WASHINGTON — Speaker Paul Ryan’s decision to move forward on tax reform after Republicans’ failure to unite behind a health care bill has left the financial services and other industries scrambling to assess what’s possible and whether a bill can make it through Congress.

Though no legislation has yet been introduced — nor is one expected soon — a handful of proposals are expected to serve as a guide for legislation: a proposal forwarded in 2014 by former House Ways and Means Committee Chairman Dave Camp, R-Mich., a blueprint released last year by Ryan, and a scant policy memo introduced by the Trump campaign.

Bank and other lenders are already using those templates as a guide to what to watch for as a bill is formulated. What follows is a rundown of those highlights, both good and bad, for the financial services industry.

A lower corporate tax rate

The existing tax regime has evolved significantly since the last time the code was overhauled in the 1980s. The federal corporate income tax rate for taxable earnings in excess of $75,000 — which includes virtually every bank and financial institution — is 34-35%.

President Trump and Treasury Secretary Steven Mnuchin
President Trump and Treasury Secretary Steven Mnuchin met Thursday to discuss tax reform. Bloomberg News

But many corporations are able to reduce the level of their taxable earnings through various deductions — for capital expenditures, say — that make their effective tax rate lower. Other deductions have been included over the years that favor certain kinds of businesses, resulting in a Swiss cheese of deductible expenses directed at specific kinds of businesses and activities.

The basic idea behind tax reform, and one that has bipartisan support, is exchanging a lower headline rate for fewer deductions. So if all corporations are paying a much lower headline rate of 25% or lower in income tax, the application of that rate would be more uniform by eliminating most, if not all, of the deductions that have been written into the law.

Bob Davis, executive vice president of mortgage markets, financial management and public policy at the American Bankers Association, said that basic idea is easy to grasp but hard to enact, and still harder to achieve without including exceptions that undermine the simplicity of the plan to a greater or lesser degree.

“As a general matter … the proposals one way or another are all about lowering marginal tax rates and broadening the base,” Davis said. “Of course, having made that simple statement, doing those two things is not necessarily that simple.”

To the extent that tax reform does lower the deadline rate, that’s good news for banks, says Francis Creighton, executive vice president of governmental affairs at the Financial Services Roundtable. Banks generally have few capital expenditures to deduct, so as a result banks tend to pay closer to that 35% headline rate, he said.

“First and foremost, this is an effort to make the tax code simpler, get a lower rate, and turn it into a territorial system,” Creighton said. “Banks and other financial companies generally pay the full sticker price. So if they can get rates down to 20% or below, that’s a very significant cost savings, and that’s a very, very big deal.”

Establishing a territorial system

A big part of the push for tax reform is moving to what is known as a “territorial” tax system. Under the existing tax code, known as a “worldwide” tax system, that 35% corporate tax rate applies to earnings by US companies no matter where in the world that money is earned. So if Coca-Cola has a subsidiary in South Africa that earned $10 million last year, that income would be taxed at 35%, even though the Coca-Cola was manufactured, marketed, and sold entirely outside of the U.S.

The biggest flaw with that system is that those earnings are not taxed at all until they are brought back to the U.S., a term called repatriation. Companies with overseas affiliates therefore have a strong incentive to keep their overseas earnings overseas, even if there may be an attractive investment for that money in the U.S.

Moving to a territorial system would tax overseas earnings when they are repatriated at a lower rate — under Camp and Ryan’s plans, earnings kept liquid would be taxed at 8.75%, while funds invested directly in the U.S. would be taxed at 3.5%. Trump’s proposal would offer firms a one-time repatriation rate of 10%, but afterward would be “followed by an end to the deferral of taxes on corporate income earned abroad,” presumably meaning firms’ overseas earnings would be taxed at the prevailing rate.

Jon Traub, managing principal of tax policy at Deloitte, said that many of the largest U.S. banks with significant overseas affiliates and activities are going to be watching very closely what will happen with not only the ultimate terms of a territorial tax system, but also how smoothly the transition from a worldwide to a territorial system is planned for.

“Larger banks with international footprints are going to be interested in seeing what the rules are going to be for moving toward a territorial system,” Traub said. “I’m sure banks will be interested in not only the territorial system going forward, but what are the transition rules and how that will affect our largest national players.”

