House Republicans Release Tax Overhaul Bill

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House Republicans Release Tax Overhaul Bill

By David Floyd | Updated November 3, 2017 — 3:54 PM EDT

On Thursday, Nov. 2, the House Ways and Means Committee unveiled the “Tax Cuts and Jobs Act,” a bill that would slash corporate tax rates, reduce the number of personal income brackets, limit or eliminate a number of popular tax breaks and – if it passes – mark the largest overhaul of the federal tax code since 1986.

The bill was initially slated for released on Nov. 1, but the committee’s chair Kevin Brady (R-Texas) held off, reportedly due to continuing disagreements over some of the bill’s key provisions.

Provisions

Personal Taxes

• Collapse the current seven tax brackets into four, paying marginal rates of 12%, 25%, 35% and 39.6%. Here is how the proposed brackets compare to those under current law (2017):

Tax Cuts and Jobs Act proposed brackets vs current law
Single filers
More than Up to Proposed rate Current rate
$0 $9,325 12% ↑ 10%
$9,325 $37,950 12% ↓ 15%
$37,951 $45,000 12% ↓ 25%
$45,000 $91,900 25% – 25%
$91,900 $191,650 25% ↓ 28%
$191,650 $200,000 25% ↓ 33%
$200,000 $416,700 35% ↑ 33%
$416,700 $418,400 35% – 35%
$418,400 $500,000 35% ↓ 39.6%
$500,000 And up 39.6% – 39.6%
Married couples filing jointly
More than Up to Proposed rate Current rate
$0 $18,650 12% ↑ 10%
$18,650 $75,900 12% ↓ 15%
$75,900 $90,000 12% ↓ 25%
$90,000 $151,300 25% – 25%
$151,300 $233,350 25% ↓ 28%
$233,350 $260,000 25% ↓ 33%
$260,000 $416,700 35% ↑ 33%
$416,700 $470,700 35% – 35%
$470,700 $1,000,000 35% ↓ 39.6%
$1,000,000 And up 39.6% – 39.6%
Source: Investopedia analysis.

• Raise the standard deduction to $24,000 for married couples filing jointly in 2017 (from $12,700 under current law), to $12,000 for single filers (from $6,350), and to $18,000 for heads of household (from $9,350).

• Eliminate the $4,050 personal exemption and the additional standard deduction ($1,550 for single filers who are blind or over 65).

• Change the measure of inflation used for tax indexing. The Internal Revenue Service (IRS) currently uses the Consumer Price Index for all Urban Consumers (CPI-U), which the bill would replace with the chain-weighted CPI-U. The latter takes account of changes consumers make to their spending habits in response to price shifts, so it is considered more rigorous than standard CPI. It also tends to rise more slowly than standard CPI, so substituting it would likely accelerate bracket creep. The value of the standard deduction and other inflation-linked elements of the tax code would also erode over time.

• Scrap most itemized deductions, including those for medical expenses and student loan interest.

• Leave the mortgage interest deduction unchanged for existing homes. Married couples can currently deduct interest on mortgages worth up to $1,000,000; that cap would fall to $500,000. The charitable giving deduction would be left unchanged.

• Retain the deduction for state and local tax (SALT) property taxes up to $10,000, but scrap state and local income and sales tax deductions. The SALT deduction disproportionately benefits high earners and taxpayers in Democratic states, though a number of Republican members of Congress representing high-tax states have opposed attempts to eliminate it, as September’s Big Six framework proposed.

• Preserve the Earned Income Tax Credit.

• Leave annual 401(k) and Individual Retirement Account (IRA) contribution limits unchanged. Reports began circulating in October that traditional 401(k) contribution limits would fall to $2,400 from the current $18,000 ($24,000 for those aged 50 or older). IRA limits, currently $5,500 ($6,500 for 50 or older), may also have been considered for cuts.

• Repeal the alternative minimum tax, a device intended to curb tax avoidance among high earners.

• Roughly double the estate tax exemption and repeal the tax entirely after six years, along with the generation-skipping transfer (GST) tax.

• Introduce a “family credit,” which includes raising the child tax credit to $1,600 from $1,000 and providing each parent and non-child dependent with a temporary $300 credit. Only the first $1,000 of the child tax credit would be refundable initially, but this amount would rise to $1,600. The $300 credit would end after five years.

