A proposal to kill a century-old business tax provision — one that’s been key to President Donald Trump’s real-estate fortune — is poised to become the next great tax-reform fight in Washington.
House Republicans want the $1 trillion that ending a deduction for businesses’ interest expenses would raise so they can offset the cost of slashing the corporate tax rate, one of the centerpieces of their tax-reform plans.
But that is riling a host of industries that say they have little choice but to rely on borrowed money and fear they will face big tax increases. Farmers, private equity, utilities, real estate, manufacturers and others are raising alarms in the Capitol, where Republicans are divided over the proposal.
Though it’s been obscured by the long-running battle over border adjustments, as that debate fades, many predict the interest-deduction fight will soon take center stage.
“This is going to be a big deal — it just hasn’t had its time yet,” said John Buckley, a former head of the Joint Committee on Taxation and longtime congressional tax aide.
It’s crucial to House Republicans’ plans because it’s their second-largest pay-for, raising even more money than border adjustments, according to an analysis by the conservative-leaning Tax Foundation.
But Trump has long backed the deduction, important to his real-estate development business — which is certain to raise anew conflict-of-interest issues for his administration.
In an interview with the Economist published Thursday, Treasury Secretary Steven Mnuchin said: “We’re contemplating keeping it — that’s our preference. But we’ll look at everything.”
There’s also skepticism in the Senate.
“It’s controversial,” said Texas Sen. John Cornyn, the chamber’s deputy Republican leader. “I think we need to be careful because there are a lot of businesses that borrow money as part of their business model.”
What, if anything, to do with the break is now a “significant” part of lawmakers’ tax talks, said one top Republican aide, though how vulnerable it is depends on how they decide to proceed.
If they opt to pursue a deficit-neutral tax reform, as House Republicans are pushing, there could be big changes because lawmakers will need a lot of budget savings, and the deduction represents a huge pot of cash.
If they decide to simply cut taxes, without pay-fors, there will be less pressure to cut the provision.
“Its usage will be determined by how low of a [corporate] rate members want to get to, and if it’s going to be deficit-neutral or if it’s going to be a tax cut,” the aide said.
As part of their tax-reform plan, House Republicans want to cut the corporate rate to 20 percent, from the current 35 percent – a reduction that would be so deep that they had to look beyond the usual cast of loopholes for ways to finance it. Trump wants a 15 percent rate and he told the Economist it would be “OK” if tax cuts weren’t offset.
Interest expenses have long been considered a normal business expense that companies can deduct just as they would their employees’ wages or their rent. Lawmakers have rarely tinkered with the provision, let alone proposed ending it.
Back in 1987, amid a wave of debt-financed corporate takeovers, Congress considered limiting the deduction in those sorts of mergers, which sparked a big selloff on Wall Street.
“All hell broke loose,” said Buckley. “The bill was quickly pulled and scrapped.”
House Republicans also want to kill the deduction so they can adopt so-called expensing, which refers to allowing businesses to immediately write off the cost of their investments, instead of having to spread those deductions out over a number of years.
That’s considered important for long-term growth, but experts say expensing can’t be combined with the interest deduction because that would provide such rich tax benefits that the government would effectively be paying companies to buy equipment, so lawmakers have to pick one or the other.
A spokeswoman for House Ways and Means Chairman Kevin Brady (R-Texas) said: “Republicans have proposed full and immediate expensing for all businesses because it will deliver robust economic growth and create jobs.”
Their interest-deduction proposal is backed by many economists who say the code so heavily subsidizes debt that it pushes companies wanting to raise money to turn to loans rather than equity. And that can make economic downturns more severe, some say.
“Firms go bankrupt when they cannot meet the demands of their creditors,” the Tax Foundation said in a recent report. “The more a firm borrows, the more it owes in interest, and if it cannot pay interest, bondholders can make claims on the firm’s physical assets to get their money back.”
“In contrast, equity is much more flexible; during downturns, equity simply accepts a loss of shareholder value. It may not accept that loss happily, but it accepts it nonetheless, and there is no immediate threat to the health of the firm.”
But the debate is underscoring how much some industries rely on loans. Among them: farmers, whose opposition to the plan is likely to weigh heavily on red-state Republicans.
“Farming and ranching is almost completely financed with borrowed money,” said Patricia Wolff, senior director of congressional relations at the American Farm Bureau Federation. “There aren’t stock options of venture capital or other ways for us to raise money so we rely almost entirely on loans from banks, life-insurance companies and from USDA programs, so anything that makes capital more expensive adds to the cost of business.”
“Even with the lower proposed [tax] rates, we could see a tax increase,” she said.
Critics of the plan are taking solace in the fact that Trump has long opposed the idea. It was not included in his revised tax plan rolled out last month, and he rejected the proposal during his presidential campaign, said former tax adviser Stephen Moore.
“Trump didn’t like it because he’s a real estate guy, and a lot of real-estate deals are financed with debt so he squashed the idea,” said Moore, who helped developed the campaign’s tax plan. “He felt like debt was an integral part of financing business deals so we didn’t get very far with that idea.”
During his campaign, Trump did eventually propose allowing manufacturers to choose between expensing and the interest break, though many experts say that is probably unworkable because Congress’s nonpartisan budget analysts tend to look askance at optional proposals. That’s because they assume businesses that rely on expensing will choose that, and those with big loans will opt for the interest deduction, leaving relatively few businesses paying little to the Treasury.
Senate Finance Chairman Orrin Hatch (R-Utah) is also wary of the House proposal, telling Bloomberg Television: “Almost everybody is borrowing at this particular point, and some borrowing in big ways, so I think that’s going to be on the table, but I think it’s going to be difficult to get rid of that.”
Added Sen. Mike Crapo (R-Idaho), another tax writer: “There’s plenty of other places in the code to achieve the necessary savings.”