Elimination of interest deduction

While banks generally don’t benefit from deductions, the Ryan plan pays for its lower headline rate in part by eliminating almost all deductions — the exceptions being the mortgage interest deduction and deductions for charitable giving. All sorts of other interest payments, including interest on car loans, business loans and interest payments on standing debt, are deductible under the current tax regime.

Ryan’s plan offsets the impact of the loss of those deductions on businesses by offering “full and immediate write-offs of their investments in both tangible and intangible assets.” That means that a company that spends $100,000 on building a new store or plant, they can deduct the full amount on that year’s taxes, rather than having an amortized deduction over several years.

That idea could hurt banks in a couple of different ways. First, while banks are often the recipients of interest payments on the loans they make, they also lend to one another and benefit from interest deductions on those interbank loans. Banks also don’t do a lot of physical investments for their own business, so they would not necessarily benefit from those changes.

Michael Bolotin, a partner with Debevoise & Plimpoton specializing in tax law, said the expectation is that interest on interbank lending will still benefit from interest deductions, but the greater question is whether borrowers will continue to want to do so if there is no tax benefit.

“If you’re in the business of lending money and today your customers get to deduct the interest they pay, and in a post-tax reform world they don’t, they might be more interested in some kind of equity financing or alternative arrangements … than they are in today’s regime,” Bolotin said.

Gary Friedman, another tax partner at Debevoise, said a secondary effect of such a change is that it could make mergers and acquisitions more complicated than they would otherwise be.

If a company were looking to acquire a large U.S.-based company – one that has international subsidiaries — if there are no interest deductions, it would make sense to finance that transaction via the company’s overseas affiliates. But some companies have withholding taxes and dividend taxes that may make it more difficult to get the proceeds of those loans out of the foreign country and into the hands of the U.S. shareholders to buy out their shares.

“Borrowing funds at the level of foreign subsidiaries would be advantageous in a world where the US parent is denied an interest deduction,” Friedman said. “Repatriation may attract withholding taxes, but there are techniques to avoid withholding taxes.”

A border adjustment tax

Much of the focus of news reports about the Republican tax proposal have centered on whether it will include a so-called border adjustment tax, or BAT.

The idea, which is included in Ryan’s plan but about which President Trump is ambivalent, is essentially a twist on a tax scheme that is used widely outside of the U.S. known as a value-added tax. VATs essentially tax a product at each stage of production, so the seller of a raw material pays a tax when it sells its materials to a manufacturer, and the manufacturer pays a tax when its sells its finished products to the retailer, and the retailer pays a tax when they sell the product to the consumer.

A BAT, by contrast, charges sellers on materials or products only when they enter the U.S. instead of applying them uniformly across industry. On its face, this would seem like an issue that has little application for banks, which do not manufacture products at all. But there is a great deal of ambiguity about whether and to what degree financial products — insurance and reinsurance policies, securities, derivatives, financial services and other activities — would be caught in the BAT net.

Davis said that most countries that have adopted either a BAT or VAT tend to exempt financial services and financial products from such adjustments, in large part because assessing a value for a financial service or product is not always straightforward. But it remains unclear whether such a carve-out will make it into the upcoming legislation, and if it does it could lead other industries to seek out their own carve-outs as well.

“Where there have been consumption-oriented taxes in other countries around the world … generally it has been decided not to tax financial services because of the difficulty in attaching value to financial services,” Davis said. “If that sort of approach is in a bill … is followed, it may not have much of an impact. But we’ll see. We don’t know that yet.”

Creighton said that even if bank services and products are exempted from a BAT, it still represents an additional tax that most Americans will have to pay. That takes money out of individuals’ pockets, which will affect the banking industry indirectly, he said.

“That is something that certainly impacts us — we want pro-growth, pro-retirement tax reform that makes tax code simpler, lowers rates, doesn’t target any industry … for punitive treatment,” Creighton said. “That doesn’t mean we won’t support it. But it’s worth noting that that is a broad-based economic tax, not something that is targeted at our industry.”

