Balance of power
- In the House of Representatives, the Second Session of the 115th Congress begins with 239 Republicans, 193 Democrats, and three vacant seats.
- In the Senate, there are 51 Republicans and 49 Democrats–including the two Independents who caucus with Senate Democrats.
House and Senate tax committees
- Rep. Kevin Brady (R-TX) continues as chairman of the House Ways and Means Committee, and Rep. Richard Neal (D-MA) remains the Ranking Democratic Member. There currently are 24 Republicans and 16 Democrats on the committee.
- The Senate Finance Committee continues to be led by Senator Orrin Hatch (R-UT), who has announced that he will retire at the end of 2018.
- The Finance Committee now is composed of 14 Republicans and 13 Democrats.
Looking ahead to the 2018 elections
- In midterm elections, the President’s party historically has lost an average of 25 House seats and four Senate seats.
- In elections where the President’s party held a majority in both chambers of Congress, the average losses were even higher at 33 House seats and roughly five Senate seats.
- Historical data shows a correlation between the President’s approval rating and the net change in Congressional seats for the President’s party in the first midterm election.
Tax reform implementation
- Congress will be closely monitoring implementation of tax reform by the Treasury Department and the IRS.
- The House and Senate tax committees also are expected to hold oversight hearings on how quickly guidance is being issued and on technical or administrative issues that may arise.
Legislative guidance and technical corrections
- The staff of the non-partisan Joint Committee on Taxation is expected to release a ‘Blue Book’ general explanation of the Act that should provide additional guidance to Treasury and the IRS.
- Congress this year may consider ‘technical corrections’ to the Act, but any such legislation would have to be considered on a bipartisan basis and would need to secure 60 votes in the Senate for passage.
Temporary tax reform provisions
- Congress this year is not expected to approve any legislation extending or making permanent individual or business tax reform proposals.
- The 2017 tax reform act sunsets nearly all the individual tax provisions.
- The Joint Committee on Taxation lists 23 separate tax reform provisions that are set to expire at the end of 2025, including the newly enacted individual tax rates, individual alternative minimum tax (AMT) relief, limitations on itemized deductions including the cap on deductions for state and local taxes, and the 20-percent deduction for certain pass-through business income.
- A future Congress and President may agree to extend or make permanent many of the temporary individual and business tax provisions.
State and local government reaction to US tax reform
- State legislators across the country are conferring with revenue officials to analyze the impact of federal tax reform on state revenue bases.
- While nearly all states conform in some manner to the federal code, they likely will consider adopting only certain of the new tax reform.
International reaction to US tax reform
- The European Commission on December 20, 2017, stated it may bring a WTO challenge against certain provisions of the 2017 tax reform act.
- This statement comes after a December 12, 2017 letter from the finance ministers of Germany, France, the United Kingdom, Spain, and Italy to Treasury Secretary Steven Mnuchin stating concerns related to several international provisions that had been under consideration at the time, including the base erosion and anti-abuse tax (BEAT), and global intangible low-taxed income (GILTI) provisions.
Outlook for other tax policy issues
- Congress is expected to take much more limited action on tax legislation this year.
- Congress this year may also act on several significant temporary business tax provisions that are set to expire in future years and that were not addressed in the final tax reform act.
Expiring and expired tax provisions
- The JCT staff updated report on expiring tax provisions, known as ‘tax extenders,’ covering the years 2016 through 2027, notes a number of tax provisions that were not made permanent as part of a 2015 tax extenders act–which made permanent the research credit and numerous other business and individual tax provisions–as well as the new expiring tax provisions that were created as part of the 2017 tax reform act.
- At 4.1 percent, the unemployment rate is at its lowest point since the end of the tech bubble in 2000.
- The economy averaged 171,000 new jobs per month over 2017, summing to more than two million jobs for the year.
- Labor force participation, particularly among prime-age workers, remains below the levels seen prior to the Great Recession, but has stabilized since the beginning of 2014.
- Despite historically low rates of unemployment, both inflation and wage growth have remained low.
Will tax reform be pro-growth?
