Tax hikes for businesses are “inevitable” as Democrats seek to pay for the infrastructure and healthcare upgrades they seek, Morningstar’s head of policy research Aron Szapiro predicted.

In fact, the veteran analyst puts the odds of new corporate taxes this year at 80%.

“Democrats hold a razor-thin majority in Congress, along with their control of the White House. And it's unlikely their plans will get any support from Republicans. Still, despite the narrow majority, the chances of a major tax package falling apart is not that high,” Szapiro said in a new blog. “We think there's about an 80% probability that it passes, and we'll keep refining that number as Congress considers the plans.” 

Democrats’ infrastructure wishlist—which includes major investment ranging from broadband, rail, sewer and water systems, renovated childcare facilities and an expansion of the Affordable Health Care Act and the child tax credit, cost a lot of money.

Morningstar estimates that simply extending the major tax provisions in the recently passed Covid-relief package would reduce federal tax revenue by around $1.6 trillion over 10 years, Szapiro said.

The American Rescue Plan Act of 2021 created larger subsidies for health insurance premiums, a more generous child tax credit and an expanded earned-income tax credit. Now, President Joe Biden has proposed another $2.25 trillion in infrastructure spending.  

“Democrats may decide that they don't need to pay for all this spending immediately—particularly one-time, once-in-a-century infrastructure upgrades. But they will certainly feel the need to pay for a lot of it. We think that could amount to a tax increase of about $2 trillion over the next 10 years,” Szapiro said.

President Biden’s bid to secure bipartisan support for his $2.25 infrastructure package is off to a rocky start. Sen. Joe Manchin (D-W.V.) and some other moderate Democrats think the corporate tax increase, which would raise corporate taxes from 21% to 28%, goes too far, creating a competitive disadvantage for U.S. companies battling to compete with China and other nations, which have a 25% corporate tax rate.

Sen. Chris Coons (D-Del.), a close Biden ally, told reporters yesterday that one month has been set aside to hammer out a deal with Republicans. But even moderate Republicans think the tax hike will hurt corporate competitiveness.

Szapiro and others believe they won’t need Republican votes, however. In the Senate, Democrats are expected to use budgetary rules that would allow them to move the package with no Republican votes. Under budget reconciliation rules, the package could avoid a Senate filibuster. That’s how Biden won quick approval of the $1.9 trillion Covid relief package without any GOP support.

“Simply put, Democrats have unified control of government for the first time since 2010, and they agree that they should use their majority to make large changes to American public policy while they have it,” Szapiro said. 

To pay for those large changes, Democrats have only so many options for raising revenues. “While we think Democrats will probably increase income taxes for top earners later in the year, any major or new taxes will mostly be focused on increasing the taxes that businesses pay. There are two reasons: politics and cold, hard math,” he added.

According to Szapiro, every single Democrat voted against reducing the corporate business tax rate from 35% to 21% and rejected the current global income tax regime in 2017. “There are enough votes to increase it at least a few percentage points,” he said. 

“There's simply no way to get to $2 trillion in tax revenue without at least a corporate business tax rate increase and, most likely, an increase in taxes on foreign profits. That's why Biden proposed both on March 31; there are not many alternatives available,” Szapiro said.  

Biden’s plan would not only raise the corporate tax rate to 28%, but would also create a 15% minimum tax on corporations with book profits of $100 million or higher. The president also wants to add a new 10% surtax on corporations that “offshore manufacturing and service jobs to foreign nations in order to sell goods or provide services back to the American market,” his plan said. This surtax would raise the effective corporate tax rate on this activity up to 30.8%.

There is some possibility that Manchin and moderate Democrats can persuade Democrats to reduce the new corporate rate to 25%, Szapiro said. But “they may also conclude that 28% is better than the alternatives—that 3% difference is around $300 billion in revenue, which either must be made up with tax increases elsewhere, less spending, or more debt.”

The “wild-card” source of revenue would be a financial transactions tax of 10 basis points on every sale of a security, which the progressive wing of the Democratic caucus has pushed for in recent years, he said. “I wouldn’t sleep on this,” Szapiro said. “We think that such a tax is less likely, but we never want to ignore a source of $700 billion in revenue that has some Democratic support, particularly from the left wing of the caucus. We'll be publishing a longer paper on this shortly, but there are some political and mathematical challenges for such a tax."

There are a number of drawbacks to a financial transaction tax, Szapiro said. Even if investors did not immediately figure out workarounds, it would reduce securities' values since they would cost more to trade. Democrats would be blamed for falling 401(k) values and it could create liquidity issues for some securities, potentially destabilizing financial markets, he said.

Although the financial transaction tax raises revenue in theory, “many other countries that have tried these taxes have found that investors are pretty good at tax avoidance, and the taxes changed behavior more than raising cash,” Szapiro said. 

With regard to individual income taxes, “we think some increases are coming for high-income families. There will also be a lot of emphasis on individual income-tax loopholes, which are perceived as unfair. But closing these loopholes does not raise that much money,” he said.

For example, the Congressional Budget Office estimates that taxing carried interest at normal income rates only raises around $14 billion over 10 years.

But raising estate taxes would net the government more. Removing the step-up basis for inherited wealth would increase capital gains for heirs when they sell inherited assets by $110 billion over 10 years.

The biggest source of uncertainty for these tax hikes “is the possibility that a Democratic senator from a Republican-controlled state dies,” Szapiro said. “There are four senators over the age of 70 from such states. When we look at the actuarial tables and crunch the numbers, it yields a 9% chance of such a death. This wouldn't be unprecedented; Democratic Sen. Ted Kennedy's death in 2009 almost derailed the Affordable Care Act.”