Business Ethos Blog

The Mielke Way: Another Defeat to be Snatched from the Jaws Victory

Dr. David Mielke, Retired Dean of the College of Business at Eastern Michigan University

As we know, the Republicans failed to pass health care reform–again–after campaigning for 7 years that reform was a priority, if only they controlled the Senate, House and oval office.  They do control all 3, but despite their promises, could not deliver.  Now they are moving on to tax reform, another campaign promise.  Will tax reform be passed, or will the Republicans be defeated again and merely reduce tax rates, or will they be defeated again without progress on either?  Tax reform and tax rate reductions, especially for corporations, have even been supported by the Democrats, including President Obama.  However, will the Democrats continue to oppose any legislation that may give the Republicans a victory?  Should Congress pass tax reform?  Should Congress instead settle on passing a reduction in tax rates?  Will either change spur the economy?  What about the impact on the national debt, now close to $20 trillion?  What is the framework that the Republicans are promoting?  Should Congress pass corporate tax reform, individual tax reform or both?  What is the “Right Thing to do?”  Let’s look at some issues:

  1. Republican Senators have agreed that, at most, any tax reform would be limited to a $1.5 trillion increase in the deficits over a decade due to any tax cuts.  The Republicans, anticipating the Democrats opposition to their proposals, will use the procedure known as reconciliation, which allows for a simple majority in the Senate to pass the legislation.  This procedure however, has a 10 year life.  That is, the reform would only be in effect for 10 years.
  2. The most important change would be to lower the corporate tax rate to 20% from 35%, which is the highest in the world.  That rate would bring the US below the industrialized world’s 22.5% average.  It would also improve the US position of 35th out of 35 nation’s in the Tax Foundation’s annual index.
  3. The framework moves to the territorial model that allows companies to pay taxes where income is earned, which is the global norm.  The current system taxes companies regardless of where the income is earned.  As a result, US companies have about $2.5 trillion overseas to avoid US taxes.  The money will be invited to come back to the US at a undetermined lower rate than 20%.
  4. Small business owners who pass through income to personal returns, by using sub-chapter S or LLCs, would see a top rate reduction from 39.6% to 25%.  There will be some guardrails to prevent lawyers and hedge fund operators from changing wages to pass throughs to take advantage of the lower rates.
  5. Companies would also be able to completely expense new machinery and equipment in the year purchased rather than write off the cost over multiple years.  This benefit would last for 5 years.  There is also talk that companies may lose the deduction for interest costs.
  6. Individual tax rates would be changed from 7 brackets to 3, 12% (higher than the current 10% at the low end), 25% and 35%.  The cut off points between the 3 brackets have not been identified.
  7. The standard deduction would be doubled to $12,000 for individuals and $24,000 for married couples, although the personal exemption of about $4,000 would be eliminated.  Doubling the standard deduction would eliminate the necessity to itemize deductions for many people.  All deductions would be eliminated except mortgage interest and charitable contributions.  State and local property taxes, income taxes and sales taxes would no longer be deductible.  Eliminating these deductions saves an estimated $1.25 trillion over 10 years.
  8. The child tax credit will also be increased to as yet an unspecified amount, but unlike the current credit the maximum cash payout will be $1,000.  There is also a new $500 credit for non-child dependents, which means caring for the elderly.
  9. The alternative minimum tax will be eliminated.  Inheritance taxes will also be eliminated.  All proposed tax changes would take effect this year.
  10. In an August letter 45 of the 48 Democrat Senators outlined their conditions for working on tax reform.  They stated no tax cuts for the top 1% of households, that Republicans should not use reconciliation to pass a bill and that any cuts would be offset with higher taxes so that there would be no increase in the deficit.
  11. Republicans maintain that their tax reform will not add to the deficit.  They explain that the cost of the cuts will be offset by eliminating tax breaks and creating faster economic growth.

Will the Republicans be able to pass tax reform this year, especially given that 45 of the 48 Democrat Senators have already opposed what has been proposed?  Will the Republicans fall back from reform to merely reducing the rates and collapsing the tax brackets?  Will the tax reform outline revitalize a weak economic expansion, lead to more new business creation and expansion, enhance worker productivity and lift wages?  Should the Republicans attempt to engage Democrats for a bi-partisan deal?  What is the “Right Thing to do?”  The Republicans must push and unify behind comprehensive tax reform along the guidelines of their outline.  Tax reform is long overdue—the last reform was over 30 years ago.  The GOP has offered an outline that will enhance US competitiveness, bring back cash held abroad by corporations, provide relief for small business owners, simplifies the tax code for individuals, provides lower rates and lower taxes for the middle class.  The Democrats have already begun the high volume criticism and the tired mantra of tax breaks for the rich.  Republicans must also resist the intense lobbying from those trying to protect their special tax benefits.  The Republicans must pass reform and do so before the end of 2017 and not fall back to just changing the rates and brackets.  If they do fall back from their promises once again, they will snatch defeat from the jaws of victory.