden elsewhere or taking away some benefits.
With these procedural limits in mind and a full congressional schedule, neither expert is optimistic that Republicans will be able to pass tax reform of any kind. As Governance Studies Fellow Vanessa Williamson put it, “real tax reform is like a legislative ballet and so far this Republican majority has two right feet.”
Implications of the Republican plan
Although Republicans have not finalized any legislation to be introduced later this year, Brookings experts have offered commentary on some of the president’s promises (including a 15 percent corporate tax rate) and other policies that would likely appear in any Republican proposal.
According to Senior Fellow Bill Galston, Americans do not necessarily agree that corporations need generous tax cuts—a cornerstone of the proposals from President Trump and congressional leadership. A Gallup poll released in April of 2017 shows that the majority of Americans believe upper-income individuals and corporations are not paying their fair share of taxes, and of those polled, fewer than 10 percent said that corporations pay too much. These results suggest that if Republicans follow through with plans to “slash corporate tax rates,” it would not be justified by overwhelming public support.
Galston is also skeptical of Republicans introducing a corporate tax holiday similar to one in 2004 that allowed companies to repatriate overseas earnings at significantly reduced values. Instead of investing in long-term growth, those repatriated earnings went primarily to stock buy-backs and to further compensate executives. According to Galston, any reform that fails to enforce positive, long-term investment would just be “another expensive failure for average Americans.”
On President Trump’s corporate tax cut, Senior Fellow Adam Looney reports that dropping the corporate tax rate from 35 to 15 percent would lead to at least $3 trillion in loses in just ten years and would create ample opportunities for tax avoidance. According to Looney, the lower tax rate would also be extremely regressive and would benefit only the top 1% of Americans.
Kansas implemented a tax plan similar to what President Trump and congressional Republicans are proposing in what Bill Gale called “one of the cleanest experiments the country has ever had in measuring the effects of tax cuts on economic growth.” As Gale explains, in 2012 Republican Governor Sam Brownback and Kansas’ Republican legislature cut the state’s top-income tax rate to 4.9 percent and the business tax rate to zero in an effort to boost growth. In reality, according to Gale, the imposed cuts did little to promote growth but instead created new opportunities for tax-sheltering and forced the state to reduce investments in public goods.
Senior Fellow Henry Aaron explains that the Republican tax reform agenda “is built on … contradictory goals.” The GOP has long said it favors reduced federal government deficits and national debt, and yet cutting tax rates would increase both. “Ideological slogans can win elections,” Aaron writes, but “real legislation on complex subjects like health insurance policy and tax laws must come to grips with current laws and real economic interests.”
Former CBO Director Doug Elmendorf, also a former Brookings senior fellow and former director of the Hamilton Project at Brookings, helped put the effect comprehensive tax reform can have on economic growth into perspective. According to Elmendorf, strong, pro-growth tax reform may only increase economic growth rate by 0.1 or 0.2 percent per year.
How could tax reform work?
Robert Pozen, a nonresident senior fellow in Economic Studies at Brookings, laid out five key guidelines for how Republicans can “actually pass corporate tax reform.” Among them, Pozen encourages the White House to take a lead role in authoring a corporate tax bill. Pozen also suggests trying to include moderate Democrats who would support repatriations of foreign profits held abroad and avoid any significant increases to the national debt that would dissuade Republicans.
Bill Gale and Tax Policy Center analyst Aaron Krupkin believe the best way to reform the tax system is to raise revenues, reform the corporate income tax, raise the tax burden on high-income households, and alleviate the tax burden on lower and middle-income households.
They advocate a number of specific policies, including a carbon tax and tax deduction on the income of a secondary-earner in a low- or middle-income family. Gale and Krupkin also argue that despite high-income households reaping most of the benefits of economic growth over the previous decades, they have not carried any additional tax burden; there are multiple measures Congress can take to adjust high-income households’ tax burden. Finally, Gale has defended value-added taxes, which he suggests would be more efficient than the current income tax and would not burden small businesses.
Adam Looney, senior fellow in Economic Studies and expert on U.S. tax policy, has endorsed the advantages of the border-adjustment tax. According to Looney, the BAT would tax companies based on where their goods are consumed, not on where their headquarters are located or profits earned. This would reduce incentives to produce abroad, allow the government to reward domestic investment, and protect American’s from shouldering the burden of corporate tax cuts.
Republicans will face many procedural obstacles and hard political and policy decisions in passing real tax reform, but with control of Congress and the presidency they are in the driver’s seat. House Ways and Means Chairman Brady has said that President Trump “is all in” on tax reform, and it is one of the highest legislative priorities for the White House and Republican majority to get something passed before the 2018 congressional election cycle starts.
Chris Mckenna contributed to this post.