Tax reform must have a pay-for at the get-go
President Trump and Republican Congressional leaders are proposing tax cuts worth up to $5.8 trillion with few details on how to pay for them. With the national debt ballooning toward the $20 trillion mark, it’s irresponsible to propose tax cuts without a clear and realistic outline for how they will be paid for. House Republicans are self-servingly suggesting that the tax cuts will not increase the deficit and rather, will pay for themselves through economic growth — an idea that has been refuted by top economists , who call those growth projections unsustainable and unrealistic. The Senate budget proposal, voted on last night, leaves room to finance tax cuts by increasing the deficit by $1.5 trillion. But that’s a number calculated by including politically-impossible cuts to Medicare and Medicaid, and willfully ignoring Social Security’s growing costs. Given how the Republican framework appears blind to a variety of reforms that could actually offset tax cuts, the proposal is even more objectionable.
U.S. PIRG has identified a few key changes to both the tax code and to federal spending that would save money, eliminate waste, level the playing field for small businesses and make common- sense changes to a tax code that leaves too much room for gaming and gimmicks.
1.) Cut down on unneeded government subsidies.
U.S. PIRG partnered with the National Taxpayers Union to identify $124 billion in government subsidies for corporations going toward research and other activities that would be better funded by the free market. For example, we identified the Fossil Energy Research Grants and the Marketing Loan Assistance Program, both of which give corporations tax breaks for activities that they are fully able to fund and carry out without government intervention. Spencer Woody, a Policy Analyst with National Taxpayers’ Union, said, “Enacting the bipartisan recommendations detailed in this report would be an important step toward reining in wasteful, duplicative and cronyistic federal spending.”
This money would be better spent either funding more useful programs, paying down the deficit or filling the massive revenue shortfall that would result if the tax framework passes as outlined.
2.) Root out wasteful spending from the federal budget
Wasteful spending can be found lurking in other parts of the federal budget as well. With leaders of Trump’s tax reform team proposing cuts that will cost trillions of dollars, it’s vital that we cut wasteful, redundant and inefficient spending from our budgets. From extraneous administrative spending to poorly-executed public programs, both sides of the aisle can agree that some areas should be trimmed down. Our Towards Common Ground report found $139 billion worth of savings by eliminating outdated military programs, reforming the operation of entitlement programs and improving government operations.
Finding that wasteful spending is easy.To save even more, we can audit some of the budgets and spending practices of the biggest government agencies. In 2015, one audit found that the Pentagon was wasting $125 billion over 5 years on inefficient bureaucratic spending, including overpaid civilian contractors, duplicative administrative costs and poor use of Information Technology resources. Even more recently, an auditor found jumbled finances and improper accounting in the U.S. Army — mistakes and oversights which likely cost taxpayers trillions. It’s more than possible that similar audits of other departments would find opportunities to cut spending without depriving Americans of useful services.
3.) Close tax haven loopholes that allow for gaming and gimmicks
Our tax code is riddled with loopholes that allow corporations to take their U.S.-earned profits and, through the magic of accounting gimmicks, turn them into foreign profits stashed in offshore tax havens. By stockpiling billions in tax haven countries, corporations are dodging over $100 billion in taxes every year.
Much of the $2.6 trillion dollars stashed offshore are not profits legitimately earned in these foreign countries, and it doesn’t make sense to allow companies to continue pretending otherwise just for tax purposes.
The reality of these offshore stashes falls apart under the slightest scrutiny, revealing little more than a web of shell tax haven subsidiaries housing billions of dollars in profits that were legitimately earned in the U.S.. Our new Offshore Shell Games report found that American corporations reported earnings of over $104 billion just in Bermuda, a country with an overall economic output of $6 billion but a conveniently low corporate tax rate of 0%. In the Cayman Islands, a country with a 0% tax rate, more than 18,000 corporations are “headquartered” in just one small house — most of them having a corporate presence on the island that amounts to little more than a P.O. Box.
In the tax framework introduced last month, Republican legislators sketched out a plan to convert our current hybrid-worldwide tax system, which allows corporations to defer paying taxes on their foreign-based profits unless and until they are brought back to the U.S., into a territorial system. Under a territorial tax system, foreign-based profits would be entirely exempt from U.S. taxation, meaning companies that book profits to offshore tax havens using accounting tricks and gimmicks would be even more incentivized to continue doing so, and with gusto.
Without careful rules and considerations, a territorial tax system would become an offshore tax gaming free-for-all, with the real tax rate for multinational corporations able to shift their profits to tax haven subsidiaries hovering just around nothing. The companies that would benefit most from this system are not small-to mid-sized domestic businesses, but rather the biggest multinational corporations, with an even more substantial benefit going to industries that can easily move around their intellectual property rights to game the system, like the tech and pharmaceuticals industries.