But Friedman said the BAT could also cut the other way. If services provided in the U.S. are treated as exports and essentially exempt from the BAT, it could drive firms providing financial services overseas to consumers there to move those personnel to the U.S. That could have implications beyond just banks, to include insurance firms, financial services firms, even law practices.

“Financial services companies that render advisory services to foreign clients could think seriously about having many of the people delivering those services work from the U.S. rather than from, say, London because the services income they earn would be export income and hence exempt under the border adjustment,” Friedman said. “So to the extent that it’s logistically possible, it would be an interesting model to render advice from the U.S. rather than from outside the U.S.”

The SIFI bank tax

Some proposals in the past have specifically targeted the banking industry, however.

The “financial industry responsibility fee” was first suggested by the Obama administration and would pose a direct tax on banks with assets of more than $50 billion as a preemptive charge to offset their additional systemic risk. The provision was included in Camp’s tax reform proposal, but was set at a rate of 0.035% of total assets in excess of $500 billion — effectively applying the rule to only the very largest U.S. banks.

Neither the Ryan plan nor Trump have embraced the idea of an additional tax on banks, but that doesn’t mean it isn’t possible, especially if other provisions that are meant to defray the cost of a lower headline tax rates can’t generate broad support. If it is taken as a given that any Republican tax reform package must be revenue-neutral, then the GOP will have to find money to pay for its plan from somewhere, and banks could be an attractive source. Davis warned that taxing banks will throw a wrench in the underlying purpose of tax reform, which is sparking economic growth.

“We think there shouldn’t be punitive taxes imposed on any business, particularly one as essential to capital formation and business activity as banking,” Davis said. “That’s just a nonstarter if you’re going to have economic growth. There’s always a tendency if you lose one kind of pay-for to look for another one, but you’re not going to achieve economic growth [with] a tax on banks.”

The kitchen sink

When considering any legislation, it is always possible that lawmakers may tack on provisions not directly related to the issue at hand, particularly in an era when so few bills are approved by both Houses of Congress and are signed by the president.

Creighton said the potential for tax reform to become a magnet for unrelated riders — such as provisions to dismantle the Consumer Financial Protection Bureau, limit the Federal Reserve’s monetary policy independence or some other measure — depends largely on whether the tax reform bill is pursued as a partisan exercise or a bipartisan effort. If it is a bipartisan effort, he said, then Republicans will probably stick to the issue and keep a bill relatively clean.

But if that effort is abandoned, especially if it is abandoned early in the process, there is less reason for lawmakers to stick to the subject, Creighton said. But that path has other limitations, such as a need to rely on reconciliation procedures, which can only apply to matters related to revenue.

“If you’re going to be strictly partisan, then you have to use the reconciliation process, and … you can’t really do a lot of those Dodd-Frank fixes,” Creighton said.

Is tax reform even happening, anyway?

There is of course no way of knowing whether a Republican-sponsored tax reform bill will make its way to the President’s desk at all. President Trump met with Treasury Secretary Steven Mnuchin on the issue Thursday, signaling it remains a high priority.

But tax reform has eluded every administration since Ronald Reagan, not least because no single issue affects literally every industry and person in the U.S. the way taxes do.

Even controlling both houses of Congress and the White House, the GOP may find it even more difficult to agree on a tax reform package than it was to find common ground on health care reform. Trump lashed out at the conservative Freedom Caucus in Congress in a tweet on Thursday — votes he will need if he seeks tax reform without Democratic support.

Still, Traub said, the Republican Party is also motivated by a deep conviction that the tax system is broken.

“I think most Republicans would tell you they would like to see tax reform passed — I think the number of people who think the current tax code is just fine is pretty small,” Traub said. “Tax reform is going to be a difficult process. It involves a lot of moving parts, many of which are going to have built-in constituencies … that will seek to preserve what’s in the current law, if not expand it.”

Creighton said the defeat of the American Health Care Act is not a very good determinant of what will come from tax reform, because it could easily act to motivate the Republican caucus to join together or reflect just how hard it is to get lawmakers on the same page.

“What happened last week could point to a path where the House and Senate are even more compelled to score a victory and work harder to get tax reform done,” Creighton said. “Alternatively, what happened last week shows how difficult it is to get anything done where there are a lot of competing interests. I can see both cases.”

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