Could the Surprise Trump-Schumer ‘Marriage of Convenience’ Give Birth to Bipartisan Tax Reform?

By Stuart E. Leblang, Geoffrey K. Verhoff,  Amy S. Elliott, and Ryan Ellis

The 3-month debt-ceiling and government funding deal that President Trump struck with Senate Minority Leader Chuck Schumer (D-NY) September 6 took Congressional Republican leaders and even Trump’s own Cabinet members and aides by surprise. But could it be the start of more Trump-Schumer deal-making in the future—even on taxes? ¹ 

There are two alternatives to the current plan by Senate Majority Leader Mitch McConnell (R-KY) and House Speaker Paul Ryan (R-WI) to pass tax reform using budget reconciliation with only Republican votes. Trump could decide to pick off a handful of moderate, vulnerable Democrats (maybe the ones he invited to dinner September 12) ² who could provide the votes to shore up a legislative victory if intractable hardliners from his party do not get with the plan. ³ 

Or, while it is highly unlikely, Trump could decide to outflank McConnell and Ryan and negotiate a “grand bargain” bipartisan tax bill. This would require many Democrats to go back on demands they made as recently as August 1 that any tax reform effort not involve deficit-financed tax cuts. While it would be a heavy lift, there is a fair bit of consensus among moderates on tax changes. We believe that moderate Republicans and Democrats may agree to the following, which would likely be a net tax cut:

• Reduce the top federal corporate income tax rate—not to 15 percent or even 20 percent but maybe 25-28 percent, with no reduction in the top individual rate;
• Provide tax relief for small businesses by creating a new, lower tax rate on the active business earnings of only certain small pass-through entities;
• Move to a territorial system of international taxation with strong anti-base erosion measures and protections to keep more U.S. companies in the United States;
• Restrict the carried interest tax preference for certain individuals; and
• Find a middle ground on keeping the deduction for state and local taxes (which Democrats want) and repealing the estate tax (which Republicans want).

While these broad outlines for tax reform compromises may seem like wishful thinking now, they have attracted bipartisan support in the past. And achieving tax reform that results in positive economic benefits for Main Street voters and American businesses is something all lawmakers—Republicans and Democrats—want before the midterm elections in 2018.

Reduce Corporate Tax Rates, But Keep the Top Individual Rate High

There is widespread agreement among Republican and Democratic lawmakers that the statutory tax rate facing corporations is too high, and Schumer himself has been outspoken on this in the past. ⁴ There are new signs that Trump is willing to compromise on tax cuts for the wealthy. Such a move could pave the way for a series of trade-offs that have been contemplated in the past between moderates from both sides of the aisle.

According to a September 19 report in The Washington Post, “the White House is considering, among other things, keeping the top tax rate for individuals at 39.6 percent.” ⁵ (Recall that Trump’s former chief strategist Steve Bannon actually wanted to increase taxes on individuals making more than $5 million per year.) ⁶ 

Democrats have been calling for bipartisan comprehensive tax reform that achieves many of the same goals as what Republicans have in mind. House Minority Leader Nancy Pelosi (D-CA), who recently was able to extract reassurances from Trump on immigration, said July 27 that “Democrats believe we need real tax reform that creates jobs for hard-working Americans and fuels economic growth, while ensuring the wealthy pay their fair share and ending tax breaks for big corporations hiding profits offshore.” ⁷ 

A corporate rate reduction that is more in the range of what former House Ways and Means Committee Chair Dave Camp proposed in 2014 (to 25 percent) or what President Obama proposed while he was in office (to 28 percent) might make it possible to avoid the limitations on business interest expense deductions that lawmakers are currently contemplating—an issue that has attracted opposition from certain business interests including the real estate industry. A higher rate might also mean that a business tax expenditure likely coveted by Trump—like-kind exchanges—and that would inevitably be on the chopping block in tax reform could be saved. Plus, the higher the rate, the less costly it would be to make such a change permanent.

The latest word on the street is that lawmakers are reportedly considering less severe limitations on the deductibility of business interest expense, including provisions that would grandfather existing debt and only haircut but not fully disallow the deductions in certain cases. ⁸ 

Tax Relief for Pass-throughs, but Targeted Only at Small Businesses

Keeping the top individual rate high to appease Democrats who insist that the wealthy and well-connected should not get even one penny of tax relief in tax reform ⁹ while cutting deductions for all businesses (including those taxed as pass-throughs) to get the corporate rate down will hurt small businesses—which lawmakers often refer to as Main Street job creators. ¹⁰ A net tax hike on them is not good politics.

