Reforming US Corporate Taxes, the Right Way

January 3, 2017 2:15 PM

The election of Republican Donald Trump to the presidency, along with his party’s dominance of both chambers of Congress, provides a unique opportunity for the sort of comprehensive tax reform that could truly benefit the US economy. The trick is making sure Washington focuses on the right kinds of reform.

Back in 2015, the Obama administration issued regulations intended to stop corporate inversions—the maneuver in which a US-based company merges with a foreign company in order to take advantage of a friendlier tax environment—but to no avail. Not to be deterred, in the spring of 2016, the Treasury Department put some bite into a new round of regulations that once again aimed at stopping inversions.

As I recently wrote in Tax Notes   (subscription required), the right solution for the inversion problem is comprehensive tax reform, not the proposed debt-equity regulations under Section 385 of the Internal Revenue Code that were finalized shortly before the presidential election:

“Although Treasury’s section 385 rules conceivably reflect good intentions, their burden to the economy (largely through compliance costs) will probably outweigh any potential benefit. The business community—and, by extension, the US economy—would have been better served if the Obama administration had taken a pass and let the next president work with Congress to implement long-term solutions to the underlying causes of America’s corporate inversion problem. The place to start is with recognition that inversions are the symptom; the problem is that our corporate tax rules are completely out of step with world norms.”

Now, that’s not to say Treasury completely ignored the overwhelming opposition and criticism of the regulations from Capitol Hill, the business community, and tax experts:

“To its credit, Treasury significantly revamped the rules before issuing the final text. Numerous transactions were excluded from coverage—for example, debt issued by Subchapter S corporations, debt issued by partnerships, and debt issued solely between foreign corporations with no relevance to the US tax system. Those exclusions, however, lengthened the regulations from 136 pages in the proposed draft to 518 pages in the final version. The complexity will be a boon to K Street lawyers and major accounting firms, but a bane to companies trying to do business.”

Ultimately, however, these rules will do little to stop companies that are simply looking to survive in the global economy:

“Considering the complexity and heft of the US tax system, it’s not surprising that companies have sought more business-friendly climates. Every company has an obligation to maximize returns to shareholders; if it can achieve that by reducing its tax burden, managers have a responsibility to consider taking measures to do so.

Unfortunately, rules like those just issued by Treasury will add more complexity, which will further encourage businesses to find workarounds—or, worse, to relocate their headquarters outside the United States. Washington should be doing all it can to lower the burden of business taxation and in other ways give leading companies good reasons to stay in the United States.”

Fortunately a viable solution to the outdated US tax system is around the corner:

“Earlier this year, House Speaker Paul D. Ryan, R-Wis., and Ways and Means Committee Chair Kevin Brady, R-Texas, put forward an ambitious tax reform blueprint that lays a framework to achieve those objectives. The plan seeks to cut rates, broaden the tax base, simplify tax preparation for most Americans, and move toward destination based cash flow taxation. According to an analysis by the Tax Foundation, the plan would create 9.1 percent GDP growth over 10 years, 7.7 percent higher wages, and as many as 1.7 million jobs.”

The last time the US corporate tax system saw significant revision was over 30 years ago during the Reagan administration. Foreign countries that compete head-to-head with the United States have become far more business-friendly during the intervening decades. It’s time the United States followed suit:

“If Washington wants to stop companies from taking advantage of tax-friendly environments overseas, or relocating altogether, it can start by making the United States a place where companies want to conduct business. That begins with comprehensive tax reform, not stopgap measures to fence industry into US tax boundaries. Unlike President Obama and Secretary Lew, the [Trump] administration should work with Congress to achieve comprehensive tax reform.”

Immediately after his confirmation, Treasury Secretary-designate Steven Mnuchin should announce hearings to revoke the final Section 385 regulations issued by Secretary Jack Lew. That action, among others, will clear the decks for meaningful reform in 2017.