What’s On Deck for the Rest of 2015

Speaker Boehner had a three step plan at the beginning of October: 1) Resign at the end of the month; 2) Clear the legislative decks of controversial and difficult items; 3) Turn the gavel over to a new Speaker to begin their tenure with a clean slate.

Looking back, he pretty much pulled it off.  Sure, the Speakership went to Paul Ryan, not Kevin McCarthy, and not all the tough legislative items cleared Congress, but the simple fact is that Speaker Ryan begins his term with a much more manageable set of issues than the laundry list of must pass items that confronted Boehner at the beginning of October:

  • Federal Funding
  • Debt Limit
  • Highway Funding
  • Tax Extenders
  • Medicare Premium Hike
  • Social Security Disability Fund

Of these, the deal brokered by Boehner, McConnell and the White House takes care of the debt limit, the looming Medicare premium hikes, and the depletion of the Social Security Disability Fund.  It also raises spending caps for discretionary funding next year by $50 billion, making the job of passing all those spending bills – most likely in the form of a single, massive omnibus spending bill – before the December 11th deadline much, much easier.

Which means between now and the end of the year, the remaining must pass items are largely limited to three – 2016 spending bills, highway reauthorization, and tax extenders.  The House highway bill is up this week, and appropriators are busy working to have appropriation bills ready for consideration later this month.  Other items, like Ex-Im Bank reauthorization, may likely catch a ride on one of these vehicles.

Which leaves extenders.  Once again, Congress has waited until the last days to adopt extensions of tax provisions that have already expired.

That to-do item will fall on the plate of the incoming Ways & Means Committee Chairman.  The election to replace Ryan will take place on Wednesday and Politico has a terrific story this AM on the race.  Here’s the key paragraph:

With just days left, lots of people think that the race between Kevin Brady of Texas and Pat Tiberi of Ohio to replace Ryan as Ways and Means chairman remains too close to call. Both Brady and Tiberi are well-liked by colleagues, and have pretty similar policy views on the issues under Ways and Means’ jurisdiction. That means this contest could be decided on issues more on the margins, like fundraising prowess and even sheer geography.

For S corporations, both candidates are terrific and have a long history of supporting independent businesses and their communities.  Let’s hope whoever wins, their first action item is to markup a tax extender package that makes as many provisions permanent as possible.  A little tax certainty would go a long way at a time when the economy looks iffy at best, and it would be a terrific start to a new era at the tax writing committee.

 

Rubio on Pass Thrus

Senator Marco Rubio did a post-debate interview with CNBC last week where he made a vigorous defense of his tax proposal, as well as the importance of S corporations and other pass through businesses to the economy and jobs:

“…I think we also need to lower taxes on pass-throughs, which is where the vast majority of American business activity is happening. You know, I have gentleman–I mentioned him last night–he’s the dry cleaner where I take my clothes in Miami. He’s an S-corp and he’s a small business and he’s probably paying a much higher rate, in fact almost guaranteed he’s paying a higher rate than a chain-owned company down the street somewhere, and that’s unfair. I think we have to make an equal playing field for pass-through companies, where a lot of working Americans are drawing their income, and have been placed at a competitive disadvantage now because of regulations, because they don’t have access to community banking the way they once did, and because of the tax code that actually treats them differently…”

As readers know, we initiated the “Pass Through Principles” letter four years ago in an effort to define what sort of tax reform the pass through business community would support.  This year, 120 groups signed the letter, which calls for making tax reform comprehensive, restoring tax rate parity for all businesses, and reducing or eliminating the double corporate tax.

The Rubio tax plan comes very close to meeting those three priorities.  It would eliminate the harmful double tax on corporate profits while leveling the tax rates paid by pass through businesses and their C corporation competitors.  Senator Rubio’s team spent an enormous amount of time working with the business community to craft their plan, and it shows.

Legislative Update

It’s been a busy week.  First, Ways & Means Chair Paul Ryan yielded to a tremendous amount of peer pressure and agreed to run for Speaker.  The Republican Conference vote to replace departing Speaker John Boehner is set for October 28th and appears to be all but decided.

