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This blog post is part of a series dedicated to analyzing the impact of the Tax Cuts and Jobs Act. Click here to see all of the blogs in the #TCJANowWhat series.
It is an honor to be included on the list of prestigious bloggers that Aparna Mathur has assembled to flesh out the Tax Cuts and Jobs Act (TCJA). Although I have written over 50 articles in Tax Notes on the TCJA, I have not yet taken the time to step back and consider the big picture. My first post for this blog seems like a good place to start. Below are some of what I consider the more notable aspects of the law. To keep the pace lively I’ll breeze through complicated issues with bullet points. I do not pretend to have all the answers — or even ask the right questions — so I look forward to learning from readers’ comment.
From an efficiency perspective, the corporate tax is our worst tax. International tax competition makes a rate above 30 percent untenable. Lowering the corporate rate is chicken soup for the code. It increases the incentive for domestic investment and reduces incentives for leverage, profit shifting, and tax shelters.
Despite loud claims to the contrary, this was not a significant impediment to investment in the United States (because the businesses most subject to lockout — namely, pharmaceuticals and high tech — had significant stores of cash in the United States anyway). But by removing the lockout effect the TCJA eliminated the spectacle of corporate treasurers and tax planners doing backflips to gets their cash back home.
In general, a minimum tax on foreign profits is an excellent disincentive to profits shifting. In fact, multilateral implementation of a minimum tax is at the top of the Organisation for Economic Co-operation and Development’s tax agenda. Unfortunately, the all-important details of the GILTI provisions, which are overlaid in existing complex rules, are mind-numbingly complex and arbitrary. And the economics stink too. In some cases, GILTI provides negative marginal tax rates on foreign investment. In other cases, it provides marginal tax rates well in excess of the US or foreign statutory rate. Major reforms and simplifications of GILTI must be undertaken by Congress passing new law. Treasury cannot fix the major problems by regulation.
“Foreign-derived” basically means “export.” So, a mechanically determined portion of income from exports attributable to trademarks, patents, and other intellectual property get a low rate. There are at least two backbreaking problems with the FDII provisions. First, exports incentives, even when well designed, are horrible economics (and this incentive is poorly designed), and they violate World Trade Organization rules. (But Treasury as an institution, even if it is not its inclination, must defend the FDII in international forums.) Second, determining precisely what exports, the income of which is preferentially taxed, are true exports and not round-tripping back to the United States is a near impossible and in any case highly complex task. The FDII provisions should be repealed.
It only applies to profit shifting related to import transactions (even though profit shifting is just as likely with export transactions). It only applies to the very largest firms. It exempts transactions that involves imports of goods but not services (even though there is no bright line between the two). It unfairly penalizes (and unduly favors) certain transactions depending on whether contract with third parties are made with US companies or their foreign affiliates. The BEAT is ridiculously complex and requires businesses to develop costly new accounting systems. The BEAT cannot be fixed by regulation and not even by Congress. It needs to go.
Limitations on the deduction for interest enacted as part of the TCJA are going to get much, much tighter after 2021. (Perhaps with interest rates so low, this may not be so much of a problem.)
It arbitrarily excludes some professional businesses from benefits. For higher-income taxpayers, it imposes a high degree of complexity and uncertainty. This deduction from income should be replaced by a simple wage credit for pass-through employers. In its current form the deduction is highly favorable to large manufacturing businesses that are structured as partnerships and S corporations.
Like their predecessors, Opportunity Zones are geographically arbitrary — that is, they often exclude many low-income areas and include economically attractive high-growth areas. Opportunity Zones provide incentives for some within–Opportunity Zone businesses, but not others. Most arbitrary in particular with the Opportunity Zone provisions is the requirement that only investors with significant unrealized capital gains may garner any benefit. So, for example, a middle-income Opportunity Zone resident who invests in a new or existing business gets no benefit. Opportunity Zone provisions should be repealed, but it would be impossible to renege on benefits already provided. Furthermore, unlike most provisions in the TCJA, Opportunity Zones enjoy support of both Republicans (who favor tax cuts) and Democrats (who favor development of low-income areas).
For those favoring the bill, this result is better than no bill. But it must be recognized that without buy-in of the minority party, the minority party can weaken the bill when it returns to power. This means instability of this legislation is significantly greater than normal. Democrats who have taken control of the House of Representative are now blocking any efforts to provide much-needed technical corrections. For the good of the economy they should drop this approach, but the temptation for revenge (for having been for all intent and purposes completely shut out of the process) and for tarnishing one of Republicans’ signature achievements is insurmountable.
