The Impact of Tax Reform on Manufacturing
Republicans plan to unveil their long-awaited tax reform package on November 1. Although the nine-page tax reform framework released in September was short on details, the plan highlights key changes to the tax code intended to reduce the tax burden on both individuals and companies, spark economic growth in the U.S., and make the tax laws more globally competitive.
In need of a legislative victory before primary season begins, House Speaker Paul Ryan (R-WI) has stated his goal to pass tax reform by Thanksgiving and for a package to go to the president for his signature by the end of the year. To fast track the soon-to-be-released legislation, Congress is using the budget reconciliation process, a procedural move that will allow the Senate to pass legislation with a simple majority of votes rather than require a filibuster-proof 60 votes. On October 26, the House of Representatives unlocked reconciliation and provided Congress with its needed vehicle for tax reform when it narrowly passed the Senate’s version of the 2018 fiscal year budget. This important step also authorizes a tax package to increase the federal deficit by up to $1.5 trillion over 10 years.
The framework outlines several key provisions that will impact the manufacturing community:
- 20 percent corporate tax rate (down from 35 percent), with a new 25 percent rate for certain pass-through entities
- Move to a territorial taxation system, which would exempt a company’s foreign earnings from taxation when repatriated back to the U.S., with the transition including a mandatory deemed repatriation tax on existing overseas earnings
- Minimum tax on foreign earnings
- 100 percent expensing for five years
- Retention of the R&D credit
- Goal of repealing the corporate alternative minimum tax
- Elimination of the deduction for domestic manufacturing
- Partial limit on the deduction for net business interest expenses
The business community has been rallying behind tax reform and moving to a territorial system for more than a decade, but support for broad tax principles is about to crash into the reality that there are always winners and losers when it comes to tax reform. The devil is in the details, and Senate Finance Committee Chairman Orrin Hatch (R-UT) has acknowledged that tax reform is “much harder than health care” and Speaker Ryan compared the debate that’s coming to “go[ing] through Class 5 rapids, which is the biggest rapid you can go through."
Several of the proposed changes would make the U.S. tax code more globally competitive and help spur economic growth, investment, and innovation in the U.S., but the framework raises serious questions for companies too: What will the transition rules look like? What will a minimum tax on foreign earnings look like (and will it actually raise taxes on some companies)? What benefits will companies lose in the inevitable tradeoffs? How will this all be paid for?
The framework would offset its cost by eliminating most individual itemized deductions, the state and local tax deduction, and the current domestic production deduction. The debate over these revenue-raising provisions will be difficult and signs of friction have already emerged, raising the possibility that tax reform could face the same in-party fighting that stalled health care reform. The proposal to eliminate the state and local tax deduction is particularly problematic for lawmakers in higher-tax states such as New York, New Jersey, and California, and several representatives in those states voted against the budget because of the proposal to eliminate it. The challenge is that its complete elimination would generate $1 trillion in revenue, making it an easy target as lawmakers look for revenue offsets to pay for lower tax rates.
Rumors of a revenue-raising proposal to cap 401(k) contributions has also received a lot of attention and even led the president to tweet his assurance that the current benefit will remain intact as it is widely used by the middle class. Deficit hawks in Congress are also likely to push for deeper spending cuts – especially since the Treasury Department recently announced that the deficit for fiscal year 2017 grew to $666 billion. Some conservative groups in Congress supported the budget agreement in order to open the door to tax reform discussions, but it’s still unclear whether they would support a final tax package if it further balloons the deficit. For the time being, Republicans remain mostly unified but that front could shatter on November 1 when the plan’s details are released.
The upcoming legislative sprint is an opportunity for Congress to overhaul the tax code for the first time in 30 years. With the release of the plan’s details due in the coming days, manufacturers need to stay abreast of what’s in the proposal and engage with lawmakers. The process is going to be painful as Congress picks winners and losers and if reform does pass this year, it could be decades before Congress tackles it again.