And now Boehner made good on his promise to clear off a bunch of “must pass” items before he left, announcing last night a deal with the White House to 1) raise the debt limit through March of 2017, 2) increase the spending caps on defense and non-defense discretionary for 2016 and 2017, 3) enact longer term reforms to prop up the Social Security disability program and 4) much, much more.

The House will vote on the package tomorrow, where a majority of Democrats are expected to provide the votes necessary to send it to the Senate.  The Senate needs to act before the November 3rd, when we run up against the debt ceiling.

The Boehner-White House package is by no means a clean legislative sweep.  Missing are the highway reauthorization, tax extenders, and the actual spending bills that make up federal funding.  Speaker Ryan will have to deal with those items in the next two months.

The current highway authorization runs out this week, but the House is already acting to extend highway authority through November 20th.  At that point, everybody expects them to adopt a 6-year reauthorization together with at least two or three years of funding.

Meanwhile, once the spending levels are set for 2016, the challenge of adopting the actual spending bills becomes much less contentious, so the odds of a government shutdown this winter just dropped sharply.  Those bills, or giant omnibus combining them, still need to be adopted, however, prior to December 11th when current funding runs out.

Which leaves extenders.  Once again, these tax items are left behind to fend for themselves.  With Ryan leaving Ways and Means and the Committee leadership in play – Brady, Tiberi, and Nunes are all vying for the chairmanship – we would be surprised if Congress gets around to extending these tax provisions before December, making this the second year in a row that Congress has allowed 179 expensing, the shorter BIG recognition period, the R&E tax credit and all the other provisions to expire for almost an entire year!  That’s unacceptable and a good argument for making as many of these provisions permanent as possible.

 

Survey of Business Tax Professionals

Last week, we updated you on three leading small business surveys, which sampled business owners from around the country to gauge the national mood on the economy. This week’s survey is a little different; it comes from The Tax Council (TTY) and Ernst & Young and focuses on business tax professionals looking at the tax policy environment. The sample includes 97 tax professionals, assessing their views on a variety of legislative issues. Here’s a snapshot of what they found:

  • 63 percent of respondents said that they think tax reform will happen in 2018 or earlier, with a plurality (28 percent) saying 2017 is most likely.
  • A plurality (45 percent) think that when reform occurs, it will be comprehensive, and another 21 percent think that it will include all businesses.
  • A majority of 54.7 percent believe that reform will be revenue-neutral, while around one-third believe it will raise revenue.
  • 91 percent of respondents think that extenders will pass this year, and two-thirds think the package will cover 2015 and 2016.
  • Since the survey was taken in early September, it also has an interesting perspective on international reform—65 percent of respondents thought it would hinder the possibility of passing a comprehensive package in the future.

So the EY survey suggests the broad outlook for tax policy is similar to the S-Corp view – expect a two-year extender package adopted this fall together with a window of opportunity for tax reform after the election. There’s also a telling consensus among professionals about what would constitute good tax policy—a comprehensive package that addresses both individuals and businesses, not just the largest corporations or those doing business overseas.  That’s good for tax policy and good for Main Street businesses.

GOP Leadership Fight Will Continue, Implications for Tax Reform

Well that didn’t go as planned.

House Majority Leader Kevin McCarthy’s surprising withdrawal from the Speaker’s race Thursday put an end to John Boehner’s carefully orchestrated plan to pass a raft of difficult bills this month, turn over the Speakers’ gavel to McCarthy on the 29th, and ride off into the sunset.

We still expect Boehner to successfully negotiate deals on spending, debt limit and highways, but where does all the turmoil leave tax policy?  Our friends at Tax Notes asked around and got this response:

Tax observers said McCarthy’s withdrawal makes it more difficult to achieve any kind of complicated tax legislation by the end of the year.

“Today’s news probably makes it even harder to do anything complicated, and more likely we get another short one- or two-year [extenders bill] at the end of the year,” a tax lobbyist said.

When asked about how the tax agenda for this year would be affected, a House Democratic aide said, “The Republican party has bigger issues to sort out.”

