Tax Overhaul Faces Major Hurdles

A House committee began considering a bill Monday that would reduce taxes by $1.4 trillion over 10 years, but disagreements over key pieces of the measure could force the GOP to make changes and slow down plans to pass it by year’s end.

House Republicans are at odds over plans to eliminate deductions for state and local taxes. Senate Republicans disagree on child tax credits and whether to accept significantly bigger budget deficits. Narrow margins in both chambers leave the party little room to maneuver.

Here’s a look at the most significant fault lines that could make or break the GOP effort to rewrite the tax code:

Individual Deductions

The tax breaks for mortgage interest, state and local taxes and medical expenses are among the most popular in the tax code, and the House plan hits all of them.

State and local income and sales taxes and medical costs would no longer be deductible. Property-tax deductions would be capped at $10,000. The mortgage-interest deduction would no longer apply to interest on debt above $500,000, home-equity loans, or second homes.

The homeownership breaks have powerful defenders in real-estate agents and home builders. And lawmakers have been hearing from the influential AARP about losing medical expense deductions, as well as constituents with chronic illnesses or whose spouses are in nursing homes.

The changes to the state and local tax breaks will cost Republicans at least several House votes from New York and New Jersey. It isn’t clear yet whether the elimination of other deductions are causing House Republicans to consider voting against the plan. But every bloc of opposition from within the GOP caucus is a problem given the party’s narrow majorities.

“These are complicated issues that have to be ironed out,” said Greg Valliere, the chief global strategist and Horizon Investments. “It’s wishful thing to get this done by Christmas.”

Child tax credit

The House plan bumps the per-child credit from $1,000 to $1,600 and moves it up the income scale. The credit would start phasing out for individuals at $115,000 and married couples at $230,000, up from $75,000 and $110,000 today.

For many families, that is enough to offset the loss of the personal exemption, which subtracts more than $4,000 from taxable income for filers, their spouses and dependents. But the credits expire over time, which could leave many households worse off by 2027 than if Congress had done nothing.

Another issue is that the credit might not be big enough in the Senate. Sens. Marco Rubio (R., Fla.) and Mike Lee (R., Utah) want a credit of $1,800 to $2,000 per child.

Pass-through Income

The bill’s big innovation on business taxes is a special 25% tax rate on pass-through businesses, such as partnerships and S corporations, which pay business taxes through the individual tax system.

Small-business groups, including the National Federation of Independent Business, are wary of the proposal because of restrictions on who gets that 25% rate. Professional-services businesses, such as law and accounting firms, would get none of the benefit. All of their income would be classified as labor income taxed at individual rates up to 39.6%. Other businesses would get part of their profits at the 25% rate.

Pass-through businesses are powerful Republican allies and having them in opposition to the plan will pose a challenge as lawmakers talk with their local business communities at home.

Rep. Mark Meadows (R., N.C.), chairman of the influential bloc of conservatives in the House Freedom Caucus, has said that he wants to “make sure the pass-through rate for small businesses is actually a pass-through rate for all small businesses.” If that isn’t the case, “that’s a problem,” he said.

House Republicans proposed changes late Thursday in response to some of those business concerns.

Tax on Foreign Payments

The House bill creates a new 20% excise tax on payments from companies in the U.S. to related parties — other parts of the same company — outside the country. The proposal would raise $154.5 billion over a decade.

The idea is to prevent companies from loading up U.S. subsidiaries with deductions and from pushing profits to low-tax countries through payments such as royalties. These are techniques often used by companies based outside the U.S., including former U.S. companies that have done inversion transactions to put their addresses abroad.

Conservative groups aligned with the billionaire Koch brothers are lining up against it, likening it to the border-adjusted tax that Republicans proposed and then jettisoned earlier this year.

Some business groups are also opposed. John Bozzella, president and CEO of Global Automakers, which represents non-U.S. based companies such as Honda and Hyundai, said the proposal would disrupt supply chains and complicate the tax code.

The proposal would encourage companies to avoid the U.S. in their global supply chains, said Nancy McLernon, president and CEO of the Organization for International Investment, a group representing foreign-based companies with U.S. operations.

Republicans proposed changes late Monday to the excise tax that appear to be less onerous on multinational companies than the original version was.

Debt and deficits

Fiscal constraints are another barrier. Some lawmakers don’t want to increase budgetdeficits.

Republicans have set a cap on the size of the tax cuts over the first decade at $1.5 trillion. That constraint means they either need to find revenue-raising provisions or set tax cuts to start later than 2018 or be set to expire.

The bill also can’t increase deficits at all beyond those first 10 years. That encourages the GOP to set tax breaks to expire. Expirations, sunsets and offsets are making the bill unappealing to some.
Source: Dow Jones

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