On April 26th, Steve Mnuchin, the US Secretary of the Treasury, and Gary Cohn, Director of the National Economic Council (NEC), unveiled the “most significant tax reform (plans) since 1986“. The proposed US tax reforms aim to address the complexity of the current structure and established rate figures, both of which have been cited as troublesome for US enterprises. The main points put forward were:
- Moving to a ‘territorial’ system by developing a foundation for the application of a 15% corporate tax rate, a sharp decrease from the existing 35% rate;
- Slashing the highest marginal tax rate from 39.6% to 35%, with the other two tax rates being 25% and 12%;
- Repealing estate tax and the alternative minimum tax;
- Providing tax relief for families with child and dependent care expenses.
Mnuchin stated that the reforms were aimed at “creating jobs and economic growth”. However, sceptics argue that the reforms are more likely to benefit the rich than the general economy and ordinary citizens. Additionally, whether or not the reforms will even be implemented remains a major doubt due to how divided Congress presently is. Nonetheless, it is worth considering the main issues at hand.
Unlike most countries, the existing American tax regime taxes corporate profits when they are remitted back home at very high rates. Furthermore, declarations of foreign profits being reinvested or held indefinitely are not subject to any fiscal charges.
The result of this is that many American businesses hold their cash overseas in havens such as Ireland or Luxembourg. The value of American cash hoarded abroad is estimated to be a rather substantial $2.6trn.
By moving to a ‘territorial’ tax system, American businesses will pay tax in the country that profits are earned, which will significantly lower net cash outflows and thus boost financial performance. In theory, this should encourage US enterprises to repatriate cash into the country.
However, this is not likely in the case of the US. Large tech giants such as Apple, GE and Microsoft, are highest on the list of US agencies that hoard cash abroad. The early signals from this group have not been positive. For example, Apple has indicated that the extra cash will be used to pay shareholders instead of being spent on domestic manufacturing.
Additionally, despite the enormous sums of money held overseas, companies hold $1.94trn cash domestically – the highest level in two years. Remittance of foreign cash will not compensate for the trillions of dollars of tax revenue lost through lower corporate and income tax rates.
Another problem cited due to the current tax structure is that firms classified as “corporations”, often change their legal status to adopt simpler entities such as partnerships, sole proprietorships and private firms with limited liability.
The reason is that these entities do not need to pay tax at the corporate level. Instead, the parties – individuals or other agencies – that receive profits from the firm pay income tax. These types of entities have increased in volume and value, and now account for half of all profits recorded within the US.
Compared to the overseas hoarding issue, Mnuchin’s tax plans address this aspect of the problem to a stronger degree. By reducing the corporate tax rate from 35% to 15% for businesses of all types and sizes, corporations are less likely to convert to simpler legal structures. Theoretically, this will cut tax bills and boost corporate profitability. The “one-tax-fits-all” approach will also ease the overall collection and payment process.
An Unlikely Proposal
Accordingly, it seems unlikely that the Trump administration’s tax plans will take off.
Despite Mnuchin’s statement that the motivation for the proposal is to stimulate wholesome economic growth and benefit “ordinary citizens”, this is somewhat disingenuous. Smaller forms of businesses, such as sole proprietorships, pay an already low 15% tax.
The real benefits of the tax plans will be reaped by the richer echelons of the US economy due to the 20% reduction in corporate tax and the approximately 5% reduction in income tax within the highest bracket.
The overall feasibility of the tax plan is another area of concern. Estimates indicate that the proposals will significantly reduce the collected tax revenue. Something that could offset this issue, albeit to a limited extent, is the application of a “one-off tax” on overseas cash being repatriated. The last time this was used was in 2004, under the Bush administration, at a 5.45% rate.
Overall, the loopholes in the tax reform proposals simply seem too numerous for further progression in Congress. The first step towards strengthening the American tax regime should be the formulation of a proposal that exclusively supports ordinary citizens of the country.