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U.S. tax reform: Key signals to watch for

Author(s): Paul Seraganian, Jennifer Lee

July 26, 2017

We’re going to get this done in 2017 
 – Speaker of the House, Paul Ryan, July 20

The political turbulence associated with the effort to repeal and replace Obamacare has obscured the direction and timing of U.S. tax reform. While there are fragmented pieces of information spinning out of Washington, it’s highly difficult to discern any meaningful guidance. Here are a few key signals that we think Canadians should be looking for as they monitor tax reform south of the border.

  • Timing: First, the timing for tax reform remains highly unclear. However, the calendar will begin to impose its own realities and many observers still identify Q1 2018 as the most likely time frame for the ultimate passage of a tax bill. In the meantime, it appears that key staff members from the House, Senate and White House continue to meet on an almost daily basis to build consensus on key planks of a tax reform plan. Many expect the contours of the tax reform discussion to come into considerably sharper focus in September, and House Ways and Means Committee Chairman Kevin Brady promised on July 24 that the House will release its comprehensive tax reform plan when politicians return from the August recess. That recess ends on September 5. The latest news indicates that a set of broad guidelines highlighting agreed-upon tax reform principles could be released as early as this week.
  • Obamacare: Second, the fate of health care reform appears to have a significant bearing on prospects for tax reform. Aside from the budgetary reality that a failure to repeal Obamacare taxes would make deficit-neutral tax reform more difficult (which may affect, among other things, how low headline tax rates may be dropped), intra-party tensions created through the bruising health care debate may carry over into the tax reform arena, making compromise more challenging. On the other hand, a successful effort to repeal and replace Obamacare may buoy the Republican party – prominent republican senator Ted Cruz recently told Fox News, “[i]f we get ObamaCare done….then I think the chances of tax reform skyrocket. If ObamaCare crashes and burns, I think the chances of tax reform drop significantly."
  • Temporary vs. permanent tax reforms: The House Budget Committee released its fiscal 2018 Budget Resolution on July 19. As expected, this resolution would pave the way for tax reform to be implemented by way of a procedural mechanism known as “reconciliation” – meaning that tax reform could be passed by majorities in both the House and Senate, without any need for Democrat votes. However, in order for tax reform provisions enacted via reconciliation to be permanent, the reforms need to be deficit neutral during the “budget window” (which is expected to be 10 years). As noted above, failure to eliminate Obamacare taxes and/or failure to implement a border-adjusted tax mechanism would make deficit neutrality daunting. This, in turn, would make temporary reforms more likely. Republican leaders have long stressed the importance of enacting permanent reforms but with the 2018 midterm elections looming, politicians may feel countervailing pressure to make a splash. Accordingly, look for the possibility of aggressive but non-permanent tax rate reductions coupled with more modest “reform”. There are also indications that the White House is exploring the possibility of making tax reform partially permanent and partially temporary. 
  • W(h)ither the BAT? By most accounts, the “border adjusted tax” (or BAT) featured in the House tax reform blueprint has been written off as a political non-starter. However, in light of the budgetary pressures outlined above, there will be pressure to consider revenue-generating measures and the BAT, which was expected to raise almost $1 trillion in revenue over the 10-year budget window, could re-emerge in some form. Signs of this have already emerged. In connection with the House Budget committee passing the budget resolution last week, a Republican member of that committee tried to introduce an amendment that would have blocked the use of the BAT as part of tax reform. The amendment was blocked, leaving the BAT a potential option, at least for now. Proponents of the BAT also point to its ability to protect the U.S. tax base against base erosion. Interestingly, there are reports from an unnamed White House official that some key stakeholders believe anti-erosion mechanisms (like the BAT) would likely not be needed if the corporate marginal rate ended up at 15% or lower (the Trump plan calls for a corporate rate of 15%). However, these stakeholders reportedly feel that anti-erosion rules become necessary if the corporate marginal rate lands somewhere in the range of 20-25% or higher (the House blueprint called for a 20% rate on corporations). All this suggests that it’s too early to totally write off the BAT and that it is possible that some mutated form of the BAT may yet emerge as tax reform discussions evolve.