Legislative Update: The Pre-Thanksgiving Edition

We’re tracking two key tax items at the moment – tax extenders and international reform.  Here’s our outlook for both.

For extenders, Congress has once again ignored the needs of American businesses by delaying adoption of a multi-year extender package until the last possible moment.  What’s the point of encouraging businesses to invest in new equipment if those provisions are enacted only retroactively?  Not only does it undermine the policy, it creates a dynamic where pass through owners are required to overpay their taxes over the course of the year, draining money from their businesses and reducing their ability to hire new workers and invest in new equipment.

The most recent word from the Hill suggests these concerns may be resonating, and that there’s a vigorous effort afoot to:

  1. Make as many of the extender provisions permanent as possible, including the R&E tax credit, small business expensing, and built-in gains relief;
  2. Extend the other provisions for two years; and
  3. Include EITC and child credit reforms important to the Administration.

In other words, we may see a reprise of the deal they nearly closed last fall.  If true, this development would represent a significant early accomplishment in Ways & Means Chairman Brady’s tenure and help to set the table for more significant tax policies to come.

If the broader package fails, we’re hearing the Administration will push for a one-year extender package (2015 only) to give them one more chance to work on tax policy prior to the 2016 elections.  Obviously, a one-year extension of policies that have already expired would simply prolong the extender roller coaster ride that we’ve been on for the past several years and should be vigorously rejected by Congress.

On the international front, we reported in October that Chairman Ryan had officially put on hold his efforts to fix our international tax code by attaching it to the highway bill.  Ryan was unable to come to terms with Senator Chuck Schumer (D-NY) over highway funding levels and he faced a reform skeptic in Speaker Boehner.

Now that he’s Speaker, that effort may have new life.  New Ways & Means Chair Kevin Brady’s remarks in the Wall Street Journal, where he adopted Ryan’s “step one, step two” approach to pursing international reform in 2016, suggest Ryan has an ally at the head of the Committee.  Add to that Pfizer’s announced merger with Allergan in the largest inversion ever, the continued vocal support of Senator Rob Portman and other key policy makers for targeted international reforms, and the G-20’s endorsement of base erosion recommendations that are likely to hit US companies, and it all builds the case that something has to be done on the international front.

On the other hand, Speaker Ryan’s “60 Minutes” interview (see below) demonstrates he understands on-going tax rate disparity faced by pass through businesses.  Successful pass through businesses currently pay tax rates significantly higher than their corporate and foreign competitors.  That disparity would likely be made worse by reforms that focus on corporate concerns only.  Meanwhile, the innovation box draft that was designed to stop corporate inversions has failed to garner widespread support in the corporate community (see below), reinforcing the perception that the business community is far from unified over exactly what international reform should look like.

So that pretty much leaves us where we’ve been for several months now – the need for reforming how we tax business income is obvious, but the path to getting there is not, particularly with a President who opposes restoring rate parity for pass through businesses.

 

Innovation Box Support

A coalition of large corporations has emerged to support the innovation box approach proposed by Ways & Means member Charles Boustany (R-LA).  We offered comments on that draft last summer and have been waiting along with the rest of the tax community for a redraft.  Rumor has it that the release of a new, improved innovation box draft is imminent, which explains the timing of this week’s announcement.  As Politico reports:

BUSINESS RESPONDS TO BEPS: A corporate coalition featuring Apple, Boeing, Cisco and Intel is using the G-20’s adoption of the OECD BEPS recommendations to ramp up their international tax reform efforts. The group, American Innovation Matters, is releasing a statement this morning pushing for an innovation box, even in the heightened gridlock of a presidential election year.

American Innovation Matters (AIM) joins at least three other coalitions out there pushing corporate tax reform, including RATE, LIFT, and ACT.  That’s a lot of corporate muscle in favor of reform.  Now if they could just agree on what it looks like.

 

Speaker Ryan on “60 Minutes”

On Sunday, House Speaker Paul Ryan appeared on “60 Minutes” to discuss his new job and the challenges he faces:

I think you can walk and chew gum at the same time. I think you can oppose the president on some issue that you fundamentally disagree with, but also work with the other party on issues you do agree with. That’s what I’ve been doing. Look, if we can find common ground, we can on highways, we will on funding the government, hopefully we can on tax policy. Those are three things that will produce certainty in this economy in the next few months. Let’s go do that.

Our friends at Politico focused on the “next few months” line and what that might mean:

The “next few months” line there is interesting. A Ryan spokeswoman said the speaker was specifically referring to extenders, an area where practically everyone expects some sort of deal by the end of 2015. But Ryan has also left open the idea that international tax reform could happen in 2016, even though plenty of people see that as quite the longshot.

During the interview, Speaker Ryan also had the opportunity to lay out his vision for comprehensive tax reform:

Scott Pelley: You have proposed having only two tax brackets, 10 percent and 25 percent. That still your position?

Paul Ryan: Yeah, I’ve always liked that plan. And our tax code really punishes our small businesses, which is where most of our jobs come from. I mean, look, we’re sitting here in Wisconsin, overseas, which to us means Lake Superior. You know, the Canadians are taxing their businesses at 15 percent. The top tax-rate on successful small businesses in America, here in Wisconsin, is 44.6 percent. How can you compete like that? How can you have jobs? How can working families get ahead with a tax system like that?

Scott Pelley: Give me three things you would do on tax reform. Very specifically.

Paul Ryan: Well, I’d simplify the code dramatically. I would collapse the rates down to two or three. And I would change the way we tax ourselves internationally, so businesses can take their money and bring it back home so American businesses stay American businesses. And we have to drop our rates on our businesses. I think those three things right there are what I would do.