Business Taxes

• Permanently lower the top corporate tax rate to 20% from its current 35% and repeal the corporate AMT.

• Reduce the top pass-through rate to 25%, while introducing safeguards to keep high earners from passing off wage income as pass-through income. Owners of pass-through businesses – which include sole proprietorships, partnerships and S-corporations – currently pay taxes on their firms’ earnings through the personal tax code, so the top rate is 39.6%.

• Introduce rules to prevent abuse of the 25% pass-through rate. These would assume that 70% of a pass-through entity’s income is compensation subject to personal income tax rates, while 30% is business earnings subject to the pass-through rate. Businesses can prove otherwise, and certain industries – law, health, finance, performing arts – must “prove out” business income in order to qualify for the pass-through rate on any earnings.

• Allow businesses to immediately write off the costs of new equipment, rather than depreciating the value of these assets over time. This provision would end after five years.

• Limit the net interest expense deduction on future loans to 30% of Ebitda with a five-year carry-forward. Firms with at least $25 million in revenues would be exempt from the cap, as would real estate companies and some utilities.

• Limit the deduction of net operating losses (NOL) to 90% of taxable income in a given year, but allow NOLs to be carried forward indefinitely – the current limit is 20 years – while eliminating carrybacks, with exceptions for disasters.

• Scrap a number of business credits and deductions, including the section 199 (domestic production activities) deduction, the new market tax credit, the orphan drug credit and like-kind exchanges.

• Retain the low-income housing tax credit and the research and development credit.

• Alter the rules governing tax-exempt groups such as religious organizations, potentially allowing them to support or oppose political candidates and retain their tax-exempt status.

• Enact a deemed repatriation of overseas profits at a reduced rate of 12% for cash and equivalents and 5% for reinvested earnings. Goldman Sachs estimates that U.S. companies hold $3.1 trillion of overseas profits. As of Sept. 30 Apple Inc. (AAPL) holds $252.3 billion in tax-deferred foreign earnings, 94% of its total cash and marketable securities.

• Introduce a territorial tax system: repatriated dividends and earnings are not subject to U.S. tax, but 50% of foreign subsidiaries’ excess returns (greater than 107% of the short-term applicable federal rate) count towards U.S. shareholders’ gross income. A 20% excise tax would be applied to payments made to foreign subsidiaries. Proponents of these measures argue that – together with the lower corporate tax rate – they will increase American businesses’ competitiveness and discourage corporate inversions.

Whose Tax Cuts?

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Speaking at a rally in Indiana shortly after the Big Six framework’s release in September, President Trump repeatedly stressed that the “largest tax cut in our country’s history” would “protect low-income and middle-income households, not the wealthy and well-connected.” He added the plan is “not good for me, believe me.” That claim is hard to verify, however, because Trump is the first president or general election candidate not to release his tax returns since the 1970s. The reason he has given for this refusal is an IRS audit; the IRS responded that “nothing prevents individuals from sharing their own tax information.”

The Tax Policy Center (TPC) and Tax Foundation, two nonpartisan think tanks that lean to the left and right respectively, have not yet scored the bill, so its distributional effects are hard to assess. Previous Republican tax proposals would have cut the top personal income tax rate to 33% or 35%, eliminated the head of household filing status and cut the corporate tax rate to 15%. As a result, most analyses forecast enormous gains for the highest earners – not just in absolute dollar amounts, but as a percentage of income – and modest gains for working- and middle-class taxpayers. Some middle earners would have seen tax rises, particularly the single parents who would no longer have benefited from the head of household filing status.

The current plan would still cut the corporate tax rate, benefitting corporate shareholders (who tend to be higher earners); eliminate the alternative minimum tax, which requires high earners to calculate their liabilities twice and pay the higher amount; scrap the estate tax; and cut the rate married couples pay on income between $470,700 and $1 million. Unlike earlier plans, it leaves the carried interest loophole open. As a result, the bill may disproportionately benefit high earners, opening it up to charges of being “a giveaway to corporations and the wealthiest,” as Senate minority leader Chuck Schumer (D-N.Y.) said on Nov. 2.

