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When historians tell the story of the great tax debate of 2017, they may mark down yesterday, June 13, as the day tax reform died. The debate will go on, but when House Ways & Means Committee Chair Kevin Brady (R-TX) signaled retreat on two issues critical to reform, the initiative’s demise seemed sealed.
Brady, conceding the political reality, told a Wall Street Journal forum that he was now looking to phase in the controversial border adjustment tax (BAT) over five years rather than impose the new system right away. He’d also exempt most businesses from another key element of real reform, his proposed repeal of the corporate interest deduction. To some degree, his remarks were a concession to the Trump Administration which has been cool, to say the least, to both ideas.
This is not to say that Congress will do nothing on taxes. A tax cut still remains very much in the cards, though its timing remains uncertain. But tax reform is another matter. And on that Brady seems well on the way to throwing in the towel.
The plan outlined last June by the House GOP leaders (including Brady) contained two critical elements of reform, a destination- based tax and a business cash flow tax. Combined, the changes became known as the destination-based cash flow tax or DBCFT.
The initial plan for taxation of cross-border transactions would have exempted all export income from tax while taxing imports (by denying US firms a deduction for their cost of foreign-sourced goods and services). Predictably, exporters embraced the idea while importers hated it. Some economists, meanwhile, argued that the new tax regime would have little effect on either imports or exports since currencies would adjust quickly to the change. Others questioned how fast or completely currencies would shift.
Phasing in the BAT has some theoretical benefits. It would be a big change and firms could argue that they, and consumers, need time to adjust.
But step-by-step idea creates three new problems:
If currency traders believe the new tax regime will be made effective in predictable stages, the dollar is likely to adjust far faster than the tax. The result: A stronger dollar with only a partially effective new tax regime would encourage imports (which would become cheaper in dollars) and discourage exports (which would become more costly to foreigners who are buying with less valuable Euros or yuan). And that’s exactly the opposite result of what Trump has demanded. He wants to boost US exports.
It would also raise much less revenue that an immediate shift. The Tax Foundation figures the change could trim $200 billion from the $1 trillion-plus that the June plan would raise.
There is another possible outcome. While the first-year’s partial shift to a BAT would occur as scheduled, Congress could delay the future changes year-by-year, leaving US businesses with a more complicated hybrid system. Such an outcome also would raise far less money than the GOP’s original plan.
Brady’s changes to the business cash flow tax would create other problems. The June plan would allow businesses to fully deduct the cost of capital investments in the year they are acquired, a system known as expensing, rather than depreciating the property of a period of years. But firms would also lose their ability to deduct interest costs on money they borrow to finance those investments. With both expensing and an interest deduction, businesses would pay a negative tax rate on such investments.
The Ways & Means chair said yesterday that he still wants to allow expensing but would exempt some business sectors from the ban on interest deductions. Small businesses (which he did not define) and utilities could continue to deduct full interest costs and so could all buyers of real estate. Small businesses, which include most US firms, already can expense capital investments and deduct the associated interest costs so Brady 2.0 wouldn’t change much for them.
The real problem is that Brady’s new formulation will set off a feeding frenzy. The definition of “small” is likely to expand. Big chunks of the economy will lobby to be included in his exempt list. Real estate firms will want to keep the interest deduction. Telecom companies will say they should be treated like utilities. And makers of everything from medical imaging equipment to assembly line robotics will insist that their products should also get special treatment.
I’m sure that Brady’s intent was to rescue tax reform. But I can’t help but think he was signaling that the next tax bill will end up looking a lot like so many of its predecessors—lots of tinkering around the edges dressed up with lofty rhetoric.
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Jacquelyn Martin/AP Photo