FEI Daily spoke with Cathy Koch, EY Americas Tax Policy Leader, during the Ernst & Young LLP's 12th Annual Domestic Tax Conference in April.
FEI Daily: Speaker of the House Paul Ryan has said that with November's election results, Congress has a once in a generation opportunity to truly reform the tax code. Congress' attempt to repeal and replace the Affordable Care Act showed just how challenging it is to get any major legislation through Congress, even with Republican control of Congress and the White House. We’ve now seen President Trump’s tax plan. Given your experience on the Senate Finance Committee, how likely do you think real tax reform will happen this year?
Cathy Koch: I do think it's likely to happen this year. I think it has to happen this year.
The political environment is right for it to happen and the will has perhaps never been stronger. Ironically, or perhaps obviously, the failure to pass ACA repeal and replace as they had hoped makes this even more critical for this president and this Congress. I think they're going to do whatever it takes to get this done.
The plan encompasses so many concepts that we have been trying to get to for years: a lower corporate rate; lower rates for individuals; something, big, for pass-through entities; as well as a territorial system that makes our international tax system work with a better set of incentives. With just those things taken together, it's practically irresistible. The question is what happens when this package of goals hits the reality of the budget? Dynamic scoring is only going to get you so far. Then there's the question of how much deficit increase can we tolerate, as a Congress, as a society. That is where I think the challenge is going to lie. I still think it's surmountable.
The slowdown is going to be in trying to determine how it fits into the budgetary picture for this country, and what we do about that. I still have confidence that people are going to be so enamored with the end result of these concepts that they're going to try hard to make it work.
FEI Daily: Many readers strongly support the establishment of a tax rate for income earned by pass-through entities. Both the House Republican blueprint and President Trump's plan call for a pass-through rate. Are there any caveats pass-through businesses should be aware of if such a rate is enacted?
Koch: A 15 percent rate for pass-through income is very attractive and certainly has political appeal that's really important when it comes to the support for this bill. We often speak of pass-throughs and small business as the same thing. Of course they're not, but small business, which does encompass pass-throughs, is a politically very potent constituency.
I think pass-through businesses should look to see how the government is going to define income eligible for this rate and how they're going to enforce that. What are the guardrails?
FEI Daily: Corporate tax directors have expressed some concern about the need for sensible transition rules if tax reform becomes a reality. How important is it for the Ways & Means and Finance Committee to take transitions into consideration as they put together tax reform legislation and is there any way for stakeholders to have a role in ensuring proper transitions are considered?
Koch: It's very important to take transition rules into consideration. You can't go from World A to World B overnight. A lot of times, transition rules are necessary to establish a sensible, non-disruptive transition. And often, transition rules help with budgetary impact and behavioral responses. If you want to get to a low headline rate, you might not be able to do it all at once. We've seen in other countries, like the UK, the corporate rate goes down a little bit at a time. Will something like that be necessary just to make the budget work, or is budget not the biggest concern?
I worked for two private companies in my lifetime, that means there are at least a million businesses that I not familiar with! That’s why the idea of going to Congress and talking with staff about transition rules, talking about how your business operates under current law and how the new world -- the tax reform proposal – would impact your company and what transition rules would make a peaceful transition, that's hugely important.
If people from companies do not communicate with people on The Hill, who are writing this tax bill, there could be unintended collateral damage. The whole system is absolutely critically dependent on exchange of information between people in the private sector, who know their business, and people in the public sector who can't possibly be expected to know every fact pattern in every business.
FEI Daily: What advice would you give executives when it comes to tax strategy?
Koch: It’s critical that the business leaders stay vigilant and help this process along by providing information about your business. Nobody knows your business like you do.
At EY, we have long believed that tax belongs in the C-suite. Tax used to be considered a cost of doing business that executives did not need to understand; tax departments would do the taxes, and say, "Okay, here's our tax bill," and executives would take that information and work with it.
Today tax is such a significant, and complex, element of doing business that we think the c-suite and the board of directors should be very aware of what a company's tax strategy is, how that interacts with business strategy, and where reputational risk lie, with respect to taxes, in this new world of information sharing.
When I was working on The Hill, one of my jobs as tax chief was to work with technical staff and work out the proposals, and then translate their impact up to the Senator, so that he could talk about what he supported and what he objected to. Senators aren't going to get on the floor, or in town halls in front of constituents, and talk very technically. Their audience doesn't want to hear that.
There are a million reasons why the C-suite and the board of directors should be very fluent in their company's tax strategy. They should understand it, and they should be able to communicate it consistently, in high-level language, so that people can understand. This is a matter of being able to speak to investors, and other interested parties, in terms that people can understand. When we start answering questions about tax strategy and tax position in hyper-technical tax speak, I think we lose our audience. We lose credibility with the greater public. It's really important for all executives to be aware of this particular element of doing business.
We don't always know how to talk about it in the right ways, especially amongst corporations where the public often has a bias assuming corporations don't pay their fair share. Let’s learn how to talk about what we do pay, as corporations, so that we can relay exactly how we are handling taxes and share the full extent of our contributions to the economy.