GOP's Proposed Tax Changes Are No Match for Status Quo -- Update

The boldest ideas for changing the nation's tax code are either dead or on political life support, as the Republican effort in Congress to reshape the tax system moves much more slowly than lawmakers and their allies in business had hoped.

The clear winner, so far, is the status quo.

Republicans, who control both chambers, are scouring the tax code, searching for ways to offset the deep rate cuts they desire. But their proposals for border adjustment -- which would tax imports -- and for ending the business interest deduction and making major changes to individual tax breaks for health and retirement have all hit resistance within the party. The only big revenue-raising provision with anything close to Republican consensus is repealing the deduction for state and local taxes, and that idea faces objections from blue-state lawmakers in the party.

The GOP's dreams have collided with interest-group lobbying and the tax system's reality. Politicians all profess to hate the tax code, but they don't agree on exactly what they hate. Voters gripe about complexity but are wary of losing cherished breaks that are woven into the economy.

"Eventually you run out of ways to pay for your promises," said Alan Cole, an economist at the Tax Foundation, which favors a simpler code with lower rates. "There aren't any free, obvious sources of money where you can just do the thing and nobody gets mad."

Republicans are still hunting for ideas to soften the revenue loss from their proposed tax-rate cuts, and party leaders say they will finish a historic tax-code revision by year's end. President Donald Trump said on Twitter late Sunday that the process was ahead of schedule and " moving along...very well."

But a fruitless revenue quest may lead the GOP to second-tier options. And they won't be able to rely on generating lots of revenue from economic growth, because congressional scorekeepers are likely to make conservative estimates.

One possibility is a temporary tax cut that would expire to comply with rules preventing long-run deficits.

"Permanent is better than temporary, and temporary is better than nothing," Treasury Secretary Steven Mnuchin told the House Ways and Means Committee last week.

Another path is settling for a 25% corporate rate instead of the 20% backed by House Republicans or the 15% proposed by Mr. Trump.

"I hope we don't have to," said Rep. Kevin Brady (R., Texas), chairman of the House Ways and Means Committee.

Republicans started 2017 with high tax-policy ambitions, seeing an opportunity to use unified control of government to achieve a long-running party goal. They hoped for a quick repeal of the 2010 Affordable Care Act and a fast pivot to taxes.

Instead, the health bill moved slowly, and during that debate, Republicans talked briefly about limiting the favored status for employer-sponsored health insurance, the largest tax break for individuals. That idea collapsed. Now, the tax bill isn't written and must wait for the health bill and budget.

Republicans are working off the blueprint Mr. Brady released in June 2016. They saw what it took the former chairman, Dave Camp (R., Mich.), in 2014, to get to a 25% corporate tax rate. And they saw how his proposed bank tax and stretched-out depreciation cycles made his plan flop on arrival.

Their plan relies on big changes, each raising about $1 trillion over a decade. Each percentage-point reduction in the 35% corporate tax rate cuts federal revenue by about $100 billion over a decade, and independent analyses show economic growth can't cover all the costs of rate cuts.

One proposed change that has met wide resistance is border adjustment, or taxing imports and exempting exports.

Big retailers such as Target Corp. and Wal-Mart Stores Inc. launched a lobbying campaign to portray border adjustment as an existential threat to their businesses and a price increase for consumers.

Senate Republicans, parts of the Trump administration and some House Republicans now say they agree, imperiling the idea and leaving the House GOP plan $1 trillion in the hole. Without an alternative there is no clear way to prevent companies from seeking out lower tax rates abroad.

Jason Pye, director of public policy at FreedomWorks, which supports conservative activists, said Republicans need to make a yes-or-no call soon on border adjustment.

"Early on, nobody knew what the hell it was. Now, everybody has a general concept and they don't like it," he said.

Mr. Brady hasn't given up on border adjustment, in part because of the lack of a Plan B. Senate Republicans haven't coalesced around a plan, and the Trump administration has released only one page of goals.

"If someone's got a better solution," he said, "bring it."

Next up is the interest deduction for businesses. Republicans would deny the deduction while letting companies write off capital costs immediately.

Mr. Mnuchin told lawmakers he prefers to leave the interest deduction alone. He cited concerns of firms that rely on debt financing, including small businesses and the real-estate industry. Keeping the deduction also would leave a $1 trillion hole over 10 years. A cap instead of repeal is possible, which would soften the impact but yield less money.

The Trump administration has taken more items off the table. The president promised to protect the tax breaks for mortgage interest and charity, though his proposed expansion of the standard deduction would limit such benefits for many middle-income households.

The administration also ruled out a carbon tax and a value-added tax and said it wouldn't touch 401(k) retirement plans. Under questioning from Sens. Sherrod Brown (D., Ohio) and Bob Casey (D., Pa.) last week, Mr. Mnuchin seemingly took more tax breaks off the table.

He said the administration wasn't considering changing last-in, first-out accounting, the New Markets Tax Credit that provides assistance in struggling areas and the low-income housing tax credit. He said he would prefer to retain the tax exemption for municipal bonds.

People's assets -- from their homes to their retirement plans -- are closely tied to tax preferences, and that makes voters and industries resistant to change, said Lily Kahng, a tax-law professor at Seattle University.

"Once you extend some kind of tax preference to people, it becomes almost like an entitlement and people are really protective of it," she said.

The tax system is part intentional and part path-dependent. The existing rules were created -- by previous Congresses -- for a reason, and choices made decades ago are hard to unwind.

"It's not like the current tax code was designed by cruel, mean, evil people who wanted to make things as unfair and complex as possible," Mr. Cole said. "They were actually doing their best."

Rewriting the tax code is a process, Mr. Brady said. "If you expect that process to be smooth, and beautiful," he said, "it's not."

Write to Richard Rubin at richard.rubin@wsj.com

(END) Dow Jones Newswires

May 29, 2017 20:00 ET (00:00 GMT)