While the rest of the world reeled at the UK’s historic Brexit decision, US House Republicans quietly unveiled a radical plan of their own.
On Friday, June 24, Speaker of the House Paul Ryan announced a comprehensive tax reform agenda. The tax proposal—explained in a 35-page document on Ryan’s website—lacks sufficient detail for a full analysis, experts told CIO. But one change is overwhelmingly clear: The US tax system would shift from an income tax to a consumption tax. The impact on owners and managers would be profound, specialists agreed.
“The House Republican plan is rather revolutionary,” said Steven Rosenthal, a senior fellow at the nonpartisan Tax Policy Center. “It raises all sorts of questions of what it would mean to change to a consumption-based system.”
A consumption tax, he explained, would upend how businesses are taxed, putting the focus on purchases rather than income. For example, the plan would do away with depreciation—writing off capital over time—and allow companies to fully expense items in the year of purchase.
“Typically with a consumption tax, returns on capital are tax-free,” Rosenthal said. “The price of returns on capital being tax-free is that expenses on capital—that is interest expenses—are no longer deductible.”
Deductible interest factors hugely into the business models of many asset managers, particularly private equity and real estate firms. These firms, which rely heavily on debt financing, would face a “real penalty,” according to Jon Traub, a managing principal in Deloitte’s tax policy group. But as the loss of deductible interest is offset by the plan’s other changes, Traub said it is unclear how managers would react.
“Some will say, ‘I really like the fact that I can fully expense what I’m buying the year I’m buying it,’” he said. “Others will say, ‘That’s great, but I’m really concerned about losing business interest deductibility.’”
The pros and cons, Traub explained, are difficult to weigh now without having more information on what this tax reform would actually look like.
“There are a lot of unanswered questions,” he stressed. “Anything we said at this point would be very speculative.”
While the effect on asset managers is unclear, asset owners would almost certainly suffer negative repercussions.
“Today, not-for-profits like endowments and institutions are simply exempt from taxation on investments,” Rosenthal said. “But if all corporations will be exempt from their capital returns, the nonprofits will lose that competitive advantage.”
But asset owners shouldn’t worry yet. For the proposal to become law, the Republican party would need an overwhelming win in November.
“For it to get through, there certainly has to be a strong Republican majority in the House and the Senate” and a win in the White House, Traub said. “There are things in there—the repeal of the estate tax for example—that make it hard to imagine Democrats allowing it to pass if they’re in the majority.”
Should Hillary Clinton win the election, Rosenthal agreed, there is “no scenario” under which the plan would go forward. Even if Trump triumphs, his campaign tax proposal—a more conventional plan—differs significantly from what the House Republicans are suggesting. But Rosenthal suggested Trump might reposition his stance closer to the Republican Party’s.
“According to press reports, Trump is reconsidering his tax plan now that he’s in the general election, just like he’s reconsidering how many Muslims he wants to ban from our country,” Rosenthal continued. “It could very well be that behind the scenes House Republicans are conferring with Trump and working to align themselves together.”
However the election turns out, the proposal in itself presents a huge break from the nation’s current tax system—and a step toward possible bipartisan reform.
“For years the Republicans have been pushing to lower the rate of tax on pass-through businesses, which also affects the rate on wealthy individuals—a sticking point with Democrats,” Traub said. “In this plan, the House Republicans have said they will provide a lower tax rate for small business income than for wage income. And that is something where Democrats could find common ground.”