Press Room: Tax Release
Candidates Highlight Tax Policy Proposals on the Campaign Trail
In recent weeks, both Hillary Clinton and Donald Trump have highlighted their respective tax plans and the stark differences between them. Much of the discussion has been along typical party lines. Clinton has attacked Trump’s agenda as more of the same trickle-down-economics historically favored by Republicans. Trump has portrayed Clinton as a tax-and-spend Democrat. No matter who is elected, the new President will have to work with Congress on tax reform. In June, House Republicans released a tax plan of their own (the Blueprint) which would move toward a consumption-based tax system for businesses. What specific proposals have been made and how would these proposals affect your business?
Key Tax Policy Proposals
The Protecting Americans from Tax Hikes Act of 2015 (PATH Act) together with the American Tax Relief Act of 2012 (ATRA) paved the way for tax reform in the future by making permanent a number of items including individual tax rates, estate and gift tax rates and business tax extenders such as the research credit. Collectively, ATRA and the PATH Act subtracted $4.5 trillion from baseline Federal government receipts against which any new tax legislation will be measured, which reduces the amount of incoming revenue necessary for, and thereby greatly helping the math of, revenue-neutral tax reform. Now that the stage has been set for tax reform, what do the candidates and House Republicans propose?
Hillary Clinton’s proposals would significantly increase income taxes on high-income filers as well as estate and gift taxes. Specifically, she would require filers with adjusted gross income (AGI) over $1 million to pay a 30% minimum tax rate. This proposal, previously introduced in President Obama’s budget proposals as the Buffett Rule imposes a minimum tax rate to counter the reduction of the preferential rate on dividends and long-term capital gains and the payroll tax wage cap ($118,500 in 2016) have had on the overall effective tax rate for some higher income filers as compared with lower income filers. In addition, she proposes a 4% surtax on AGI above $5 million (before the net investment income tax). Hillary Clinton’s proposed surtax is reminiscent of her husband Bill Clinton’s campaign promise of a 10% surtax on AGIs over $250,000, which became law during 1993 (his first year in office).
Donald Trump’s proposals would decrease the number of individual tax brackets to three, at 12%, 25%, and 33%, which is the same as that proposed in the House Republican Blueprint. Trump originally proposed brackets of 0%, 10%, 20% and 25%, but aligned his proposal with that of House Republicans in his August 8 speech at the Detroit Economic Club. House Republicans would eliminate all itemized deductions other than the mortgage interest deduction and charitable giving deduction, and Trump would limit the value of itemized deductions (other than charitable and mortgage interest). Both would also eliminate the alternative minimum tax.
Hillary Clinton would create a new tax rate schedule for long-term capital gains for assets held more than two years with rates declining as the holding period increases. The lowest capital gain rate of 20% would apply to assets held more than six years. She would retain the net investment income tax of 3.8%, for a total rate of 23.8% for assets held more than six years. Imposition of the Buffett Rule would indirectly raise the marginal tax rate on dividends and capital gains for affected taxpayers with AGI over $1 million. She would also tax carried interest as ordinary income.
Donald Trump has not proposed any change to the present law top capital gain rate of 20% for assets held more than one year. He proposes to repeal the Affordable Care Act, which would repeal the 3.8% tax on net investment income, reducing the top rate from 23.8% under present law to 20% under his proposal. He proposes to tax carried interest as ordinary income, but his campaign has not provided details on how this proposal would interact with special rates for pass-through business income (discussed below).
House Republicans propose a different approach for taxing investment income. The Blueprint would tax interest income, dividends and capital gains as ordinary, but would allow a 50% exclusion for this income. This is equivalent to a top bracket rate of 16.5% for investment income. Providing a preference for interest income equivalent to that for capital gains and dividends represents a significant change from present law for investors.
Estate and Gift Tax
Hillary Clinton would reduce the estate tax exemption to $3.5 million and increase the top estate tax rate to 45%, which is the same as President Obama’s proposal to restore the estate tax parameters in effect in 2009. So far, Clinton has remained silent with respect to President Obama’s proposal to repeal stepped-up basis, which would treat death as a tax realization event where the deceased would incur income tax on any unrealized gains, prior to imposing the estate tax. See January 2015 Tax Release on Obama’s State of the Union proposals. In contrast, Donald Trump and House Republicans would repeal the estate and gift tax.
Hillary Clinton has called for business tax reform that would raise at least $275 billion over the 10-year budget window. She acknowledged that base broadening should lower the tax rate to be more competitive in the global economy, but has not specified a tax rate. She has also proposed to strengthen anti-inversion and anti-earnings stripping measures. She has not discussed any specific proposals to limit deferral of taxes on corporate income earned abroad or to have a one-time deemed repatriation of previously untaxed foreign earnings, which have been proposed by President Obama.
Donald Trump has called for a top tax rate on business income of 15%, whether in corporate or pass-through form. Trump has proposed broadening the business tax base to support the reduced rates, but has not provided specifics. He has also proposed to allow businesses to immediately expense new business investments. Recently, he said he does not support proposals to curb the deduction for business interest expense. Trump proposes a one-time deemed repatriation of previously untaxed foreign earnings at a 10% discounted rate and to end the deferral regime on corporate income earned abroad.
The House Republican Blueprint shifts the taxation of business income to a consumption-based approach focused on business cash flow. The corporate rate would be reduced to a flat 20% and the maximum rate for income from pass-through businesses would be 25%. The key element of the consumption-based Blueprint plan is to allow the cost of capital investment to be immediately expensed, but to couple expensing with a complete disallowance of net interest expense. The proposal eliminates most business credits and incentives except for the research credit and it also retains the last-in, first-out (LIFO) inventory method. It includes a fully territorial tax system with a one-time deemed repatriation of previously untaxed foreign income at a tax rate of 8.75% for cash and 3.5% for other profits. It also modifies all business income taxes to be border-adjustable, similar to the operation of a value-added tax (VAT). Under the proposal, products, services and intangibles that are exported outside the U.S. will not be subject to U.S. tax regardless of where they are produced. Products, services, and intangibles that are imported into the U.S. will be subject to U.S. tax regardless of where they are produced.
The Blueprint is a dramatic departure from the tax reform proposal made by former Republican House Ways and Means Committee Chairman Camp that would have lengthened cost recovery periods but retained the deduction for business interest. The Blueprint cites economic research concluding that consumption-based tax systems are widely regarded as more pro-growth than income-based tax systems. The Joint Committee on Taxation’s macroeconomic analysis estimated that Camp’s tax reform proposal would increase gross domestic product (GDP) by $3.4 trillion over a 10-year period, which would increase federal receipts by $700 billion during that timeframe. Presumably, the House Republicans expect that the policy contained in the Blueprint will result in far greater increases in economic growth than Camp’s plan.
The chart below provides a side-by-side comparison of the major aspects of the tax plans.
The next President will likely take up tax legislation of some sort, whether it be as part of a sweeping grand bargain or as a patchwork of changes to the existing system. Whoever is elected President will almost certainly have to work with a Republican-controlled House, which has proposed fundamental changes to the way business income is taxed in the U.S. A consumption-based tax, if enacted, would disallow deductions for net interest expense while allowing immediate expensing of capital investments. This type of system would have a dramatic impact on the way most businesses are taxed, whether highly leveraged, capital-intensive, or both. Much of the groundwork has been laid for tax reform to move forward following the election. Individuals and businesses should carefully consider how they might be affected by these policies as legislative action could come swiftly following the election.