On July 14th, the IRS held a public hearing for the debt-equity rule (section 385 of the IRS code) that the Treasury Department proposed last April. The hearing, which had as many as 16 speakers from various industries,...
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Likely “Solutions” to Highway Trust Fund Shortfall Violate Sound Tax Policy and User-Pays Principle
Congress appears deadlocked over how to plug a $100 billion shortfall in the Highway Trust Fund over the next six years. Some members are looking for a short-term funding solution that would keep the fund from going broke in late July or early August, while others are looking for long-term solutions that would put the trust fund on a sound financial footing through 2020.
Unfortunately, many of the leading proposals to fix the trust fund crisis either violate the principles of sound tax policy or they violate the user-pays intent of federal trust funds.
Bad Tax Policy: Taxing Multinationals to Pay for Roads
A number of the Senate proposals being floated would close the gap in the Highway Trust Fund with revenues extracted from U.S. multinational corporations. While some of these ideas are just bad tax policy and should not be considered anyway, any proposed changes to our international tax rules should only be considered within the context of making the U.S. more competitive—not putting a finger in the dike of a domestic trust fund.
One proposal being considered is a temporary tax holiday on any foreign profits that U.S. companies repatriate from overseas. Similar to the 2004 tax holiday, companies could shield from U.S. tax 85% of the profits they repatriate. According to the Joint Committee on Taxation, this proposal would raise about $20 billion in new revenues in 2014 and 2015, but loose a total of $96 billion over ten years.
One can understand the attractiveness of a policy that seemingly has twin benefits of raising short-term cash for the trust fund and unlocking more than $2 trillion in foreign profits trapped abroad. But, using a tax holiday to plug a hole in the trust fund is simply a gimmick and does nothing to make the U.S. tax system more competitive with our major trading partners. The only way lawmakers should consider another repatriation measure—whether it is voluntary or involuntary (such as a “deemed” repatriation)—is within the context of comprehensive international tax reform.
The same case could be made for another proposal that would use the revenues generated from changing the tax rules governing corporate “inversions” to save the trust fund. At best, this proposal amounts to demagoguery, but more importantly, such proposals avoid dealing with the structural issues that are making this country less competitive—such as our high corporate tax rate and worldwide tax system.
Another ill-considered proposal would deny U.S. companies a tax deduction for their interest costs on any domestic borrowing that was done to “avoid” repatriating foreign profits. Because of the high toll charge (35%) that companies have to pay on any profits brought back to the U.S., many prefer to leave their foreign earnings overseas and borrow money domestically to fund expansion or pay dividends. Critics object to this practice because companies can deduct the cost of borrowing domestically which lowers their U.S. tax bill and avoids the tax incurred when bringing their cash back home.
Advocates of this policy believe that penalizing companies by denying their interest deduction will force them to repatriate their foreign earnings. Supposedly, this will benefit the Treasury in two ways: raise revenues because of the denied tax deduction and with the taxes paid on the forced repatriations.
This measure is not only punitive, but it is bad tax policy. The reason the tax code allows businesses to deduct their borrowing costs is (1) because it is a legitimate business expense (like the cost of advertising and employee salaries), and (2) because the lender is being taxed on those interest payments as income. To deny the deduction of interest effectively double-taxes lending and raises the cost of capital.
Violating the User-Pays Principle
Beyond the violations of good tax policy, the bigger issue here is the integrity of the user-pays model of federal trust funds. The underlying idea of federal trust funds—such as the Highway Trust Fund, Social Security, Medicare, or even the Federal Sport Fishing Account of the Aquatic Resources Trust Fund—is that users pay taxes into the trust fund and derive some benefit in the future.
The sanctity of this pact between taxpayers and the government breaks down if unrelated revenues are used to pay for those benefits. Thus, it makes no more sense to tax multinational firms in order to fix the nation’s highways than it does to uses those taxes to plug shortfalls in funding for Medicare, Social Security, or state sport fishing programs. Such policies violate the user-financing intent of all federal trust funds.
In a similar fashion, the House proposal to shore up the Highway Trust Fund gap with the savings from suspending the delivery of mail on Saturdays is also a gimmick and misuse of those savings. There is no rationale for denying postal customers a service to fund a short-term shortfall benefiting drivers.
Lawmakers are chasing down two mistaken avenues to rescue the Highway Trust Fund from red ink—raising taxes on U.S. companies, who already face the highest corporate tax rate in the developed world, and postal customers, who may already be receiving poor service. Both of these paths violate the spirit and intent of the user-pays principle underlying the trust fund.
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