Updating our tax code’s “operating system”: Tax Reform 2.0

  • The House Ways and Means Committee has passed ‘Tax Reform 2.0,’ three bills modifying the tax code, in hopes of setting a precedent of updating tax code every year.
  • Reforms include making individual and small business tax cuts permanent, promoting family and retirement savings, and removing barriers to creating small businesses.
  • House GOP leaders expect to vote on the plan at the beginning of October.

Updating our tax code’s “operating system”: Tax Reform 2.0

Fresh off the passage of the Tax Cuts and Jobs Act, the largest update to the U.S. tax code in three decades, GOP lawmakers on the House Ways and Means Committee already have a new round of reforms in the works. It began last July, when committee chairman Rep. Kevin Brady, R-Texas, introduced a “listening session framework” for Tax Reform 2.0, a series of updates to the federal tax code that he hopes will set a precedent for Congress to improve the tax code every year (rather than the current practice of every few decades).

On Thursday, the House Ways and Means Committee passed a trio of bills on a party line vote, taking these updates one step closer to becoming law.

In a rapidly changing world, Brady argues that regular updates to the tax code, similar to the software updates we regularly make to our smartphones and computers, are critical to America to maintaining its innovative and competitive edge.

“It’s time to change the culture in Washington where we only do tax reform once a generation,” said Brady in a statement upon introduction of the legislation. “This legislation is our commitment to the American worker to ensure our tax code remains the most competitive in the world”

What’s different in version 2.0?

The three bills in the Ways and Means Committee’s reform package are as follows:

First, the Protecting Family and Small Business Tax Cuts Act would make permanent the individual and small business tax cuts of the Tax Cuts and Jobs Act. These cuts were set to expire in 2025. It would also make permanent the $10,000 cap to the state and local taxes paid deduction and the lower mortgage interest deduction, as well as the expanded standard deduction and child tax credit. Brady argues this will “create over 1.5 million new jobs, continue to raise wages, and boost long-run GDP.”

Second, the Family Savings Act would make several significant changes to promote family savings. It would create new Universal Savings Accounts that individuals may contribute up to $2,500 annually, with tax-free withdrawals. It would expand 529 Education accounts so that they could be used to pay for learning a trade, apprenticeship fees, covering the cost of home schooling, or paying off student debt. And it would allow families to draw from their retirement accounts without a penalty to help cover expenses when bringing a child into their family—either by birth or adoption.

Third, the American Innovation Act aims to remove barriers to small business by allowing start-up businesses to write off more costs, raising the amount that businesses are allowed to deduct of their initial start-up expenses from $5,000 to $20,000.

For a more detailed summary of the legislation, the Tax Foundation offers an early analysis.

The fraught road to passage

With the shifts in the political landscape over the past year and the midterm elections coming up, the three bills that make up Tax Reform 2.0 face a difficult road to passage. First and most obvious, there’s the possibility of a “blue wave” flipping the House and/or Senate to Democratic control.

Furthermore, unlike the Tax Cuts and Jobs Act, which passed without any support from Democrats, this legislation would require 60 votes in Senate. So even if Republicans maintain control of the Senate after the midterm, it’s likely to require a significant number of votes from across the aisle.

Even with a need for Democratic votes in the Senate, such a scenario is not out of the question. As Matthew Frankel points out in the Motley Fool, there has been some bipartisan support for a number of provisions in Tax Reform 2.0, such as the retirement and education savings portion, as well as some reforms that have been suggested to encourage entrepreneurship.

There are also certain portions of Tax Reform 2.0 that could be changed or scrapped if proved too unpopular. For example, some GOP lawmakers reportedly have expressed concerns about the part of the plan that would help make permanent the individual provisions of the Tax Cuts and Jobs Act with a $10,000 cap on state and local tax deductions. Such a move would prove controversial in high-tax Democratic states like California, New Jersey, and New York, putting GOP congressional candidates in tight blue-state races at a further disadvantage.

The Ways and Means Committee’s gameplan

“This is critically important if you care about jobs, opportunity and higher paychecks,” said Brady in an interview on Fox Business on Friday. Brady is framing the reforms as key to giving American businesses “the certainty they need to grow and thrive,” as well as “helping every American citizen enjoy a happy retirement and peace of mind in the years when they deserve it the most.”

With the bills now out of the Ways and Means Committee, House Speaker Paul Ryan, R-Wis., said he wants to have the House vote on them by the end of the month, consistent with Brady’s vision of seeing an early fall passage out of the House.

The Senate, however, is a different animal. In an interview with CNBC’s ‘Squawk Box’ on Wednesday, Brady said that Senate Majority Leader Mitch McConnell, R-Ky., is unlikely to move on any component of Tax Reform 2.0 until after the midterms — and only then if he believes he has sufficient support to get it passed.

“I think all of it could pass the House,” Bill Smith, managing director for CBIZ MHM’s National Tax Office, told Accounting Today. “There’s a good chance because even the House [GOP] members in the high income tax states who are upset about the $10,000 cap, they don’t need those votes to pass it in the House. They could abstain so they’re not being seen as voting against the bill, but still say, ‘I couldn’t vote for it because the $10,000 cap is hurting my constituents too much’ and the bill could still pass. My personal opinion is it’s likely to pass the House so that they can tout it. Even Brady said a while back we’re not responsible for what happens in the Senate. Our job is to put together the best tax bill that we can and send it over to them.”

For Brady and the Ways and Means Committee, 2.0 is only the tip of the post tax-overhaul iceberg. “We’re already planning for 2019, 2020. I want to do tax cuts every year the Republicans are in control of the process,” he said in a conversation with Americans for Prosperity Texas earlier in the year. “We want to make what has merit, get it in there, get the rest out of there…Simpler is better. Permanent’s always better.”

Will Tax Reform 2.0 create a better system?

Often lost in the political maneuvering by both sides is the question of whether Tax Reform 2.0 is actually good policy that will help America’s fiscal outlook. The Tax Foundation, an independent tax policy nonprofit, found that making the individual income tax changes permanent would increase long-run GDP by 2.2 percent and create 1.5 million new full-time equivalent jobs. This would come at a cost of “$166 billion a year on a static basis and $113 billion on a dynamic basis.”

However the Peterson Foundation, a non-partisan organization dedicated to addressing America’s long-term fiscal challenges, argues that the specific reforms in this package are the last thing America needs.

“Last year’s tax legislation did major damage to our fiscal outlook — adding trillions to our national debt. After this irresponsible policy, it’s especially disappointing that lawmakers are looking to dig the hole even deeper. More debt is the last thing America needs,” said foundation Chairman and CEO Michael A. Peterson. “Lawmakers should absolutely take a second look at tax policy, not to extend the irresponsibility, but to implement reforms that actually improve our fiscal situation.”

Image Credit: “Money and Tax Return” by 401(K) 2012 is licensed under CC BY-SA 2.0 

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