Congress returned this week with most people focused on the Super Committee and its prospects for producing a deficit reduction plan by the end of the year.
To recap, the Budget Control Act created a Super Committee of twelve members charged with coming up with at least $1.2 trillion in deficit reduction by the end of the year. How they devise these savings is up to them, but if they fail, we will see $1.2 trillion in automatic spending cuts equally divided between defense and domestic spending starting in 2013 and spread out over nine years.
For tax wonks, the big question is whether the Super Committee will include tax policy in its report. The three options seem to be to include 1) comprehensive tax reform, 2) more narrow provisions like repatriation and expensing (likely offset with corresponding tax hikes), or 3) nothing at all.
On the tax reform front, Democratic think tank Third Way recently called on Congress to pursue corporate only reform (see below), as does an expected White Paper from the Obama Treasury Department.
Beyond that, there appears to be little energy or interest in the Super Committee for reforming the tax code. Super Committee member and Ways and Means Chairman Dave Camp told constituents last week he opposes including broad-based tax reform in the Super Committee product. While he is open to including some sort of mandate for reform as part of the package, that’s consistent with his view that Congress should tackle comprehensive reform in 2012.
For Option 2, it’s easy to see a smaller package of revenue-neutral tax provisions included in the Super Committee plan. There are a whole slew of tax items that expire at the end of the year, including the President’s payroll tax reduction.
On the other hand, Camp and others have made the case that any tax provisions included this December will reduce their options for crafting tax reform next year by consuming tax expenditures that could be used to help reduce the corporation and individual rates.
Moreover, taxes and entitlements are joined at the hip on this one. The House won’t accept tax hikes in the package, and Democrats in both bodies are unwilling to consider entitlement reform without them, so anything that even looks like a tax increase is going to face an uphill road to adoption.
All these reasons cause us to expect Option 3 — nothing at all. The prospect of “saving” everything for tax reform combined with the inherent difficulty of permanently raising taxes on some taxpayers in order to pay for temporary tax relief for others should provide enough of a hurdle to block tax provisions from the Super Committee’s work product.
The wild card in this prediction is the economy. If the markets and the broader economy continue the path they’ve taken in the last six weeks, pressure will grow on Congress to “do something.” That something could be the President’s jobs package to be outlined tomorrow, or it could be something else, but whatever it is, the vehicle is likely to be the Super Committee process already put into place, with its expedited procedures and limited membership.
More on Corporate Tax Reform
As we mentioned above, the Democratic think tank, Third Way, released a policy memo last week calling for reforming the corporate tax code.
Entitled “The Case for Corporate Tax Reform,” the memo makes a strong case for overhauling the tax rules governing C corporations. Here’s the summary:
High rates, low revenues, cash kept overseas, and thousands of pages of complexities – nothing about our corporate tax system seems to be working. Our corporate tax code is a relic, last substantially reformed in 1986, before the Internet, before the Euro, and before capitalist China. Many of America’s competitor nations have revamped their codes, but not the United States. Reform of our corporate code has been restrained in part by concerns that lowering rates would benefit only multinational corporations while doing little to create decent jobs or raise revenues. However, it is increasingly clear that modernizing our corporate code is a competitive necessity. Done right, corporate tax reform can help businesses create jobs and wealth here, and generate revenues to address the deficit and fund national priorities. In this paper, we lay out the seven reasons why America should embrace corporate tax reform that lowers rates, changes our taxation of international profits, and reduces complexity in the tax code.
We agree. The tax code should be revamped to address these issues — but not at the expense of firms that pay their taxes at individual tax rates rather than the corporate tax rate.
While the authors of the Third Way memo avoid direct attacks on the pass-through sector, they lay out a program — budget neutral corporate-only reform — that almost guarantees tax hikes on pass-throughs.
Once again, if you’re going to reform the tax code, you need to address both the individual and the corporate sides at the same time. Otherwise, pass-through employers will be hurt — right alongside the 70 million workers they employ.
Jobs Package
President Obama plans to roll out a new jobs proposal at a Joint Session of Congress tomorrow. While the exact contents the package has been the subject of speculation for the past week, the details are beginning to come together, including:
- A total size of $300 billion;
- $170 billion from the extension of the payroll tax holiday;
- $30 billion for a new tax credit for hiring unemployed workers;
- Full expensing for purchases of new equipment;
- Financial assistance to states and local governments;
- Spending on public works projects and infrastructure; and
- Provisions to enable “underwater” homeowners to refinance more easily.
This list is probably pretty close to what the President will announce tomorrow, but whatever the details, the package itself faces a difficult future, particularly in the House. The deficit impact of the package is problematic, as is the short-term nature of most of the provisions.
To address the deficit impact issue, the President is preparing a separate “deficit reduction” package that he will make public in coming days. The goal of this package is to address long-term deficits as well as to address the short term impact of the proposals listed above. As Bloomberg reports:
Obama will call on Congress to offset the cost of the short-term jobs measures by raising tax revenue in later years. This would be part of a long-term deficit reduction package, including spending and entitlement cuts as well as revenue increases, that he will present next week to the congressional panel charged with finding ways to reduce the nation’s debt.
This process of “spend now, save later” is also likely to attract criticism from the Hill. It’s really a no-win situation, where the lack of economic growth and huge projected federal deficits are pulling the Administration in two different policy directions at the same time. Critics on the Hill are likely to argue that the federal government’s fiscal policy needs to focus on just one — the deficit — rather than try to address both.
Moreover, most of the policies listed above have been tried in one form or another previously, by this Administration or others. The payroll tax holiday, for example, is already in law. So while there’s nothing wrong with reducing the payroll tax on employment, there’s also little evidence it’s helped in a meaningful way.
For our membership, policy stability appears to be a priority. Temporary reductions in payroll taxes are fine, but addressing the threat of higher rates and the loss of expiring provisions is more critical. Beyond that, we’re hearing a lot of “Ricardian Equivalence” noise, with our members observing that the massive deficits the government is running will have to be paid by somebody, and they’re hunkering down in expectation of the bill.
Reasonable Comp Revisited
Earlier this month, the American Institute of CPAs put out a really nice summary of the reasonable compensation issue as it affects S corporations. Written by Tony Nitti, the piece runs through the history of the issue, the more significant court cases, and the IRS guidance to date. It also closes with this note:
S corporation reasonable compensation is a hot issue. The 2005 TIGTA report recommended imposing self-employment tax on the undistributed income of all shareholders owning more than 50% of an S corporation’s stock. Similarly, the GAO report posed several alternatives for S corporation reform, including imposing self-employment tax on the undistributed income of all shareholders. Most recently, in 2010 the House of Representatives passed proposed legislation that would have subjected all undistributed income of professional service S corporations to self-employment tax.35 The measure died in the Senate, but if a similar law were to be passed, the inherent employment tax advantage these corporations have long enjoyed would disappear.
It is likely that the limitation on the amount of Social Security wages subject to payroll tax will continue to increase, with some suggesting that Congress might remove it entirely. If this were to occur, the likelihood of abuse would only increase. Suffice it to say that Watson will not be the last we hear regarding S corporation reasonable compensation.
Something to keep an eye on as Congress debates deficit reduction and the future of business taxation.