Trump has been clear that he wants tax cuts for businesses across-the-board, no matter if they are formed as C corporations, S corporations, partnerships or any other pass-through entity. But lowering the rate that individuals and other business owners pay on the income that flows to them from a partnership, for example, could create a huge new tax loophole to disguise personal services income as business income eligible for a lower rate. Trump’s advisers have acknowledged the challenge, saying they will exclude services firms from the lower rate. ¹¹ But additional limitations will likely be necessary to get some Democrats on board.

Progressives see the new pass-through rate as largely a benefit to millionaires and not struggling small business owners. ¹² According to the Tax Policy Center, 76.9 percent of business income earned by pass-through entities is taxed at marginal rates higher than 28 percent. ¹³ To bring some Democrats on board, tax writers might consider making the new pass-through rate available only in cases where it would actually provide relief for small business job creators, not all pass-throughs.

Territorial with Measures to Stop Inversions and Profit Shifting

As we have written about before in our August 16 report “Contemplated Move to Territorial Tax System Could Have Significant Negative Impact on Some Large U.S. Multinationals, Including Certain Pharma and Tech Firms” and our April 27 report “Gauging the Relative Winners and Losers of Trump’s Move to a Territorial System of International Taxation,” there is bipartisan agreement that our system of international taxation needs reform. Jobs, including high-paying manufacturing jobs, have left the United States over the last few decades, and while our tax policies may not be to blame for such offshoring, the recent wave of tax-motivated inversions and acquisitions of U.S. firms by foreign acquirers has only rubbed salt in the wounds of devastated cities across the rust belt.

The bipartisan push for territoriality is not new. In 2015, Democratic and Republicans senators that were part of an international tax reform working group led by Rob Portman (R-OH) and Schumer issued a report indicating that a move away from a worldwide system of taxation is imperative to ensure that U.S. businesses can “compete and win in this growing global market.” They cited without hesitation studies showing that when a U.S. multinational increases its foreign jobs and wages, its U.S. jobs and wages also increase. ¹⁴ 

The failed “Gang of Six” deficit reduction plan in 2011 called for tax reform that moved away from worldwide and toward territorial, but also reduced the top corporate tax rate to between 23 percent and 29 percent. ¹⁵ The group was comprised of three Democrats: Senator Mark Warner (D-VA), Senator Dick Durbin (D-IL) and Senator Kent Conrad (D-ND). Warner and Durbin are still in the Senate. Territoriality was also suggested by the National Commission on Fiscal Responsibility and Reform ¹⁶ in 2010, which was led by Erskine Bowles, former chief of staff to President Clinton, and former Senator Alan Simpson.

But a move to territorial must come along with new anti-base erosion measures that prevent U.S. multinationals from shifting profits outside of the United States’ now-smaller taxing jurisdiction and help stem the tide of inversions. Those who doubt Trump’s willingness to ensure that U.S. multinationals pay their “fair share” should remember that early on in his campaign, Trump advocated not for a move to territorial, but for the repeal of deferral in the context of a preserved system of worldwide taxation and a top corporate rate of 15 percent. At one time, his plan provided that “since we are making America’s corporate tax rate globally competitive, it is only fair that corporations help make that move fiscally responsible.” ¹⁷ 

Tax Carried Interest at Ordinary Rates

Democrats have sought to end the preferable tax treatment of carried interest since at least 2007, when a Democrat-controlled House tackled the issue in the Temporary Tax Relief Act of 2007 (H.R. 3996). During the campaign, Trump was not shy about his desire to curtail the carried interest benefit for hedge fund managers. ¹⁸ 

But agreement between Democrats and Trump on taxing at ordinary rates what is arguably compensation for services provided may not be clear-cut after all. Treasury Secretary Steven Mnuchin, who spoke at CNBC’s Delivering Alpha conference September 12, said Trump wants the carried interest tax preference to remain available to “entities that create jobs.”^[19]In any case, estimates for how much carried interest could amount to in additional revenue are fairly low (from $10 billion to $30 billion over 10 years, and much less if the provision is more targeted) relative to the other tax expenditures on the table.

Negotiating Estate Tax and State and Local Tax Deduction Deal

The trickier areas of compromise involve the estate tax and the deduction for state and local taxes. Trump promised as recently as September 6 to repeal the estate tax, ²⁰ but by September 19, it was looking like the White House may have given up on that promise. ²¹ Democrats generally view the estate tax as a progressive means of acquiring needed revenue.

On the other hand, Republicans generally want to do away with the deduction for state and local tax (SALT) in connection with a significant increase in the standard deduction, but taxpayers in Democratic strongholds like California and New York—where the deduction is most valuable²²—generally want it preserved.

