Tuesday, March 13, 2018

Tax Reform is Fine But Revenue Scoring is Bogus

Having been involved in tax policy analysis for over 30 of my 45 years in the tax business, I have no quarrel with the basic outlines of the recently enacted tax reform package.  While the press and the public seem to feel otherwise, the fact is that the press, propelled by statements made by politicians for public consumption, is incapable of accurately conveying tax policy issues to the public.  For example, both politicians and political observers continually call for a “simple and fair” tax law.  However, anyone who has any familiarity at all with the tax law knows that “simple” and “fair” are incompatibly conflicting goals.  A simple tax law by definition cannot be fair.  A fair tax law cannot be simple, since simplicity equates to one size fitting all. and the world is much too complicated for that.  (It is possible, however, to have a tax law that is complicated and unfair.)   But fair and simple is what the public and press want to hear.  And when it goes more complicated issues of tax policy, the press and the public consistently get it totally wrong. 
Turning to the recently enacted tax reform bill, the press and the public point to the cut in the top corporate tax rate from 35% to 21%, and characterize this as a giveaway to business.  However, the US taxing system does not exist in a vacuum, but is part of an international system, and with a rate of 35% and taxing a US corporation’s income whether it was earned in the US or abroad (something which very few countries in the world do), the US taxing system was an outlier.   (That's why inversions were invented as a form of self-help.)  Indeed, foreign governments around the world were miffed at the United States for being  totally out of step with the rest of the world in their taxing system.  Even the Democratic party recognized the US outlier status, as President Obama’s annual  budget proposals consistently called for a cut in the corporate tax rate, albeit to 28%, as opposed to the 21% that was ultimately adopted. Still, the Obama 28% proposal (which was viewed as an "opening bid" to Congressional Republicans) was a 20% reduction in the tax rate and was widely acknowledged by Congressional Democrats as being necessary to get the United States in step with the rest of the world.  However now, though well aware of the need for corporate tax reform like that included in last year's bill, Democratic politicians pile on against the enacted tax reform corporate tax cut because that's what their constituents want to hear.
What I do take issue with is the fact that the tax reform bill created a $1.4 trillion budget hole, something which might be needed if we were coming out of a recession, but not when we were 10 years into an economic recovery.   The tax reform discussion over recent years involves two separate elements–lowering the top tax rate such that corporations operating at the margin would be incentivized to invest in the United States, while reducing credits and deductions to pay for the rate reduction.  That Congress chose to create such a large budget gap is regrettable. A 21 percent corporate tax rate itself is not inordinately low in today's international tax system, but the Republicans did not have the courage to broaden the tax base further by eliminating more deductions and credits.

But on top of this they doctored the budget numbers, which is inexcusable. In particular I am appalled by the enactment of amended Sec. 461(j) for excess business losses of non-corporate taxpayers, which disallows nonpassive losses of a taxpayer (passive losses are alreaded restricted) in excess of $500,000.  It’s not the provision itself that irritates me, but rather it’s the revenue scoring of this provision as a $150 billion revenue raiser, to get the total revenue loss of the tax reform bill under the Budget Reconciliation limit.  This $150 billion amount was likely intended to offset the $410 billion revenue loss attributable to the 20% passthrough deduction intended to put passthrough business owners on a somewhat equal footing with C corporations garnering the new 21% tax rate.  It’s also equal to the total amount raised by the BEAT anti-base erosion minimum tax being imposed on multinational corporations.  The problem is that Sec. 461(j) only provides for a year-of-loss disallowance.  The next year it goes into the taxpayer’s NOL where it can be used (at least up to 80%) starting the very next year.  How Sec. 461(j) raises $150 billion under these circumstances is a mystery to anybody who thinks about this.  I’d say that $1.5 billion is a more realistic figure than $150 billion, and that by itself the miscalculation of the Sec. 461(j) revenue effects puts the tax reform bill out of compliance with the Budget Reconciliation rules.
Revenue forecasts for proposed tax legislation is probably largely voodoo in any event.  But the forecast for Sec. 461(j) makes you wonder who the witch doctor was. 

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