The only reason tax-cutting Republicans did this was to keep the official estimated revenue cost below the $1.5 trillion limit in the budget resolution (which allowed the passage of the bill with only 51 votes in the Senate). Almost all the individual tax cuts will expire at the end of 2025. A variety of business tax increases are also scheduled, including a (nonsensical) requirement that research expenditures be amortized over five years (instead of being written off in the first year); the phase-out of 100 percent bonus depreciation; rate increases for GILTI, FDII, and BEAT; and (as mentioned) the tightening of restrictions on deductibility of business interest.
My own review of the data — on gross domestic product, investment, employment, employee compensation — reveals that the economy in the 20 months since the passage of the TCJA has performed about as well as in the 20 months before. Now, there are two reasons to reject what I say. First, perhaps I am adopting the practices so clearly described in the Howard Duff classic How to Lie with Statistics. I may have cherry-picked the time periods (which does make a difference) or perhaps I have excluded some important measures that tell a different story. (For the record, I have not done those bad things — at least not consciously.)
Second, using changes over time as explanation of the effect of something that happened before that time is one of the weakest forms of empirical economic analysis. And in these tempestuous economic times this is especially true. Trade wars, Brexit, deregulation, worldwide political instability, and changes in monetary policy have all been in the mix since the passage of the TCJA on December 22, 2017. Nobody can tease out the changes in economic indicators due to the TCJA. So, for example, it may be the case that the TCJA has had huge positive effects on growth but these effects have been offset by negative effects of tariffs.
It is important to monitor the economy’s performance since passage of the TCJA because the public and the media will in large part judge the tax bill and the Republican’s overall performance based on the economy’s performance. The economy gives important cues about the durability of the TCJA and the election prospects of Republicans.
Furthermore, it profligately added to the federal debt when the federal finances are on an unsustainable trajectory. There is a new view, however, put forward by some economists not known for supporting conservative causes, that argues that deficit-financed stimulus may be good for long-term economic growth (so timing of TCJA is not necessarily poor) and that increasing the debt is not necessarily such a bad idea as it was in the 1980s (because government interest rates are at extremely low levels). This view that the US economy may be entering a period of long-term stagnation (unlike the first half of the 20th century in the United States, like Japan over the past two decades) is gaining wider acceptance in the economic profession. (I personally am beginning to change my long-held views.)
Tax-free like-kind exchanges of equipment were discontinued by the TCJA but not tax-free like-kind exchanges of real estate. Investors in real estate investment trusts qualify much more easily for 20 percent pass-through deduction than other investors. At the last minute a qualification for the 20 percent deduction was relaxed explicitly to allow investors in real estate to qualify. Undoubtedly real estate developers will be a main—if not the main — beneficiaries of the Opportunity Zone provisions.
The TCJA statutes were written in haste. Only 50 days elapsed between introduction in the Ways and Means Committee and the signing by President Donald Trump. Moreover, deliberations on the details were so secret that in some drafting sessions even the Republican Treasury Department was excluded (or so I have been told). There is a lot of talk about a lack of hearings before the TCJA compared to the dozens upon dozens of hearing before the passage of the Tax Reform Act of 1986. The paucity of hearings is true. It is, however, largely irrelevant.
When the rubber hits the road and the legislative language is in its near-final form, it is formal and informal vetting by knowledgeable parties — bar associations, law professors, lobbyists, and business groups — that give drafters important review and reality check for drafters. By all accounts this did not occur to any considerable degree. The result is the legislative language at best gets a C+ where historically A– was the norm. This means that Treasury (luckily for Republicans in Congress, of an administration of the same party) has to repair as much as they could within their regulatory authority.
The Treasury and IRS regulation writers made Herculean efforts under tremendous time and political pressure. But there are at least four problems with excessive lawmaking by Treasury.
First, to the extent they provide taxpayer-favorable guidance that exceed that which was contemplated by congressional revenue estimators (whose assumptions remain secret) regulation writers are providing unscored stealth tax cuts. Second, almost all the public input provided to Treasury on technical issues is from practitioners and their clients who want relief. I have little doubt that the integrity of the Office of Tax Policy and the IRS is of the highest level. But regulation writers like all of us are human. Under incessant pressure from technical lobbyists it is only human nature that they will give the squeaky wheels the most grease. Third, unlike other government agencies — for example, the Office of Management and Budget — the Treasury does not disclose with whom it has meetings nor does it disclose anything more than official correspondence (and therefore excludes email). Fourth, because courts require standing, only private, interested parties who find Treasury regulations will challenge Treasury regulations in court.
Well, I’ve already taken up more space than I should have. Of course, many of these ideas are controversial. Welcome are other points of view and new information — even if it means this author must admit (yet again) to a mistake. So, if you can spare the time, please send me a comment on Twitter.
Martin Sullivan is the Chief Economist at Tax Analysts.
Return to the series.
Since the TCJA has been enacted the economy has ______. You or your favorite pundit can fill in the blank.
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