On the other hand, some conservative commentators see a profound difference in approach between earlier Republican plans and the one released Nov. 2. The Wall Street Journal’s editorial board called it “a surrender to Democratic class warriors” (casting part of the blame on President Trump’s “flightiness and lack of principle”), arguing that the result will be “more income redistribution.”

A Middle Class Tax Hike?

While the standard deduction would increase under the bill, that increase would be mostly offset by the loss of the personal exemption. Currently a middle-income single filer does not pay tax on the first $10,400 they earn: the $6,350 standard deduction plus one $4,050 personal exemption. In other words, the standard deduction is roughly doubling only in the most technical sense; it is raising the amount that can be earned tax-free by a single filer with a moderate income by 15.4%. For people who are blind or older than 65, who would no longer receive the $1,550 additional standard deduction, the increase is just 0.4%.

For families with children, the loss of the personal exemption could result in a tax hike, though the increased child credit would offset the change at least in part.

The Estate Tax

The bill would roughly double the estate tax deduction to $10 million, indexed to inflation, and eliminate the tax entirely in six years. Speaking in Indiana in September, Trump attacked “the crushing, the horrible, the unfair estate tax,” describing apparently hypothetical scenarios in which families are forced to sell farms and small businesses to cover estate tax liabilities; the 40% tax only applies to estates worth at least $5.49 million. According to TPC, 5,460 estates are taxable under current law in 2017. Of those, just 80 are small businesses or farms, accounting for less than 0.2% of the total estate tax take.

The estate tax mostly targets the wealthy. The top 10% of the income distribution accounts for an estimated 67.2% of taxable estates in 2017 and 87.8% of the tax paid.

Opponents of the estate tax – some of whom call it the “death tax” – argue that it is a form of double taxation, since income tax has already been paid on the wealth making up the estate. Another line of argument is that the wealthiest individuals plan around the tax anyway: Gary Cohn reportedly told a group of Senate Democrats earlier in the year, “only morons pay the estate tax.”

Carried Interest

The bill would not eliminate the carried interest loophole, though Trump promised as far back as 2015 to close it, calling the hedge fund managers who benefit from it “pencil pushers” who “are getting away with murder.” Hedge fund managers typically charge a 20% fee on profits above a certain hurdle rate, most commonly 8%. Those fees are treated as capital gains rather than regular income, meaning that – as long as the securities sold have been held for at least a year – they are taxed at a top rate of 20% rather than at 39.6%. (An additional 3.8% tax on investment income, which is associated with Obamacare, also applies to high earners.)

Corporate Taxes

In his Indiana speech Trump said that cutting the top corporate tax rate from 35% to 20% would cause jobs to “start pouring into our country, as companies start competing for American labor and as wages start going up at levels that you haven’t seen in many years.” The “biggest winners will be the everyday American workers,” he added.

The next day, Sept. 28, the Wall Street Journal reported that the Treasury Department had deleted a paper saying the exact opposite from its site (the archived version is available here). Written by non-political Treasury staff during the Obama administration, the paper estimates that workers pay 18% of corporate tax through depressed wages, while shareholders pay 82%. Those findings have been corroborated by other research done by the government and think tanks, but they are inconvenient for the institution that produced them. Treasury Secretary Steven Mnuchin is selling the Big Six proposal in part through the assertion that “over 80% of business taxes is borne by the worker,” as he put it in Louisville in August.

A Treasury spokeswoman told the Journal, “The paper was a dated staff analysis from the previous administration. It does not represent our current thinking and analysis,” adding, “studies show that 70% of the tax burden falls on American workers.” The Treasury did not respond to Investopedia’s request to identify the studies in question. The department’s website continues to host other papers dating back to the 1970s.

Can Tax Reform Be Done?

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The Republican push to overhaul the tax code has proceeded at a slower rate than the Trump administration initially promised. Mnuchin said in February that a bill would be passed and signed before Congress’ August recess. In September he shifted that target to the end of the year.

Byrd Is the Word

A string of efforts to repeal and – ideally – replace the Affordable Care Act (ACA or “Obamacare”) set the GOP’s tax reform push back in a number of ways. The White House and congressional Republicans decided to pursue healthcare legislation first because, by cutting funding for premium and cost-sharing subsidies and programs such as Medicaid, they could create some room to introduce tax legislation that is not strictly revenue-neutral: the Senate’s Better Care Reconciliation Act, for example, would have shaved an estimated $321 billion from the federal deficit over a decade.