- The Act is likely to positively impact the economy in 2018 through several major channels. The first will be the stimulative effect of lower personal and corporate income taxes.
- The second stimulative effect from the Act will come from allowing businesses to immediately deduct the full cost of any new investments in equipment.
- Another channel for growth will come from the repatriation of retained earnings from overseas, which are now eligible to come back to the United States after being subjected to the repatriation toll tax.
How will the Fed manage with low unemployment and no inflation?
- The Fed has indicated it plans three more 25-basis point increases in the Federal Funds rate this year.
- In addition to these projected rate hikes, in October 2017 the Fed began the process of gradually selling off part of its $4.4 trillion balance sheet.
- As long as inflation remains low in 2018, the Fed is likely to keep to its expected schedule of a 75-basis point increase in the Fed Funds rate in 2018, bringing the rate to between 2 and 2.25 percent by the end of the year–still well below historical averages.
Will trade decline in 2018?
- Trade policy could evolve in such a way as to affect negatively the overall growth picture, especially if there is disruption with any of America’s three largest trading partners–Canada, Mexico, and China.
- The Trump Administration is considering taking several actions against Chinese government support for its export market, which also could result in higher prices for American consumers and lead to retaliation against US exports.
Federal budget outlook
- Even without taking into account the Act, the CBO in 2017 had been projecting deficits as a percent of GDP of 5.2 percent by 2027, due to what it calls ‘rapid growth in spending for federal retirement and health care programs targeted to older people and to rising interest payments on the government’s debt.’
- With the Act, annual federal budget deficits are now set to exceed $1 trillion in 2020.
- Extension of the Act’s changes to personal income taxes that currently expire in 2025 would push annual deficits by 2027 to over $1.6 trillion, or close to six percent of GDP.
- The increases in government debt used to fund Social Security and Medicare, as well as increased spending on Medicaid will erode the ability of the economy to grow.
- It appears unlikely that Congress will take steps soon to modify these programs to either slow the growth of spending or supplement the dedicated revenue streams that support them, which will lead to a worsening long-run fiscal picture that could become a drag on economic growth in future generations.
- The increases in government debt used to fund these programs will erode the ability of the economy to grow.
Global tax controversy
- The uncertainties for US and non-US multinational corporations (MNCs) created by global tax controversies likely will intensify in 2018.
- The impact of US tax reform is being closely monitored by other countries as they seek to introduce their own reforms–some of which resemble, while others differ significantly from, the US approach.
- The OECD, if it is to continue holding its position as the international standard-setter, will need to encourage patience and compromise in order to maintain the underlying global corporate income tax (CIT) framework that has survived nearly 100 years.
Digitalization of the economy
- The most significant global tax policy development in 2017 was the emergence of taxation of the digital economy as the biggest focus for policymakers and MNCs.
Other OECD developments
- Multilateral Instrument and other treaty developments
- Country-by-Country reporting and information exchange
- Transfer pricing
- ‘Harmful Tax Practices’
- Dispute resolution (and prevention)
Other EU developments
- State aid
- ATAD 2
- Public CbC reporting and ‘blacklist’
- Mandatory disclosure rules (MDR)
- Dispute resolution
US tax treaties
- No new US tax treaties or protocols have entered into force since 2010 due to objections raised by Senator Rand Paul (R-KY) about information-sharing agreements that generally are part of all US tax treaties.
Trade and other policy priorities
- Actions in 2018 related to international trade, infrastructure investment, and federal regulations could have a significant effect on businesses and individuals.
- The US Department of Commerce reported on January 5, 2018 (in its most recent monthly survey for November 2017) that the United States ran a net trade deficit in goods and services for the first 11 months of 2017 of $513.6 billion, which reflected $2.6 trillion in imports offset by $2.1 trillion in exports.
- Presidential trade and tariff authority
- Trans-Pacific Partnership (TPP)
- North American Free Trade Agreement (NAFTA)
- United States-Korea Free Trade Agreement (KORUS)
- Tariff relief
- The Trump Administration appears to be preparing to unveil its long-awaited $1 trillion infrastructure plan utilizing public-private partnerships.
