Tax Reform Drill Down (Jul. 26)

The latest today is that we may have recess as originally scheduled — i.e., starting at COB Friday — after all.  That night, the (not so) Secret Six Republican tax planners — Steve Mnuchin, Gary Cohn, Mitch McConnell, Orrin Hatch, Paul Ryan, and Kevin Brady — announced they will release an outline of a tax proposal package. Tonight, the group meets to finalize positions, per an observer close to the administration.

The last few weeks, Republicans on Ways & Means have focused on one revenue-generating proposal: eliminating the business interest deduction.  The GOP seeks to avoid owning a national debt preponderantly of its own making.  With the failure of BAT and the  as politics of the state and local deduction, the GOP has precious few revenue options.  More below.

Best,

Dana

________________________________

Whether to maintain or eliminate the business interest deduction is a point of dispute among the Secret Six Republican tax planners.  The 2016 House Blueprint for Tax Reform proposed eliminating the deduction.   Steve Mnuchin expressed the preference that the deduction be maintained, pitting the Secretary against at least one third of fellow Secret Six members — Paul Ryan and Kevin Brady.

If Mnuchin and Cohn are persuaded by House colleagues and agree to support the elimination of the interest deduction for business, it could generate $1.2 trillion in revenue over ten years (not net revenue).  The White House is not the only force opposing the provision — major national business groups are fighting to preserve the deduction.

Eliminating the deduction would unhinge a founding doctrine of American tax policy.   Since the enactment one of the the first modern federal income taxes in 1913, businesses have been able to deduct all interest expenses on borrowed capital.  To compensate for the revenue loss, the federal government taxes lenders on interest receipts.

The problem: interest is often received in tax-preferred forms, such as retirement plans, often effectively escaping taxation.  So eliminating the deduction is not calculated to accomplish any fiscally-oriented policy objectives for the GOP.

Ending the business interest deduction could generate around $1.2 trillion over ten years according to the conservative Tax Foundation.  Note that this is not a net figure — the amount would not come close to offsetting the $2 trillion that would be lost from reducing individual income tax brackets to 12, 25, and 33 percent.

Democrats could be persuaded to see a future for eliminating the deduction, provided it simplifies the tax code burden in a progressive fashion.  Given the current environment and the Republicans’ need in some circles to find revenue, it’s unlikely that the Republicans will see fit to suggest anything the Dems would consider equitable reform.  But since deficits don’t seem to matter, we’ll probably see this fall to the cutting room floor after some debate.

The Ryan-Brady wing of the Secret Six has advocated for the elimination of the deduction since releasing the “Better Way” agenda.  They intend to make up for the hit to business by allowing for 100 percent expensing of business investment in the first year.  Allowing immediate expensing and denying interest deductions is a large step toward turning the corporate income tax into something more akin to a consumption tax.  This would replace a system in which businesses depreciate assets over useful lives prescribed by law. Despite this, their plan is out of step with American businesses.

The Businesses United for Interest and Loan Deductibility (BUILD) Coalition has informed both the Senate Finance and House Ways and Means that it opposes to eliminating the deduction.  The coalition of mostly farmers and small businesses emphasizes the important role borrowing plays in fueling their operations.  The deductibility of interest lowers the cost of such borrowing.

The coalition also takes issue with the second plank of the Ryan-Brady plan: 100 percent expensing of first-year business investment.  The coalition argues full and immediate expensing is redundant, as small businesses are already able to expense annual expenditures.  Overall, the coalition insists the policy would raise the cost of capital and reduce investment over the long run.

Additionally, interest deductibility is a key component of the business model of real estate developers, who would be expected to oppose such a change in the law, ironic in view of the president’s erstwhile livelihood.

Steve Mnuchin’s business background ought to incline him to preserve the deduction.  During a Ways and Means Hearing earlier this year, Mnuchin testified, “On the business tax, my preference is to maintain interest deductibility, which is important for small- and medium-sized businesses.”  He went on to say that eliminating this deduction, like others, remains on the table despite the controversy.

With Steve Mnuchin, Paul Ryan, and Kevin Brady’s views on record, what is known regarding the remaining Secret Six members’ approach to the deduction?

•  NEC Chair Gary Cohn: Cohn holds the same view as Mnuchin.  On May 9, they both met with Republican senators and expressed their desire to maintain interest deductibility. Their unity means Trump likely supports keeping the deduction.

•  Sen. Orrin Hatch, Chair of Senate Finance:  Sen. Hatch’s stance on the issue is unclear.  He has stated in the past that the Congress may not reconsider the deductibility of interest expenses, but said he was open to re-evaluating the question. Early this month he said: “Some people think that would be a tremendous move in the right direction, on both sides . . . I can see it one way, and I can see it the other way, too. These are tough issues. There’s nothing easy about tax reform.”

•  Sen. Mitch McConnell, Majority Leader: McConnell’s stance on the issue is unclear. He hasn’t come out for or against the deduction. The most he’s said when referencing it is: “There are going to be critics of any way you try to provide revenues to buy down rates.”

House GOP tax writers are weighing middle ground options between the total elimination of the business interest deduction and its preservation.  An interest deduction may be kept for farmers and small businesses.

House Ways and Means Tax Policy Subcommittee Chair Peter Roskam says he is “actively working” on how to define which small businesses and farmers would be allowed to keep their interest deductions while taking advantage of the expensing provisions in the tax reform bill that Ways and Means is working on.

There is also the possibility of a “haircut” for interest deductions, say with 20 percent of net interest not allowed as a deduction.

It is not known if opposing or undecided members of the Secret Six will sign on to  these approaches.  If you’re anxious to know just where the Secret Six stands on this deduction and all the other important elements of tax policy, stay tuned — you will find out more on Friday regarding the big recess reveal.