Fiscal prudence aside, Republicans felt a procedural need to balance the books, since they control only 52 of 100 seats in the Senate. Without the 60 seats needed to defeat a Democratic filibuster, they will have to use a fast-track process called reconciliation, which only requires 50 votes (plus Vice President Pence’s tie-breaker). Reconciliation must be authorized by a budget resolution; the Senate passed one on Oct. 19, and the House, in an unusual move, voted on the same resolution rather than drafting their own. The resolution passed the lower chamber on Oct. 26 by a narrow margin, 216 votes to 212. No Democrats supported the resolution, and 20 Republicans voted “no” to signal their opposition to plans (since abandoned) to eliminate the state and local tax deduction entirely.

Bills passed through reconciliation must also comply with the 1985 Byrd Rule, which limits the budget effects fast-tracked bills can have over a 10-year period. The budget resolution authorizes the Senate Finance Committee to draft a bill that would raise the deficit by $1.5 trillion over that period (the deadline to present a bill is Nov. 13). Citing the Joint Committee on Taxation, Brady said on Nov. 2 that the bill’s provisions would add $1.51 trillion to the deficit over 10 years.

Traditionally the party of fiscal responsibility – with exceptions – Republicans are taking pains to pay for their proposals. The budget resolution instructs the Senate Energy and Natural Resources Committee to achieve $1.0 trillion in savings; a likely route would be to allow oil and gas drilling in the Arctic National Wildlife Refuge, which is located in committee chair Sen. Lisa Murkowski’s (R-Alaska) home state. (Murkowski voted against multiple Obamacare repeal bills over the summer.) The party is also arguing that well-designed tax reform would more than pay for itself. Mnuchin told NBC’s “Meet the Press” at the beginning of October:

“On a static basis our plan will increase the deficit by a trillion and a half. Having said that, you have to look at the economic impact. There’s 500 billion that’s the difference between policy and baseline that takes it down to a trillion dollars, and there’s two trillion dollars of growth. So with our plan we actually pay down the deficit by a trillion dollars and we think that’s very fiscally responsible.”

Supply-side economics, an influential idea in the GOP, contends that tax cuts increase government revenue through the relationship described by the Laffer curve: lower taxes encourage higher rates of investment, spurring economic growth and ultimately increasing the government’s tax take. Republicans have also proposed scrapping a number of tax breaks and loopholes. The state and local tax deduction (skip to section) is the most controversial item under negotiation.

The Congressional Budget Office, however, “doesn’t always measure all the dynamic effects,” Diana Furchtgott-Roth, a Trump transition team member and Labor Department chief economist under George W. Bush, told Fox Business in March. Even if it did, Congress’ research arm would be unlikely to share Mnuchin’s optimism. The CBO released a study of the budgetary effects of a hypothetical 10% across-the-board tax cut in 2005. It estimated that a shift in the economic growth rate would make up for perhaps 28% of the resulting budget shortfall or, in the worst-case scenario, exacerbate it by 3%.

Maya MacGuineas, president of the fiscally hawkish Committee for a Responsible Federal Budget (CRFB), doubts that the GOP’s tax cuts can pay for themselves. In a statement emailed to reporters on Nov. 2, she said the bill “continues to rely on unrealistic economic growth assumptions to justify its cost.” She was less critical of the proposal than she was of the Big Six framework, which she called “fiscal fantasy”: “We are pleased to see the House put forward a number of serious pay-fors to help finance rate reductions,” she wrote. “But given the huge unpaid-for gap remaining, this plan does not constitute true comprehensive, revenue-neutral, and pro-growth reform.”

Trump has repeatedly asserted that gross domestic product (GDP) growth could exceed 3% per year following a tax overhaul; during the campaign he went as high as 6%, and speaking in Indiana following the release of the Republican framework he predicted that “everything takes off like a rocketship.”

What About the Democrats?

President Trump has openly flirted with Democrats when it comes to tax reform, reflecting his frustrations with Republicans in Congress after repeated Obamacare repeal failures, as well as a bipartisan desire to simplify the gargantuan tax code. The fact that his top tax negotiators, Mnuchin and National Economic Director Gary Cohn, are both former Democratic donors may also play some role in his attempts to woo the left.