A renewed focus on extenders would be nice.  It’s almost November, and they expired January.

But the Tax Notes story was written before the entire Republican apparatus turned its attention towards recruiting Ways & Means Chair Paul Ryan to replace John Boehner as Speaker.  If anybody has a chance to placate the so-called Freedom Caucus members, it would be Ryan, but he has made clear he isn’t interested in the job – he really likes being in charge of tax and entitlement policy.

So it’s unlikely he agrees to run, but it’s also unlikely the pressure coming from Republican leadership abates anytime soon.  Which means tax policy, and extenders in particular, will take a back seat until the Republican leadership question is resolved.

 

International Tax Reform Off the Table, For Now

In a related development, Ryan has officially given up trying to negotiate an international tax reform package with Senator Chuck Schumer.  As The Hill reported last Friday:

Ryan, the House Ways and Means chairman, and Sen. Charles Schumer (D-N.Y.) have held discussions for weeks over a potential deal that would have something for both parties — long-term and robust funding for highways, and more generous tax rules for multinational corporations.

The two powerful lawmakers had always faced a number of difficult hurdles in striking a deal, including an Oct. 29 deadline on highways and opposition from key Senate Republicans.

But aides to Ryan and Schumer also acknowledged on Friday that they had not bridged significant policy differences in negotiations, most notably over how much to spend on highways.

These negotiations had always been accompanied by a fair amount of skepticism, particularly among Senate leadership, but Ryan, Schumer, and others put in an enormous effort to construct a plan that could improve how we tax overseas operations while appealing to Republicans and Democrats alike.  It now appears that plan will have to wait until the 2016 elections and after.

 

More on Treasury’s Effective Rate Study

Having recently put out a paper on effective tax rates, we can confidently say that determining effective tax rates is really, really complicated.  This is particularly true for C corporations, where foreign income and foreign tax payments play such large roles.

That said, in a perfect world, an effective tax rate would measure the actual tax paid by a taxpayer in a particular year divided by the real income of the taxpayer in that same year.

The Treasury Department agrees.  Back in 2012, as part of an interesting discussion on tax burdens and effective tax rates in the President’s “Framework” on corporate tax reform, Treasury emphasized that its measure of effective marginal tax rates for corporations used “economic income” as the denominator.

In their more recent study, however, Treasury appears to use “taxable income” as the denominator, at least for C corporations.  From our perspective, that really undermines the whole point of doing an effective rate analysis.  Here’s why:

Take two businesses, one a manufacturer and one a retailor.  They both make $100 and pay a 35% tax rate.  The only tax benefit they receive is a Section 199 deduction of 9% for production income.

Manufacturer Retailor
Net Income $100 $100
Section 199 Deduction $9 $0
Taxable Income $91 $100
Tax Rate 35% 35%
Tax $31.85 $35
Effective Tax Rate According to Treasury 35% 35%

If you were the retailor in this example, you’d be a little annoyed that the Treasury Department was claiming your average tax rate was the same as the manufacturer who pays less in taxes on the same income.  Using “taxable income” removes the effect of most the business tax expenditures – bonus depreciation, accelerated depreciation, Sections 199 and 179, etc – from the analysis.  That’s obviously not the correct result, but apparently that’s the result Treasury reports in their paper.

So if Treasury is not measuring the effect of most tax expenditures on tax burdens, what are they measuring?  Setting aside tax credits and other adjustments, they are essentially measuring the effect of progressive rate schedules.  Think about it this way – if nearly all C corporation income was taxed at the 35 percent tax rate in 2011, while one third of pass through income was taxed at rates below 35 percent, then the “average” tax rate for pass through businesses will be pulled down by the lower rates.

But those lower rates are generally earned by shareholders of smaller, less profitable businesses.  What about big S corporations where shareholders do pay the top rates?  Our study showed that large S corporations pay the highest effective at 35 percent.  What does the Treasury study say about that?  It doesn’t.  The paper doesn’t break down average tax rates by company size, so there’s no means of comparing apples to apples, or in this case large S corporations to similar sized C corporations.

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