Legislators have, for years, tried and failed to close corporate tax haven loopholes. A territorial system would expand those loopholes into loop-doors and loop-gateways and make avoiding taxes on profits booked offshore into a permanent feature of our tax system, making them even harder to close.
If Congress opts to adopt a territorial tax system, it must tread carefully and do due diligence to slam shut tax haven loopholes — or else it will be creating a tax system even more complex and ripe for gimmicking than what we currently have. The proposed framework acknowledges this tension, suggesting that corporations would pay a minimum tax on offshore profits. However, other countries which have adopted similar plans have struggled for years to manage this, creating an even more inefficient and overly-complicated tax system and largely failing to prevent offshore tax dodging.
By failing to close the tax haven loophole, Congressional leaders are ensuring that the “statutory” tax rate — whether it is 15% or 25% — is applicable only to the small- and medium-sized domestic businesses that can’t lobby and game their way into an even lower rate through the magic of tax haven gimmicks.
4.) Do not allow corporations to repatriate offshore tax money at a bottom-of-the-barrel rate
This tax framework suggests a solution for the $2.6 trillion currently booked offshore — a one-time tax holiday. Previous iterations of this proposal, called “repatriation,” have suggested this one-time tax rate be as low as 7%. By giving corporations a bottom-of-the-barrel tax rate on their offshore profits rather than taxing them in full, this scheme further incentivizes the gimmicks and tax gaming that led to all that money being booked in tax havens in the first place. If the U.S. does not switch to a territorial tax system, this plan would bolster corporations to pretend even more ardently that their U.S.-earned profits are actually earnings in tax haven countries, safe in the knowledge that one day they will be able to take advantage of another repatriation holiday at a low tax rate. When a repatriation holiday was implemented in 2004, corporations brought their offshore profits to the U.S. at a rate of 5% — and spent a majority of the money paying out dividends and buying back shares, not investing it as proponents of the holiday hoped. Even if the U.S. does switch to a territorial system, not taxing these offshore profits at the full tax rate would be rewarding decades of bad behavior. There is almost no economic benefit to a repatriation holiday and there is a lot to lose.
5.) Close the carried interest loophole
This framework remains mum on the carried interest loophole, a well-known loophole used by hedge fund managers to pretend that income that anyone else would pay taxes on doesn’t technically count as “income” and is therefore taxed differently. This loophole is so absurd that it has earned opponents on both sides of the aisle, with President Trump putting it in his crosshairs early in his presidential campaign and, according to recent reports, he is still committed to closing the loophole.
Here’s how it works — when managers of hedge funds and private equity firms produce a profit for their investors, they receive compensation in two forms. First, they receive 2% of the total value of the fund as a management fee, but they also receive a 20% cut of the interest accrued by the assets they manage, which can often amount to quite a bit of money. While the management fee is taxed like income, the 20% yield from investments, or the “carried interest,” is taxed like a capital gain. Why does this matter? Well, the top tax rate for capital gains is only about half as much as the top tax rate for labor income, and since hedge fund managers make most of their money through carried interest, their effective tax rate can be, as in the case of former presidential candidate and Bain Capital executive Mitt Romney, as low as 14%.
People from across the political spectrumagree that this loophole should go, as it defies logic and plays word games with our tax code. Just closing this loophole would raise an additional $18 billion over 10 years.
Tax reform should aim to simplify our tax code, eliminate needless loopholes that undermine the logic and integrity of our economy and ensure that small businesses and families aren’t made to pick up the tab for the biggest multinational corporations. Further, pursuing tax cuts needs to be paired with a realistic plan to pay for them — a goal that can be achieved in part by first picking off low-hanging fruit including unhelpful corporate subsidies and other forms of wasteful spending, and would be further bolstered by closing tax loopholes such as the carried interest and tax haven loopholes. Our recommendations alone still wouldn’t balance the cost of the proposed tax cuts, but they are a start — Congress could pursue other innovative options to fill the difference, rather than adding trillions to our deficit and justifying that with hand-waving.
One option would be to link tax cuts to a carbon tax, effectively raising tax revenue while addressing climate change and still offering substantial tax cuts to families and businesses.
We can’t continue to shift the burden of our ballooning national debt to the next generation, assuming that unrealistic or unsustainable economic growth will make it alright. If Republican leaders want to pass responsible tax cuts, they should take a close look at our recommendations and start to balance the revenue shortfalls by eliminating the worst loopholes and cutting out the most bloated and unhelpful pieces of our federal budget.