In order to gain Democratic support, Trump has promised repeatedly not to cut taxes on the wealthy, but those promises may not square with the elimination of the estate tax and alternative minimum tax and the decrease in the pass-through rate.

Congressional Republicans have been less eager than Trump to reach across the aisle. McConnell said in August that his party intends to use reconciliation to pass tax reform, rebuffing an offer by 45 of 48 senators in the Democratic caucus to work with Republicans on the issue – albeit on Democrats’ terms, such as not lowering taxes on the rich.

Speaking on tax reform in Missouri at the end of August, Trump preemptively laid the blame for failure at Congress’ feet, saying, “I don’t want to be disappointed by Congress, do you understand me?” He referenced Republicans’ failed attempts to pass healthcare legislation and blamed congressional Democrats in particular, saying that Sen. Claire McCaskill (D-Mo.) should vote for tax overhaul or lose her seat.

Speaking North Dakota the following month, he invited another Democrat, Sen. Heidi Heitkamp (N.D.), to the stage; the gesture followed a deal struck the previous day between the president and Democratic senators, which raised the debt ceiling and provided relief for those affected by Hurricane Harvey. Heitkamp and McCaskill are among the 10 Democratic senators facing reelection in 2018 whose states went for Trump.

Internal Divisions

Before they can worry about the Democrats, however, Republicans must shore up support in their own party. As the healthcare battle showed, the priorities of the GOP’s moderate and Tea Party wings are difficult to reconcile, and proposals put forth by the leadership tend to alienate both camps – for diametrically opposed reasons. Given the thin Republican majority in the Senate, these tensions have so far prevented the passage of major legislation.

GOP factions clashed during the spring over border adjustment, a now-dead proposal that would have taxed imports and domestic sales but exempted exports. The fight pitted big importers, major Republican donors and the president, who all opposed the measure, against the House Republicans who proposed the measure and the prominent anti-tax crusader Grover Norquist, who supported it. The Big Six issued a statement in July saying they would drop border adjustment.

Since the release of the Big Six framework in September, a fight has been raging over the fate of the state and local tax deduction. According to a TPC analysis of IRS data, the ten jurisdictions where the highest share of returns claim the state and local tax deduction are Maryland, New Jersey, Connecticut, D.C., Virginia, Massachusetts, Oregon, Utah, Minnesota and California. Collectively they account for 35 Republican seats in the House – more than the GOP’s 23-seat majority.

New York Republican Chris Collins told the New York Times on Oct. 3 that Brady and House Majority Leader Kevin McCarthy (R-Ca.) had separately assured him, “it’s safe to say, we’re no longer going to be talking about a full repeal” of the state and local tax deduction. If Republicans ditch that idea, however, $3.6 trillion in savings will disappear over the first two decades after reform, according to TPC’s estimates. The Nov. 2 framework struck a compromise, allowing $10,000 in property tax deductions but scrapping other aspects of the state and local tax deduction.

A conflict is also brewing between Trump and Republicans in Congress. Sen. Bob Corker (R-Tenn.) is engaged in a full-blown feud with the White House, which he called an “adult day care center” in response to insults Trump tweeted in October. The spat has added acrimony to a policy disagreement: Corker said as the Big Six framework was released, “there is no way in hell I’m voting” for a bill that increases the deficit, as the bill released Nov. 2 likely would. Without Corker, the White House is left with one vote to lose. That vote could be Jeff Flake’s (R-Ariz.), who announced that he would not run for reelection on Oct. 24, while delivering a blistering rebuke of Trump on the Senate floor. He called the president’s behavior “reckless, outrageous and undignified,” as well as “dangerous to democracy,” earning him a barrage of revenge tweets from the White House. Speaking to CNBC, Sen. Rob Portman (R-Ohio) said both Flake and Corker would ultimately vote for the bill.

Trump has not displayed the political finesse that suggests he can work with a slim margin. Two tweets in particular indicate he does not understand the process ahead of him. The day after the Big Six proposal was released, he referred to the “great reviews” the “Tax Cut and Reform Bill” was receiving. There would not be a bill – at least one the public could see – for over a month.

Trump had perhaps alluded to that process two weeks earlier, but using odd language: “The approval process for the biggest Tax Cut & Tax Reform package in the history of our country will soon begin. Move fast Congress!” Members of Congress are unlikely to embrace the idea that they are engaged in an “approval process” for the executive branch.