Compromise on these two issues could get tricky. On September 12, Schumer held a press call with other Democrats stressing that Trump’s effort to enact a full repeal of the estate tax would benefit the wealthy at the expense of those less fortune, adding that he could not support tax reform that repeals the state and local tax deduction. “Schumer said that Democrats will work with the president where they can, but also are ‘not going to abandon our principles.’” ²³ 

But not all Democrats adhere to Schumer’s principles. Three Democratic senators failed to join their Senate Democratic caucus colleagues in signing an August 1 letter to Trump and Republican Congressional leaders. The letter insisted on bipartisan tax reform that does not increase the tax burden on the middle class, that is enacted through regular order and not reconciliation, and that stays away from deficit-financed tax cuts. The three senators—Joe Donnelly (D-IN), Heidi Heitkamp (D-ND) and Joe Manchin III (D-WV)—are widely viewed as the most likely Democratic supporters of a Republican-led tax reform bill.

Where do these three stand on the estate tax? All three voted in 2013 in support ²⁴  of scaling back or repealing the estate tax, as long as it was done in a “fiscally responsible way” (presumably that means with pay-fors so as not to increase the deficit). The 2013 roll call vote in the Senate to repeal the estate tax attracted the support of 35 Democrats, 26 of which are still serving today.

The Senate has not had to vote on elimination of the SALT deduction. It is estimated that such a move would cause the following average federal tax increases ²⁵ for Donnelly’s, Heitkamp’s and Manchin’s constituents (also noted is the reliance on federal aid ranking of their respective states, ²⁶ which could matter if states respond to elimination of the SALT deduction by reducing taxes and services, thereby potentially needing more assistance from the federal government):

Getting Vulnerable Democrats to Join the Cause

Trump has already set his sights on Donnelly, Heitkamp and Manchin. He invited the three to a dinner on tax reform at the White House September 12. Following the dinner, Manchin seemed pleased with Trump’s tax reform intentions, telling CNBC that the administration is “very aggressive on this. They want it done and they want it in a bipartisan way.” ²⁷ (Republicans have a four-person majority in the Senate, and if they use reconciliation to pass tax reform, they can only afford to lose the support of two Republican senators.)

These aren’t the only Democrats that Trump reportedly has in his sights, as Manchin told reporters September 12 that he thought the president was going to try to pick off at least eight Democrats to join with Republicans in support of tax reform. ²⁸ Other likely targets include Senator Clarie McCaskill (D-MO), Senator Bill Nelson (D-FL) and Senator Jon Tester (D-MT).

It remains to be seen whether Trump’s deal-making can bring about tax relief in early 2018. But a September 20 opinion piece by The Wall Street Journal Editorial Board may offer just the right scolding at the right time to get hardliners on board with a budget deal that could produce as much as $1.5 trillion in tax cuts over the next 10 years, writing: “Republicans should . . . get past phony budget obstacles, and move on to fulfill their promise to reform the tax code. ²⁹ 

^{[1] Allen, Mike, Sept. 11, 2017, “Inside the Trump-Schumer marriage of convenience,” Axios (https://www.axios.com/the-trump-schumer-marriage-of-convenience-2483922824.html).}

^{[2] Shelbourne, Mallory, Sept. 12, 2017, “Trump reaching out to Dems on tax reform: report,” The Hill (http://thehill.com/homenews/administration/350178-trump-hosting-senators-in-outreach-to-dems-on-tax-reform-reports).}

^{[3] “The lack of details of a tax plan is frustrating members of the House Freedom Caucus, who are making clear they’re ready to effectively hold the budget resolution hostage until they get some specifics from their leaders,” reported Sahil Kapur, Sept. 11, 2017, “Trump Debt Limit Deal Undermines Trust Among GOP on Tax Overhaul,” Bloomberg (https://www.bloomberg.com/news/articles/2017-09-11/trump-debt-limit-deal-undermines-trust-among-gop-on-tax-overhaul).}

^{[4] “To preserve our international competitiveness, it is imperative that we seek to reduce the corporate tax rate from 35 percent and do it on a revenue-neutral basis,” Schumer said Oct. 9, 2012, as reported by Michael M. Gleeson, Oct. 15, 2012, “Schumer Opposes Rate Reductions in Tax Reform,” Tax Notes (Doc 2012-20932) .}

^{[5] https://www.washingtonpost.com/news/wonk/wp/2017/09/19/white-house-seriously-considers-abandoning-some-tax-cuts-for-the-wealthy/?utm_term=.0dbaa471ce95}

^{[6] Talev, Margaret, July 26, 2017, “Bannon Calls for 44% Tax on Incomes Above $5 Million,” Bloomberg (https://www.bloomberg.com/news/articles/2017-07-26/bannon-is-said-to-call-for-44-tax-on-incomes-above-5-million).}

^{[7] https://www.democraticleader.gov/newsroom/72717/}

^{[8] Basu, Kaustuv, Sept. 18, 2017, “Hatch: Big-Six Tax Framework Won’t Dictate Finance Bill,” Bloomberg BNA Tax Management Weekly Report.}

