by Grant Wardell-Johnson, Leader, Australian Tax Centre
The election of Donald Trump to United States (US) President raises four main taxation questions for the US
Are they likely to be legislated?
What will they mean for the budget and the economy?
What does Mr Trump mean for the global tax agenda?
What are his policies?
Mr Trump tax policies have evolved over the campaign. In one sense they have become less dramatic and more in tune with the views of the Republican House Ways & Means Committee. Under the latest plan, Mr Trump plans to provide personal tax cuts by replacing 7 tax brackets with 3 brackets; 12 percent, 25 percent and 33 percent. The top marginal rate is currently 39.6 percent. He also intends to raise the standard deduction, which acts as a tax free threshold.
According to the unaligned Tax Policy Centre in the US, this will impact those on higher incomes more beneficially with those in the top 0.1 percent of income earners benefitting by 14 percent in terms of after tax income. Those in the middle quintile benefit by 1.8 percent and those in the lowest quintile by 0.8 percent of after-tax income.
In addition to raising the standard deduction, Mr Trump proposes to provide a deduction for childcare and eldercare with certain caps based on numbers of children or dependents, the average cost of care in a state and income levels.
Mr Trump also intends to eliminate death duties, although capital gains tax will apply on death with a high threshold. There is a special investment income tax of 3.8 percent associated with the health care reforms that Mr Trump intends to repeal.
On the business front, Mr Trump intends to reduce the company tax rate from 35 percent to 15 percent. This will come with some odd base-broadening. Manufacturers (New York speech) or all entities (Detroit speech) will be able to claim investment in capital upfront (rather than over time), but will not be able to claim interest deductions if they do so. This is an imbalanced approach if one takes the view that it is economic gains that should be taxed. It is also likely to attract some odd structuring.
One feature of the US economy is that it contains a substantial number of business activity located in transparent or pass-through entities. Mr Trump has indicated that these entities will be optionally entitled to the 15 percent tax rate at the owner level, rather than the personal tax rates of 25 percent or 33 percent. This will encourage workers providing services as employees to “incorporate” into a business structure, given an 18 percent difference between the top marginal rate and the business rate. How this would be dealt with is unknown. There are clearly, strong equity issues associated with this measure.
Mr Trump’s tax plan involves the taxation of existing (pre-2017) unrepatriated earnings. The rate of tax is 10 percent for such earnings held in cash and 4 percent for other earnings. This one of tax liability will be able to be spread over 10 years. A similar rate will presumably apply to future earnings.
Are Mr Trump’s policies likely to be legislated?
There are two important considerations. Firstly, Mr Trump’s plan may be considered to be an ambit claim for a more moderate plan with less detrimental impacts on revenue. This may be a question of the new President negotiating with key Republicans in Congress.
Secondly, while the Republicans will have majority control over the House and Senate, they will not have a super-majority or 60 percent of the Senate. This means that legislation making changes to the tax system can be defeated in the Senate by filibustering. There is a procedure under US Congressional rues called “Budget reconciliation” which provides a mechanism for subverting a filibuster. Under this technique, revenue, expenditure or debt ceiling measures can be passed as part of a budget process. This is a Plan B mechanism. The disadvantage is that the measures have a limited life of 10 years and thus do not become a permanent feature.
My view is that it is likely that a compromise package will get through Congress under a Budget reconciliation process. However it is unlikely that the corporate tax rate will fall to 15 percent.
What will they mean for the US Budget and the economy?
The US Tax Policy Centre (TPC) in conjunction with a Penn-Wharton modelling team have concluded that Mr Trump’s tax program will cost about $6.2 trillion over the first 10 years in lost revenue. This is before additional interest costs from the increased deficit and macro-economic effects. About three quarters of this loss of revenue is from the business taxation measures.
Reduced taxation clearly promotes additional business activity when considered in isolation. However, there is a trade-off because the increase in the deficit will result in increased government borrowing, increased interest rates and crowding out of investment. TPC and Penn-Wharton conclude that by 2026 with increased debt of about $7.7 trillion, the Trump tax plan will lead to lower GDP than would be the case without it.
This will feature in any compromise reached between a new White House and Congress on tax reform.
What does Mr Trump mean for the global tax agenda?
This is difficult to say and may depend to large extent on the advisors he appoints. There are probably five major points here.
- Mr Trump appears to have an antipathy to international cooperation and thus is unlikely to embrace a Base Erosion and Profit Shifting (BEPS) agenda, at least one with an international branding.
- Mr Trump does not have a strong relationship with Wall Street and large business, although many Republicans with whom he would need to negotiate a tax package would do so.
- A sub-text, if not text, of Mr Trump’s plan is closing concessions and loopholes. Such ‘closures’ can fill holes in funding packages. Something Mr Trump is likely to need for this tax plan.
- Mr Trump is seeking to promote business activity “at home” and not “abroad”. This oddly may give rise to implicit support for measures which assist US firms reduce taxation offshore.
- A lower corporate tax rate in the US is likely to increase pressure on Governments, including Australia’s, to reduce its corporate tax rate. The world appears to be moving to a corporate tax rate band of between 17 percent and 25 percent. The US, Japan and India are three major outliers, currently. If that changes the pressure for corporate taxation in a competitive band for smaller and medium economies will be even greater.
The world is a changed place on many dimensions with the election of Mr Trump. In the tax realm it is likely to be more uncertain, more volatile, with more likelihood of unintended consequences. On the other hand, there is greater likelihood for a “coordinated” tax package change with the Republican control of Congress. We will watch this space with trepidation and interest.