The Voters

Polling on the bill released Nov. 2 is not available yet, but an NBC-Wall Street Journal poll published Nov. 1, only 25% of repsondents called Trump’s tax plan a “good idea” (though 54% of Republicans did so). Harry Enten, senior political writer at FiveThirtyEight, told Investopedia by email on Nov. 3 that voters “don’t just want the rich getting richer. And the problem is that they feel this tax bill is doing exactly that. That’s the issue, and it’s showing up in poll after poll.” Asked whether perceptions would change as the details of the latest bill percolated through the media, he said, “I tend to doubt that public opinion will move that much.”

Special Interests

In attempting to rework the tax code, Trump and Congress are picking their way through a minefield of vested interests. As the Economist put it, “Where once the passage of bills was smoothed by including federal money for pet projects in congressmen’s districts, tax breaks are now the preferred lubricant.”

This trend has created a difficult situation for would-be reformers of either party: while the overall benefits of an overhaul would be enormous, they would be diffuse, with each household and firm saving some money and some time. For a few interest groups, on the other hand, particular carve-outs and loopholes are essential, meaning they are willing to expend significant time and money lobbying against reform. The last sweeping tax reform to pass Congress was called the Lobbyists’ Relief Act of 1986 in K Street circles; the New York Times reported in late September that companies and trade associations have submitted 450 filings to lobby on tax issues so far this year, far outstripping the total for 2016. In short, Trump’s promises to “drain the swamp” and to overhaul the tax code may not be compatible. (See also, Goldman Reduces Buyback Forecast After Trump Tax Reform Delay.)

One group is dependent not on any particular aspect of the complex tax system, but on the complexity itself: as NPR and ProPublica have reported, TurboTax maker Intuit Inc. (INTU) and H&R Block Inc. (HRB) lobby against bills that would allow the government to estimate taxes, saving much of the hassle on which the firms’ business depends. In addition to bills aimed at simplifying the filing system, tax-preparation firms may also oppose bills aimed at simplifying the tax code itself.

The Pledge

As of the previous (113th) Congress, only 16 Republicans in the House and six in the Senate have failed to sign Norquist’s pledge not to raise taxes. If Norquist decides that an aspect of a Republican proposal violates the pledge – or Republicans decide to invoke it to avoid a showdown with special interests – the bill could be dead on arrival.

That some American households would see their tax bills rise is not exactly a remote possibility, given the range of proposed changes: the bottom personal tax rate would rise, which may not be fully offset for all households by a higher standard deduction – particularly given the loss of the personal exemption.

The Bulls Weigh In

Despite the obstacles facing the tax reform efforts – fiscal constraints, a slim Republican majority, intra-party rifts, the “swamp” and a potentially inconvenient pledge – the market is bullish. A Bank of America Merrill Lynch team led by chief investment strategist Michael Hartnett wrote in a note on Oct. 5 that equities are “starting to anticipate tax reform,” which accounts for a string of all-time highs. On the other hand, the team notes, a correction “requires higher rates,” which the Fed would only deliver if stubbornly low inflation were to perk up – or Congress delivered tax reform.

What’s Wrong With the Status Quo?

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People on both sides of the political spectrum agree that the tax code should be simpler. Since 1986, the last time a major tax overhaul became law, the body of federal tax law – broadly defined – has swollen from 26,000 to 70,000 pages, according to the House GOP’s reform proposal. American households and firms spent $409 billion and 8.9 billion hours completing their taxes in 2016, the Tax Foundation estimates. Nearly three quarters of respondents told Pew in 2015 that they were bothered “some” or “a lot” by the complexity of the tax system.

An even greater proportion was troubled by the feeling that some corporations and some wealthy people pay too little: 82% said so about corporations, 79% about the wealthy. According to TPC, 72,000 households with incomes over $200,000 paid no income tax in 2011. ITEP estimates that 100 consistently profitable Fortune 500 companies went at least one year between 2008 and 2015 without paying any federal income tax. ​There is a widespread perception that loopholes and inefficiencies in the tax system – the carried interest loophole and corporate inversions, to name a couple – are to blame.

 

Published at Fri, 03 Nov 2017 19:54:00 +0000

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