Last week the Trump administration released the outlines of the president’s proposal for tax reform. While some of the provisions are critical for boosting US economic growth, like a lower corporate tax rate and a so-called “territorial” system for taxing companies’ foreign profits, the plan is silent on many other key measures that are necessary to boost productivity and competitiveness.
Critically, the plan also would add trillions of dollars to the deficit over the next decade, an issue the administration further aggravates by proposing to cut taxes on so-called “pass-through” businesses. The unfortunate effect of these flaws will be to divert attention away from other proposals that have a greater chance of passing Congress, which will slow progress toward much-needed tax reform to boost the U.S. economy.
Earlier this year, the Information Technology and Innovation Foundation issued a report spelling out five key provisions that any tax reform should include. The Trump plan has a mixed record on these. The plan does lower the corporate rate to 15 percent. It also moves the United States to a territorial system in which companies pay U.S. tax only on their domestic profits. This will immediately make the United States more attractive as a place to do business. Companies based in America would face the same marginal tax rates as their competitors when they sell in overseas markets. Perhaps even more important, a lower rate will reverse the incentives to move profits abroad through so-called “inversions” or transfer-pricing agreements. The proposal also contains a one-time tax on past earnings that have been parked abroad. This will produce hundreds of billions in tax revenue and remove any incentive to keep the money overseas in the future.
Unfortunately, the proposal contains no realistic method of paying for at least some of the lower rates. Indeed, it aggravates the problem by extending tax cuts to individuals, especially on their business income. Pass-through entities would not only continue to enjoy a much lower total tax rate than regular corporations, but their owners also would pay much lower taxes than their employees. As ITIF has argued previously, any attempt to deal with growing financial deficits will require higher taxes on individuals. Cutting pass-through rates, which would mainly benefit the well-off, is the opposite of what is needed.
The Trump plan also is silent on some of the other key components of reform that would boost US productivity and competitiveness. There is no mention of the research and development tax credit, which needs to be expanded to spur more innovations that benefit the whole economy. Nor is there any mention of an “innovation box” that would give companies a lower tax rate on profits derived from intellectual property, another way to incentivize research. Finally, the plan is silent on whether it would allow companies to depreciate capital expenditures at a faster rate, which would encourage them to invest in their own productivity.
A plan supported by House Speaker Paul Ryan would allow firms to write off the full cost of their investments in new software, machinery, and equipment. At a minimum, any reform should make current provisions for bonus depreciation permanent and allow all firms to write off the first $500,000 in qualified investments. These three provisions are critical not just because they would directly spur more innovation and investment, but also because they would help firms in globally traded industries succeed in the face of intense competition.
There are two reasons for an administration to issue its own proposal. The first is to set forth a clear vision for reform that is compelling enough to attract the support of others. The second is to identify a compromise that can attract enough supporters to pass. For either strategy to succeed, people have to believe that the administration is fully committed to the ideas it is putting forth. This plan does not meet either test. It is a step backward because it diverts attention away from the House bill, which continues to have the best chance of passing in a modified form, and therefore moving the debate to the Senate.
Joe Kennedy is a senior fellow at the Information Technology and Innovation Foundation.