- Since taking office, President Trump has signed a series of executive orders directing federal departments and agencies to provide relief from federal regulations.
- Executive Order on Reducing Regulation and Controlling Regulatory Costs
- Notice 2017-38
- Notice 2017-36
- Second Report to the President on Identifying and Reducing Tax Regulatory Burdens
- Withdrawal of two proposed regulations
- 2017-2018 priority guidance plan
Health care and entitlement reform
- House Republican leadership has expressed interest in addressing entitlement and welfare reform in 2018, and President Trump previously had urged a return to health care reform.
- Concerns about the 2018 midterm elections may impede Congress’ ability to enact entitlement reform measures this year.
- Republicans also may revive efforts to transform federal funding for Medicaid into a system of block grants, which was included in various 2017 proposals to repeal and replace the Affordable Care Act (ACA).
- The most recent short-term funding bill approved by Congress provides a two-year moratorium on the 2.3-percent medical device excise tax for sales during 2018 and 2019; a one-year moratorium on the annual excise tax imposed on health insurers for 2019; and a two-year delay of the excise tax on high-cost employer health coverage (the so-called ‘Cadillac’ tax), so that this tax would be effective for the first time in 2022, instead of 2020. The CR also reauthorizes Children’s Health Insurance Program (CHIP) funding through FY 2023.
- Implementation of the Act primarily will be the responsibility of the IRS, together with the Treasury Department, at a time when the IRS has decreased funding and staffing and continues to be scrutinized by lawmakers and the public for its handling of certain tax-exempt status applications several years ago.
- The top two IRS positions–Commissioner and Chief Counsel–became vacant last year.
Congressional review of IRS procedures
- The Act does not provide any overarching restructuring to the administrative organization or procedures of the IRS.
- House Ways and Means Committee Chairman Brady plans to consider IRS restructuring legislation this year.
LB&I examination updates
- In 2017, the IRS LB&I Division continued its efforts to refine its examination process in moving toward issue-focused examinations.
- In 2016, the IRS had signaled that it would be instituting compliance ‘campaigns,’ that is, plans focused on the right issues, using the right resources, and using the right combination of ‘treatment streams’ to achieve the intended compliance outcome.
- In January and November 2017, the IRS formally identified these campaigns, along with potential treatment streams.
State tax policy trends
- Aside from responding to the consequences of federal tax reform, states are advancing a number of tax policy proposals.
Physical presence nexus provisions
- Massachusetts transformed the physical presence debate in 2017 by promulgating a regulation specifying that internet vendors with more than $500,000 in sales into the state comprising over 100 transactions must collect and remit sales and use tax if they establish a physical presence through the use of in-state software such as ‘apps’ and ancillary data such as ‘cookies.’
- While there may be constitutional challenges to the Massachusetts regulations, the history of state tax nexus expansion reflects that a single state’s efforts may be adopted quickly by other states, regardless of any potential controversy attached to the position.
Constitutional challenges to the physical presence standard
- While many states continue to expand the definition of what constitutes a constitutionally required physical presence for purposes of mandating a sales and use tax collection responsibility, an increasing number are choosing instead to directly challenge the Quill physical presence requirement.
- States such as South Dakota, Alabama, Tennessee, and Wyoming have enacted or promulgated economic nexus standards to trigger sales and use tax collection requirements.
- The South Dakota law, enacted in 2016, requires out-of-state sellers to collect and remit sales tax based
- The question presented to the US Supreme Court is whether it should abrogate Quill’s physical presence standard.
- Should the Court overturn Quill, it may effectively eliminate any incentive for states to simplify their tax systems.
The single sales factor and alternative apportionment approaches
- In the state income tax area, one important trend has been the use of an alternative to the statutory apportionment formula.
- In the 1950’s, a tumultuous period in state taxation, the National Conference of Commissioners on Uniform State Laws approved the Uniform Division of Income for Tax Purposes Act (UDITPA).
- However, over time a significant number of states have dropped the three-factor formula in favor of a single sales factor and the use of market-based sourcing.