Don't expect a smooth ride for U.S. tax reform

The art of the deal didn’t work for changing U.S. health care. It will be put to an even more gruelling test when it comes to tax reform.

The withdrawal of the health care bill for lack of support in Congress has eroded President Trump’s reputation as a deal maker and roiled markets around the world. It has also removed a trillion dollars that would otherwise have helped to pay for lower taxes.

It may be too early to write off changes in health care altogether. Congress may be more amenable in the future if legislation is reintroduced as part of a broader tax reform package. That is, assuming that a deal can be reached on tax reform in the first place. The debate about health care is likely to pale in significance in comparison to the political wrangling about to erupt over taxes, and corporate tax reform in particular.

Republicans applauded enthusiastically when President Trump promised a “big cut” in U.S. business taxes in his first address to Congress. Since early on in his election campaign, the President has insisted that he would reduce the corporate tax rate to 15 per cent and simplify the tax system by eliminating special deductions and tax credits (except for those concerned with research and development). His intentions generally seem in line with the Blueprint for Tax Reform published last June by the Republican majority in the House of Representatives. The Blueprint would reduce the tax rate to 20 per cent, keep R&D incentives intact, and eliminate a number of other deductions and tax credits.

But, the similarities end there. Fundamental differences exist between the Republican plan and the President’s proposals that will need to be reconciled either before or after legislation is introduced in the House of Representatives. It won’t be easy.

Much attention has already been focused on the proposal to tax imports and exempt exports. Major producers of chemical products and machinery and equipment manufacturers stand to save a lot of money from border tax adjustments. Other business sectors like retailing, petroleum refining, construction, and health care services would see costs dramatically increase. But, border adjustments are just one element of the Republican plan that would skew financial impacts from one business sector to another. Inclusion of the full purchase price of fixed assets in the tax base and the elimination of the net interest expense deduction and foreign tax credit would also affect some industries far more than others.

When all changes are considered, the Blueprint works out to be slightly more generous for business than the President’s proposals. On average, the Republican plan would save corporations about 0.1 per cent more of their pre-tax revenues every year. However, this masks a wide divergence in financial impacts across industries. The Blueprint, for instance, offers rental and leasing companies the prospect of a tax rebate worth more than 28 per cent of their pre-tax revenues. The pipeline industry would receive a rebate of almost seven per cent of pre-tax revenues. At the other extreme, trust funds would need to pay 13 times, and the retail sector six times, more in tax than they currently do.

There is considerable variation in savings and losses across other industries as well. Businesses in mining, oil and gas, chemical production, machinery, computer and electronics manufacturing, air transport, information services, investment, waste management, and accommodation services would enjoy major savings if the Republican plan were adopted. Meanwhile, industries like construction, wood products, printing, petroleum refining, furniture manufacturing, insurance, real estate, food and beverage and other personal services would end up with far heftier tax bills than at present.

The President’s approach is far more practical. His plan may not be as generous for the corporate sector as a whole, but all industries would save money and the outcome would be far more uniform across business sectors than under either the Blueprint or the current tax system.

Of course, what makes sense in economic terms does not necessarily prevail in the realm of politics. The wide variation in financial impacts across business sectors created by competing tax reform proposals will greatly complicate the legislative process. The polarization of business interests between winners and losers under the Republican Blueprint, and the disappointment that will be expressed by those who expect tax reform to do more than simply deliver a lower tax rate, will be played out within the Trump administration, in negotiations between the White House and House Republicans, and in Congress itself.

It’s no wonder that tax reform was put on a back burner with the hope that health care could be resolved first. A rocky road lies ahead for long-awaited corporate tax reform in the United States.