The Flow-Through Business Sector And Tax Reform

Business Community Opposes Tax Hike

Following yesterday’s comments by President Obama, the S Corporation Association joined together with more than 30 other business associations to make the case for action by Congress to avoid the massive tax hike on private enterprise looming next year. As the letter states:

Main Street businesses are America’s job creators. They are responsible for 60 percent of the net new jobs created in the last decade. But uncertainty about the economy and looming tax hikes have kept this sector from hiring new workers, resulting in a weak economic recovery and slow to nonexistent job growth. Until Main Street begins to hire, we fear the unemployment rate will remain unacceptably high.

Congress returns next week and the first order of business will be the much-delayed package of small business tax provisions. This legislation is the perfect vehicle for extending the tax rates and Congress should jump at the chance. According to the Joint Committee on Taxation, failure to take action would mean that taxes next year will rise on families and businesses by $227 billion.

Despite the President’s opposition, momentum for extending all the expiring rates appears to be growing. In recent weeks, senators Ben Nelson (D-NE), Kent Conrad (D-ND) and Evan Bayh (D-IN) have all expressed support for extending all of the rates. Meanwhile, former OMB Director Peter Orzag wrote in the New York Times earlier that, given a choice between doing nothing and extending everything next year, Congress should extend everything.

Each of these Senate defections is significant since any effort to extend current tax policy will need 60 votes, and the Democrats only control 59 prior to the elections. As The Hill noted today:

Senate Democrats would need all 59 Democrats and at least one Republican to pass the Obama administration’s plan to extend tax cuts for the middle class while allowing the tax breaks for the highest-income tax brackets to expire. That plan could be a non-starter in the Senate without Nelson’s support, since another GOP vote would be needed for passage.

Moreover, the Democrat’s majority may shrink immediately after the November elections. Three states — Delaware, Illinois, and West Virginia — will immediately seat their new Senators after the elections in November rather than wait until January, which means if any of those seats change parties, support for a full extension would grow.

As before, we continue to believe the most likely outcome is continued stalemate on extending the rates and no action by Congress this year, followed closely by Congress choosing to extend all of the rates for at least a year. Each additional defection, combined with any Republican victories in Delaware, West Virginia, and Illinois, increases the odds that the latter option becomes law.

S-CORP on Fox Business News

S Corporation Association Executive Director Brian Reardon appeared on Fox Business News last week to discuss the Obama Administration’s newest stimulus proposals.

As discussed above, if the Obama Administration wants to see some real stimulus, it should seek to remove the policy uncertainty hanging over the private sector and support extending all of the current tax provisions that either expired last year or are scheduled to expire next year.

While some of the specific tax items offered up — particularly expensing and a permanent R&E tax credit — are attractive to members on both sides of the aisle, finishing the existing “honey-do” list of tax items is more important.

The amount of capital available to the private sector — and currently buried in money market funds and ridiculously low-interest Treasuries — completely dwarfs the $180 billion package proposed by the President, even without the offsetting tax hikes that are planned to accompany the package. Getting that capital off the sidelines is the first step towards helping the job market recover.

Baucus III

The tax community is still waiting for the third version of the Baucus substitute to be released. A “trial balloon” draft circulated yesterday made certain changes, but failed to address many of the sticking points holding up the overall bill.

Meanwhile, Senators Baucus and Reid spent most of yesterday negotiating with swing Republican votes — at this point, just Maine Republican Senators Olympia Snowe and Susan Collins — to identify what changes are necessary in order to gain the 59th and 60th votes needed. As CongressDaily reports:

The chief target appears to be $24 billion to extend higher Medicaid matching funds for six months, first authorized in the stimulus last year. Options floated Tuesday included phasing down the percentage boost and using untapped funds elsewhere in the Recovery Act for offsets. Snowe and Collins were noncommittal, having not seen details. Senior Democrats appeared resigned that the net cost of the Medicaid assistance would be scaled back. “They’re having to cut it back to try to get Republican votes, and it affects my state; it really affects Harry Reid’s state,” said Sen. John (Jay) Rockefeller, D-W.Va., who with Reid was an original lead Senate sponsor of the six-month Medicaid boost. “But it looks like the best we can get.”

The challenge for Senator Baucus is that the deficit spending in the package represents only half the opposition. There is a lot of opposition to the tax increases as well, including the payroll tax hike on S corporations and partnerships. Senator Snowe of Maine has led the fight to strike this provision from the bill. As The Hill notes:

Kyl said he isn’t sure winding down FMAP is the elixir Democrats think it is in garnering Republican support for the bill. “Whether that will satisfy more Republicans remains to be seen,” he said. “There are other issues with the bill as well, including issues related to the tax provisions.”

The current “K Street” rumor is that Chairman Baucus has been given a limited amount of time to round up the 60th vote. If he’s unable to do so, Majority Leader Reid would set the extender package aside and move on to other items. Whether the rumor is true or not (K Street rumors typically run about 50/50 on the accuracy dial), the clock is ticking.

In addition to Senate consideration, this bill would need to return to the House, where its adoption is by no means assured. If the House makes any changes, it would come back to the Senate. And then, since most of the spending and all the tax items expire before the end of 2010, we’d have to do it all over again before January.

We’ve observed previously that getting the entire business community to oppose a bill centered on extending business-friendly tax breaks is fairly remarkable. The current bill before the Senate is anti-business, and would need to be changed significantly before businesses could support it. It appears that several determined senators share those concerns.

Budget’s Impact on Employers

S-Corp allies over at the Manufacturer’s Alliance commissioned a new study on next year’s tax policy and what it means for S corporations and other business forms. Specifically, the study looked at the tax policies in President Obama’s 2011 budget and asked how these policies would impact economic growth and job creation. The verdict?

In terms of macroeconomic effects, the tax proposals in the 2011 budget are forecast to shave an average of 0.2 percent from annual GDP growth through the middle of the decade, resulting in $200 billion of foregone output and a net job loss of almost 500,000 relative to the baseline. Because taxable business revenues are highly concentrated in manufacturing firms, they will account for a disproportionate share of these output and employment gaps.

So despite much of the rhetoric coming from Washington these days, the rules of economics have not been turned on their figurative heads — the tax forecast for next year is higher tax rates imposed on a larger tax base, which means less investment and less job creation over time. Who will get hit the hardest?

The tax provisions of the 2011 budget will affect S corporations and other pass-through manufacturing firms much more heavily than both firms outside of manufacturing and C corporations within manufacturing. Pass-through businesses in the manufacturing sector will see their tax bills increase by an average of 14 percent. Given the growing importance of S corporations and partnerships to economic growth and job creation over the past 25 years, it is important to understand that tax increases intended to help contain deficits will exact a high price in terms of the competitive posture of U.S. manufacturing and the growth of the economy as a whole.

The study’s authors calculate that S corporations and other “pass through” firms will see their aggregate tax burden rise by $177 billion over the next ten years. Ouch.

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