^{[9] The “Not One Penny” campaign is buying ads in congressional districts “with large numbers of white voters without college degrees who voted for Donald Trump in 2016” and who may not appreciate the wealthy getting tax cuts when they themselves are having trouble getting by, reported by David Weigel, Aug. 3, 2017, “Liberals launch ‘Not One Penny’ campaign in effort to stop Trump tax cuts,” The Washington Post (https://www.washingtonpost.com/news/powerpost/wp/2017/08/03/liberals-launch-not-one-penny-campaign-in-effort-to-stop-trump-tax-cuts/?utm_term=.216182774252).}

^{[10] September 2012, “Frequently Asked Questions about Small Business,” Small Business Association (https://www.sba.gov/sites/default/files/FAQ_Sept_2012.pdf).}

^{[11] Davidson, Kate, Sept. 12, 2017, “Mnuchin: Services Companies Won’t Get ‘Pass-Through’ Rate Under Tax Plan,” The Wall Street Journal (https://www.wsj.com/articles/mnuchin-services-companies-wont-get-pass-through-rate-under-tax-plan-1505224808).}

^{[12] Thornton, Alexandra and Seth Hanlon, Aug. 24, 2017, “The ‘Trump Loophole’ Would Benefit Millionaires, Not Small Businesses,” Center for American Progress (https://www.americanprogress.org/issues/economy/reports/2017/08/24/437654/trump-loophole-benefit-millionaires-not-small-businesses/).}

^{[13] http://www.taxpolicycenter.org/model-estimates/distribution-business-income-march-2017/distribution-business-income-statutory}

^{[14] July 2015, “The International Tax Bipartisan Tax Working Group Report,” United States Senate Committee on Finance (https://www.finance.senate.gov/download/the-international-tax-bipartisan-tax-working-group-report) page 5.}

^{[15] https://budget.house.gov/hbc-publication/252770/}

^{[16] http://www.washingtonpost.com/wp-srv/politics/documents/TheMomentofTruth.pdf}

^{[17] https://assets.donaldjtrump.com/trump-tax-reform.pdf}

^{[18] Wood, Robert W., Aug. 31, 2015, “Trump As Tax Code King And Hedge Fund Slayer,” Fortune (https://www.forbes.com/sites/robertwood/2015/08/31/trump-as-tax-code-king-and-hedge-fund-slayer/#378dc55a74ca).}

^{[19] Robb, Greg, Sept. 12, 2017, “Mnuchin says hedge funds will lose carried-interest loophole in tax overhaul,” MarketWatch (http://www.marketwatch.com/story/mnuchin-says-hedge-funds-will-lose-carried-interest-loophole-in-tax-overhaul-2017-09-12).}

^{[20] Curry, Jonathan, Sept. 11, 2017, “Trump Plays Up Bipartisan Outreach, Touts Magnitude of Tax Cuts,” Tax Notes (Doc 2017-68504).}

^{[21] https://www.washingtonpost.com/news/wonk/wp/2017/09/19/white-house-seriously-considers-abandoning-some-tax-cuts-for-the-wealthy/?utm_term=.0dbaa471ce95}

^{[22] “California and New York account for about one-fifth of all returns claiming the SALT deduction, and almost one-third of the total deduction claimed,” according to Frank Sammartino, April 15, 2016, “A Closer Look at the State and Local Tax Deduction,” Tax Policy Center (http://www.taxpolicycenter.org/taxvox/closer-look-state-and-local-tax-deduction).}

^{[23] Jagoda, Naomi, Sept. 12, 2017, “Senate Dems blast Trump for ‘absurd’ call to repeal estate tax,” The Hill (http://thehill.com/policy/finance/350247-senate-dems-blast-trump-for-seeking-estate-tax-repeal).}

^{[24] https://www.senate.gov/legislative/LIS/roll_call_lists/roll_call_vote_cfm.cfm?congress=113&session=1&vote=00066}

^{[25] http://www.pewtrusts.org/en/research-and-analysis/blogs/stateline/2017/02/07/threat-to-tax-deduction-roils-high-tax-states}

^{[26] https://taxfoundation.org/states-rely-most-federal-aid/}

^{[27] https://www.cbsnews.com/news/senator-joe-manchin-says-trump-wants-bipartisan-support-for-tax-plan/}

^{[28] Collins, Eliza, Sept. 12, 2017, “Ahead of Trump meeting, Manchin said he thinks president wants bipartisan solution on tax reform,” USA Today (https://www.usatoday.com/story/news/politics/onpolitics/2017/09/12/ahead-trump-meeting-manchin-said-he-thinks-president-wants-bipartisan-solution-tax-reform/658208001/).}

^{[29] https://www.wsj.com/articles/tax-reform-progress-1505948487?mg=prod/accounts-wsj}