The Administration and Treasury Department released a joint report titled “The President's Framework for Business Tax Reform: An Update,” which is an updated version of their 2012 proposal. In addition to providing the President's vision for tax reform, the report includes recent figures to demonstrate the urgent need for such reform, including statutory vs. effective tax rates, effective rates broken down by industry, and global corporate tax rate trends.
This updated report emphasizes that “...the urgency of closing loopholes and reforming the tax system more broadly has grown” significantly since 2012, pointing to:
- the increased number of corporate inversions occurring over the past couple years
- the global problem of base erosion and profit shifting (BEPS), currently being tackled by the Organization for Economic Cooperation and Development (OECD).
Statutory vs. Effective Tax Rates. The U.S. has the highest statutory corporate tax rate among G-7 countries (Canada, France, Germany, Italy, Japan, the United Kingdom (U.K.), and U.S.) at 39%, with the average among the other six countries being 29.6%.
However, the report cautions that effective tax rates don't “give a complete picture of how the tax code affects decision making and the competitiveness of the U.S. economy and U.S. firms in world markets.”
The effective marginal tax rate in the U.S. is 18.1%, which is significantly closer to the 19.4% average marginal tax rate among the other six G-7 countries. The difference between the statutory and effective rates in the U.S. suggests that corporate tax reform should lower the statutory rate while broadening the base to maintain the same level of revenue. Eliminating loopholes and subsidies would “level the effective marginal tax rates,” and encourage decisions to be made for business and investment reasons instead of tax.
Distortions in Location of Production & Allocation of Products. Under the current rules, U.S. companies can reduce their tax by shifting their reported profits to lower-tax jurisdictions and/or engaging in corporate inversions (i.e., changing their tax residence to a low-tax country by merging with a foreign corporation). This causes economic distortions both from encouraging firms to invest and grow business activities abroad and by causing firms to spend their money on tax planning instead of productive investment.
The President's framework for business tax reform is intended to reduce tax distortions, including those discussed above, and to address problems with the current international tax system. include:
- Reduce the top corporate tax rate from 35% to 28%.
- Eliminate the corporate alternative minimum tax (AMT).
- Revise current depreciation schedules that generally overstate the true economic depreciation of assets. (The report notes that many other large countries have scaled back depreciation allowances as a way of paying for rate-lowering corporate tax reform.)
- Limit the deductibility of interest.
- Cut the top corporate tax rate on manufacturing income to 25% and to an even lower rate for income from advanced manufacturing activities. This would be accomplished by reforming the Code Sec. 199 domestic production activities deduction to: focus more on manufacturing activity; increase the credit to 10.7%; and increase it even more for advanced manufacturing.
- Eliminate tax breaks for specific industries “with the few exceptions that are critical to broader growth or address certain externalities.” Specifically, the President's framework would: eliminate last-in, first out (LIFO) accounting; eliminate tax breaks for the oil and gas industry; reform the treatment of the insurance industry and products; and reform the measurement and character of gains, including modifications to the rules for like-kind exchanges.
- Provide reforms specific to the financial sector, including imposition of a financial fee (i.e., a tax on large financial institutions based on the amount of their liabilities), increase certain transaction fees, close the “carried interest” loophole, and modernize the taxation of certain financial products to prevent tax arbitrage.
- Promote innovation by expanding and simplifying the now-permanent research credit.
- Consolidate, enhance, and permanently extend key tax incentives to encourage investment in clean energy while repealing fossil fuel subsidies.
- Effectively cut the top corporate tax rate on manufacturing income to 25% by reforming the Code Sec. 199 domestic production activities deduction and increasing the credit to 10.7%.
- Establish a new per-country minimum tax (19%, less a foreign tax credit equal to 85% of the per-country average foreign effective tax rate) on foreign earnings that would reduce firms' ability to avoid U.S. tax by shifting profits overseas, reduce the incentive to shift production overseas, and increase the global competitiveness of U.S. corporations.
- Impose a one-time 14% tax on unrepatriated earnings, which could then be repatriated without any further U.S. tax.
- Limit U.S. interest expense deductions to curb “earnings stripping.”
- Limit inversions by preventing firms from acquiring smaller foreign firms and changing the tax residence as a result, and from changing their tax residence to any country where they do not have substantial economic activities if their operations in the U.S. are more valuable than their operations in the other country and they continue to be managed and controlled in the U.S.
- Close loopholes and stop strategies that facilitate BEPS, including tightening rules governing cross-border transfers of intangible property, closing loopholes by expanding the scope of the existing Subpart F rules, and restricting the use of “hybrid” arrangements that take advantages of differences in tax rules. The report notes that these reforms are consistent with the cooperative efforts being made by the OECD's BEPS project, which were endorsed by President Obama and other world leaders at the 2015 G-20 Summit.
- Allow small businesses to expense up to $1 million in investments.
- Allow cash accounting for businesses with up to $25 million in gross receipts.
- Simplify additional accounting rules for small business and harmonize eligibility.
- Quadruple the deduction for start-up costs (from $5,000 to $20,000).
- Reform and expand the health insurance tax credit for small businesses.
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