US tax reform promises little for individuals but much for companies

25 April 2017

He may not have been the first to use the phrase, but in 1789 US Founding Father Benjamin Franklin famously observed that ‘in this world, nothing can be said to be certain, except death and taxes’.

With less than 24 hours to go until President Donald Trump replaces executive tweets with a more formal announcement of the possible shape of the future US federal tax system, the certainty identified by Benjamin Franklin seems to be moving into and out of focus.

Before we consider what this means in practice, let’s have a quick look at how taxes funded the US government in 2015:

Tax  Per cent
Individual incomes taxes        47.4
Payroll taxes  32.8
Corporate income tax  10.6
Excise taxes  3.0
Other  6.2
Total  100.0

Source: Pew Research Center

For all the emphasis on corporate taxes, the biggest contributor to US government funding are individual income taxes. Data from the Pew Research Center indicates that in 2014 Americans with adjusted gross income of $250,000 or more filed 2.7 per cent of tax returns but paid 51.6 per cent of all income taxes. For comparison, the nearest equivalent UK figures show that the top 1 per cent of taxpayers pay 27 per cent of all income tax.

Calls for fundamental reform of the US tax system have echoed around the corridors of Washington for many years, but deadlock in government meant that the prospects of reform were zero. With tax reform as a major plank of his pre-election commitments, Donald Trump was determined to seize the initiative. Key components of his promises to the electorate were to:

  • reduce income taxes with the expectation that everybody will benefit;
  •  cut corporate taxes from a headline rate of 35 per cent to something much lower, perhaps 15 per cent, so boosting the domestic economy while encouraging the repatriation of profits held offshore by US-based multinational corporations; and
  • impose a border-adjusted tax to penalise imports of goods and services, encourage domestic production and favour exports.

As they say, that was then but this is now. While we still expect the President to announce the overall shape of his tax reforms before his first 100 days in office have expired, tomorrow’s announcement is unlikely to include specific tax rates and details of many measures. We do expect some clarity on the range of possible rates which might be considered, along with some of the key features of the new system, but much more work will be required before precise details are published in the summer.

Who will be the winners and who will be the losers? 

Commentators think there probably isn’t much in it for low-income groups because there simply isn’t the scope to manoeuvre: those with adjusted gross income of less than $50,000 account for 62.3 per cent of tax returns but only 5.6 per cent of income tax paid. But high-income groups would welcome tax cuts with open arms.

And what about companies? An encouragement to repatriate profits with a low rate of federal corporate income tax would potentially provide a 2-3 year window of very high tax yield as companies moved profits back to the US in what would be one of the biggest transfers of cash the world has ever seen.

The question of the sustainability of the measures will be paramount. Including a border-adjusted tax had the potential to raise approximately $1tn, aiding sustainability and taking the pressure off the federal budget deficit. We now understand that the White House has moved away from this proposal, raising concerns that the overall reforms will not be fiscally neutral. Everything will then depend on the extent to which tax reductions boost growth within the economy. To say that opinion is divided on this would not do justice to the depth of disagreement.

The existence of taxes is certain, but the shape of the future US tax system is anything but clear.

If you have any questions, please get in touch with George Bull.