Paul Ryan has always been a vocal advocate for Main Street businesses and he understands the challenge S corporations and partnerships face with top marginal tax rates of over 40 percent.  The vision he outlined on “60 Minutes” meets the criteria outlined in our Pass Through Principles Letter signed by 120 of the largest and most active business trade groups in Washington DC.  Now that he’s the Speaker, he has an opportunity to move tax reform the fits that vision through the House.

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.

The Importance of Pass Throughs

Put on your “must read” list a new paper from our friends at the Tax Foundation highlighting the importance of pass-through businesses to jobs and employment. It’s the best written and most comprehensive summary of the issue we’ve seen to date. Here’s how it starts:

Support for lowering the corporate tax rate – now the highest in the OECD – has been expressed by both Democrats and Republicans in order to improve the competitiveness of American businesses. However, they differ in their plans for the individual tax code. While Republicans have proposed lowering the top individual rate from 39.6 percent to 25 percent, in parity with the proposed corporate tax rate, Democrats are less willing to consider lowering the individual tax rate.

The implications of these policy differences are considerable because of the tremendous growth in non-corporate business forms over the past thirty years. Today, there are vastly more non-corporate businesses than traditional corporations and they now earn more net income than traditional corporations. These businesses face top marginal tax rates higher than 50 percent in some states. Thus, ignoring the top individual tax rate – even while lowering the corporate rate – means the United States will continue to expose a broad swath of business to high tax burdens.

And how it ends:

As lawmakers consider policies to improve the competitiveness of American businesses, they should not forget that individual income tax rates are just as important to business activity as the corporate rate. The various proposals to raise income taxes on high-income earners, either by increasing the top marginal rate, closing “loopholes,” limiting deductions, or implementing a minimum tax, would fall very heavily on America’s non-corporate businesses. Pass-through businesses are currently facing top marginal rates on average between 44.5 percent and 47.5 percent and as high as 51.8 percent in California. These pass-through businesses account for a large percentage of business income and employment in the United States. Raising taxes on them could curtail their hiring and other investment plans, putting more strain on an already struggling economy.

The paper adds something new to the defense of the pass-through structure. Past arguments in support of a strong pass-through sector include:

  • Best Tax Policy: S corporations are the way business income should be taxed. It’s taxed once, when the business earns the money, and then that’s it.
  • High Effective Tax Rates: As our recent Quantria study demonstrates, pass-through businesses already pay a high level of tax, and they pay it when the income is earned.
  • More Progressive: By taxing business income using the progressive individual tax rates, policymakers ensure that business income is taxed in a progressive manner, with high income shareholders paying a higher rate, and lower income shareholders paying a lower one.
  • Diversification: Pass-through businesses spread investment and employment decision making across the country and into local cities and communities. As the recent financial crisis makes clear, diversification of these actions is critically important.

Thanks to the Tax Foundation, we can now add to that list “Economic Stability.” As the Tax Foundation notes:

It is also interesting to note the relative stability of pass-through business income to the volatility of C corp income. The period between 1999 and 2010, shown on Figure 2, is a good example of how volatile corporate income can be. After the tech bubble burst in 2000, C corp income plunged 24 percent over the next two years, after adjusting for inflation, and then rebounded 119 percent by 2005. After this temporary peak, C corp income fell again by nearly 33 percent over the next five years.

By contrast, pass-through income has not experienced such wild gyrations. After the tech bubble burst in 2000, pass-through business income actually increased in 2001. In 2002, net income fell by just 2 percent but then rebounded by 5 percent in 2003. In the four years after the 2003 tax cuts, the net income of pass-through businesses grew by nearly 60 percent, after adjusting for inflation. In 2010, pass-through business income exceeded C corp receipts by 40 percent.

Is there anybody remaining in Washington who still doesn’t understand the importance of pass-through business to our economic health? If you find them, please send them this Tax Foundation paper!

Breaking Up Tax Reform

Last week, Politico Pro is reporting something we’ve been concerned about for a while:

PATH TO PASSAGE? SENATE FINANCE COULD USE SMALL BILLS TO APPROVE TAX REFORM: The universal truth of tax reform is that it is, and always will be, hard to pass. But the folks over at the Senate Finance Committee are considering various ways to more easily push tax reform legislation through Congress – including splitting a comprehensive reform bill into smaller measures. Our Kelsey Snell reported for Pros that “separating business tax reform from the more contentious individual tax code would allow [Senate Finance Committee Chairman Max] Baucus to continue debate on corporate taxes, the international tax code and the treatment of some benefits for small businesses – where there’s more agreement between the parties – without opening a battle over how much revenue should be raised through changes to the individual code.”

The news outlet subsequently filed a couple corrections that left the story’s ultimate meaning in doubt, but the notion that you can split tax reform into small bites is definitely out there. Comprehensive is just too hard, some say, so let’s do a corporate bill where there’s more agreement.

Our concern with this approach is two-fold: First, we reject the idea that you can separate out the corporate tax code without doing significant harm to the pass through business sector. Corporate-only proposals to date would either raise taxes significantly on pass through businesses or they would treat them like second class citizens, instead of the majority source of employment and business income in the United States (see story above).

Second, the “consensus” on corporate reform is less than it appears and it will depend on the same, top line question confronting comprehensive reform — should it be budget neutral or raise revenue? Until that question is answered (and you know where we stand on that), any reform effort is going to face an uphill climb.

We support corporate tax reform, but only as part of a broader effort to reform the entire tax code.

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