The Missing Trillion Dollars in Republican Tax Reform Plan

November 12, 2017

By Jeff Ferry, CPA Research Director

The Republican tax reform plan is suffering from a shortage of funds. Paul Ryan and his colleagues are trying to give the American people a substantial tax cut as their signature achievement of 2017.

However, they are constrained by Congressional rules that limit increases in the federal budget deficit to just $1.4 trillion over 10 years. As a result, the plan is peppered with small-bore cutbacks to tax deductions and other maneuvers that make the plan seem small-minded and miserly.

Thankfully, there is one potentially large tax reform that could bring in a whopping $1 trillion, and empower the Ways and Means Committee to be truly generous with the American middle class. 

There is a move toward sales factor apportionment (SFA) on the corporate income tax. The current Republican plan (also known as TCJA—the Tax Cuts and Jobs Act) sounds bold because it is slashing the top corporate income tax rate from 35% to 20%. Yet aside from that change on the corporate side, TCJA is basically a nip and tuck job. It fixes a few loopholes, but keeps most corporate loopholes, deductions, and exclusions in place—leaving us with one of the leakiest corporate tax systems in the world. Billions of dollars in corporate profit will continue to escape the IRS because they will be hidden in offshore subsidiaries or other tax structures that exempt funds from US taxation. This is called base erosion, since the tax base of corporate profits earned by US-based corporations escapes the IRS through clever tax planning.

SFA corporate income tax would be truly fundamental reform. SFA taxes corporations based on the portion of their profit that corresponds to their US sales. If they make half of their sales in the US market, then they pay tax on half of their global profits; it doesn’t matter if they use clever accounting to attribute profit to an offshore tax haven; it doesn’t matter if the consumer buys the product from a subsidiary in a tax haven. The data the IRS needs to calculate tax liability under SFA is much more readily available and much harder to fudge than the data used under the present system.

In an article to be published later this month in Tax Notes, we estimate that a move to SFA taxation would raise US corporate income tax revenue by a whopping 34% a year.  That 34% uplift comes mainly because there are so many large corporations paying far below headline tax rates today. Just by requiring them to pay the headline rate on their US-destination profits raises the tax take substantially.

Here are the numbers: According to estimates from the Congressional Budget Office, the current tax system is set to generate $3.9 trillion in corporate income tax revenue over the 10 years from 2018-2027. Corporate tax cuts in the TCJA (mainly the rate cut from 35% to 20%) slice $847 billion off that total. A switch to SFA taxation, while maintaining the 20% rate, would add an estimated $1.04 trillion to the 10-year tax take. In 2018 alone, a move to SFA would add $68 billion to the corporate tax take.

That extra trillion dollars would make many other tax cuts feasible, in particular on the individual tax side. For example, the current plan to eliminate the deductibility of state and local tax payments could be dropped; the cap on mortgage interest deductibility could be raised or eliminated; and, most fundamentally, income tax rates for the middle class could be lowered further, making the tax package unarguably a “middle class tax cut.”

The Republicans claim they are attacking the erosion of the corporate tax base with their proposed 20% excise tax on payments by US corporations to foreign-based affiliates. But only days after lobbyists found about the excise tax, the Republicans have reportedly added new exceptions that reduce its revenue by as much as 95%. This only makes a complex, inefficient system even more complex. It’s a sure bet that, within a short space of time, clever corporate accountants will find new ways to avoid what remains of the excise tax. In fact, you could almost rename the corporate side of this act the Tax Cuts and Jobs for Accountants Act.

 There are other advantages to SFA taxation, such as greater fairness, greater predictability of future revenue, and benefits for small companies. So why haven’t the Republicans embraced it? The answer is that too many huge corporations paying little or no tax have been lobbying behind the scenes for months to prevent fundamental reform of today’s corporate tax system. It’s time for Congress to face up to the vested interests and consider some fundamental corporate tax reform. 

Showing 3 reactions

Please check your e-mail for a link to activate your account.
  • Tom Terry
    While Republicans are in charge now, there is also a huge silence on the part of Democrats. Why wasn’t this employed long ago? Why do we give tax breaks like the one on the table now and then later claim that we have to slash medicare or medicaid while we allow these tax havens and strategies that cheat the treasury out of tax money?

    Our political class has become captured. They can not or will not fix our problems. Instead, they use the problems to make additional cuts like corporate tax cuts. Why aren’t they taxing imports from countries with VATs that distort trade? Why can’t they fix Chinese and other currency issues? Our political class lacks leadership on the real problems and then come up with more carrots like tax breaks to bring offshore profits (many of which were pushed offshore through the pencil) back home?
  • Franklin Kirkland
    An SFA-based corporate income tax sounds so logical on the surface it seems like it would be an easy sell. Since it’s not selling, I have some questions:

    1. What would critics say are it’s flaws, and how would SFA advocates counter those points?

    2. How can we be sure shrewd tax accountants won’t find loopholes like they do with current law?

    3. How does it discourage companies from moving overseas?

    4. Is passthrough income treatment independent of SFA? If not, how does SFA influence the passthrough debate?

    5. Who’s ox is gored by SFA and what might their workaround be? And how could the legislation preemptively prevent such avoidance?

    6. At least some Republicans like Ryan wanted actual “reform” such as the use of a border-adjustable tax. Why have they not embraced SFA?

    7. And why wouldn’t Dems embrace it as an alternate to the GOP’s approach? (Except that Dems seem content to criticize rather than offer competing solutions.)

    It would also be helpful to understanding the mechanics and results of SFA if specific corporate examples were provided.
  • James Crawford
    Dear Jeff,

    Since all the macroeconomists associated with the CPA routinely and dogmatically dismiss the credibility of the legislative process, what business do you have appealing to the members of Congress to do anything?

    And since all your macroeconomists believe in is telling the executive branch what to do, why aren’t you dissing the Trump Administration for failing to keep those pesky legislators in line?

    If you want to make direct appeals to the legislature, I suggest you get up off your intellectual behind and come up with a theory of political economy that encompasses such activities.