United States

Thinking smaller: Tax reform for individuals and small business only?

Jun 19, 2017
From the Tax Governance Institute

Is the Blueprint on a collision course with political reality?

By  Ronald Dabrowski, Principal, Washington National Tax, KPMG LLP

Read more Tracking Tax Reform blog posts

When we’ve talked about tax reform over the past few months, we’ve focused primarily on corporate and business tax reform. But the way things are shaping up, tax reform might end up impacting mainly individuals and small businesses.

There’s been a lot of controversy and disagreement surrounding business and corporate tax reform. But there’s actually been a lot of consensus on the approach to individual tax reform, whether you look at the GOP Blueprint, President Trump’s individual tax reform proposal, or the Tax Reform Act of 2014 (the Camp bill).

Numbers workable for individual rate cuts

The Tax Foundation scoring of the GOP Blueprint’s individual rate cuts found it created an almost $800 billion shortfall.[1] That’s a big number, but it’s not unsolvable, especially in light of a seemingly improving economy which may help generate more revenue than was originally forecast.

There’s also been a lot of political talk about a willingness to live with deficits, and possibly amend the Senate’s budget reconciliation constraints (for example, by using a 20-year budget window instead of a 10-year window).

And, perhaps most importantly, there’s a fair amount of wiggle room to adjust percentages to mitigate any revenue shortfall tied to an individual tax rate cut. For example, both the Trump and Camp plans had higher top-end regular income rates for individuals than the Blueprint (35 percent versus 33 percent). And Trump’s capital gains rate (20 percent) was higher than the Camp plan (15 percent) or the Blueprint (16.5 percent).

As for small business, their targeted tax incentives historically have not been very costly.

Math’s harder on corporate side

Making the numbers work to justify cutting corporate tax rates and moving to a territorial tax system where offshore active income isn’t subject to U.S. taxation – two key components of corporate tax reform – is a much tougher task.

Reducing the corporate rate to 20 percent would require more than $1.0 trillion to make up for lost revenue.[2] And there simply hasn’t yet been enough political support generated to raise that much revenue. And, in order for a territorial tax system to work (without resulting in base erosion), you need to significantly reduce corporate income tax rates. So the success of international tax reform may hinge on the success of domestic corporate reform efforts to reduce tax rates.  

Political realities working against big corporate reform?

The November 2018 mid-term elections are on the horizon. Many Congressional incumbents may feel that it is beneficial to return to their constituents with a tax cut to their credit. With a lot already on Congress’s plate (e.g., health care reform, the debt ceiling, highway funding, the FY2018 budget), the path of least resistance could be an individual and small business-focused tax reform package.

So for the short run, the business community might have to be satisfied with politically popular, but less thrilling, corporate relief, such as permanent bonus depreciation and an international repatriation bill (either voluntary or mandatory).

Stay tuned!

 

[1] Tax Foundation dynamic scoring estimates from “Details and Analysis of the 2016 House Republican Tax Reform Plan” https://taxfoundation.org/details-and-analysis-2016-house-republican-tax-reform-plan/ (July 5, 2016). 

[2] Ibid.

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This article represents the views of the author only, and does not necessarily represent the views or professional advice of KPMG LLP.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.