Tax reformers consider cash flow business taxes, VATs, and integration.

• Author: Gutman, Harry L.
• Position: Value added taxes

In the last Congress, tax reformers considered cash flow business taxes, VATs, and integration as part of potential business tax reform.

What's the Outlook for Congressional Tax Reform?

The second session of the last Congress saw some positive developments in the seemingly never-ending quest for business income tax reform. Dramatic proposals from Republicans in both the Senate and the House have the potential to break the logjam over whether and how to reform business taxation. Change will not happen overnight. However, as the debate unfolds, tax executives and C-suite occupants need to know what is on the table, the prospects for passage, and the potential effects on operations and effective tax rates. They should also be cognizant of how important it is that business should present a unified front and lead the reform effort.

Why Hasn't Tax Reform Happened?

Although there is a consensus that our business income tax system needs reform, there is no agreement on what a reformed system should look like. There is no groundswell of public support for reform, and the president has not made it a priority. Revenue constraints impose an insurmountable mathematical obstacle to a significant rate reduction using the traditional model of financing through eliminating business tax preferences, a method that creates winners and losers in the business community and results in a politically untenable tax increase on the over forty-four percent of business income earned in noncorporate form.

What Are the New Developments?

Lawmakers are well aware of the reasons for the current stalemate. This recognition has produced two major lines of "new" thinking about how to solve the problem. The first is a proposal by Senator Orrin Hatch (R-UT) to eliminate the corporate tax through a dividends-paid deduction, called "partial integration." The second includes proposals by the House Republicans, Senator Ben Cardin (D-MD), and Representative James Renacci (R-OH) to reduce the corporate tax rate or replace it with a consumption tax, either in the form of a credit-invoice value-added tax (VAT) or the economically equivalent business cash flow tax.

The Hatch proposal would allow a deduction for all dividends, limited by the amount that is subject to full taxation. The limitation denies a deduction for dividends paid out of preference income or foreign source income that has been sheltered by foreign tax credits. A withholding tax of thirty percent would be imposed on the...