The President’s budget came out today, and despite the fact that it and the many proposals it contains are unlikely to move through Congress, there are a number of items of specific concern to S corporations that are worth a look. You can find the overall budget documents at the OMB website. For S corporations, the items that jump out at us include:
- Expiration of current rates for higher income taxpayers.
- Imposition of a new “Buffett Tax” on taxpayers earning more than $1 million.
- Principles for tax reform.
We’ll get to these items, but first, a note about baselines. One possible area of confusion moving forward is the unique baseline used by this Administration to measure how its policies might raise or lower the deficit. The Congressional Budget Office uses a current law baseline, so that any effort to extend all or part of the Bush tax cuts would be scored as raising the deficit, since the Federal government would be foregoing revenues it would otherwise collect under current law.
The Administration, however, uses what might be termed a “modified” current services baseline, so they score the expiration of the Bush tax relief for higher income tax payers as a tax increase, even though its already set in law. Because the Administration uses a different baseline, their deficit reduction claims will not match up with the numbers used by Congress. As an example, the Administration claimed that last year’s budget reduced the deficit by several trillion dollars, whereas the CBO determined that the Presidentb’s budget actually increased spending and the deficit over the ten year budget window. Expect the same dynamic this year.
On the Bush tax relief, the Administration remains consistent in its effort to cap the lower tax rates and other tax benefits to those taxpayers making $250,000 or less ($200,000 for single taxpayers). This means that owners of S corporations and other pass-through businesses who earn more than $250,000 will see tax rates rise on their business income. How much?
Current Law Top Rate: 35%
Sunset of Current Rate: 4.6%
Expiration of Pease: 1.2%
New Investment Surtax: 3.8%
Layered on top of this tax increase is the new proposal for a Buffett tax on taxpayers, including business owners, who make more than $1 million. Here’s what the budget says:
Observe the Buffett Rule. No household making over $1 million annually should pay a smaller share of its income in taxes than middle-class families pay. As Warren Buffett has pointed out, his effective tax rate is lower than his secretary’s. And, the President is now specifically proposing that in observance of the Buffett rule, those making over $1 million should pay no less than 30 percent of their income in taxes. The Administration will work to ensure that this rule is implemented in a way that is equitable, including not disadvantaging individuals who make large charitable contributions. And he is proposing that the Buffett rule should replace the Alternative Minimum Tax, which now burdens middle-class Americans rather than stopping the richest Americans from paying too little as was originally intended.
Beyond this description, details on the Administration’s Buffett Rule are wholly lacking, including any sense of how the Buffett Rule would replace the AMT. It may resemble the legislation introduced in the Senate recently, but we don’t know since neither an explanation of the Buffett Rule nor an idea of how it would replace the AMT are included in the explanatory Treasury “Green Book“ released along with the budget. For our purposes today, suffice it to say that the Buffett Rule tax will impose a new, higher layer of tax on taxpayers who make more $1 million a year, four out of five of whom own businesses.
On the tax reform front, the Administration reiterates the five principles it first outlined back in September:
- Simplify the Tax Code and Lower Tax Rates. The tax system should be simplified and work for all Americans with lower individual and corporate tax rates and fewer tax brackets.
- Reform Inefficient and Unfair Tax Breaks‘ Eliminating Them for Millionaires While Making All Tax Breaks at Least as Good a Deal for the Middle Class as for Wealthy Americans. Reform should cut and simplify tax breaks that are now inefficient, unfair, or both, so that wealthiest Americans cannot avoid their responsibilities by gaming the system, that middle class working Americans receive their fair share, and that Americans can spend less time and money each year filing taxes. That means eliminating tax subsidies for millionaires that they do not need; there is no reason that those making over $1 million should get any tax subsidies for housing, health care, retirement, and child care. And it means ensuring fair incentives for the middle class to buy a home or save for retirement, as opposed to allowing the most well-off to get two to three times as much.
- Decrease the Deficit While Protecting Progressivity. Reform should cut the deficit by $1.5 trillion over the next decade through tax reform, including the expiration of tax cuts for single taxpayers making over $200,000 and married couples making over $250,000. And it should do this while keeping the tax code at least as progressive as if the high-income 2001 and 2003 tax cuts were eliminated, as the President proposes.
- Increase Job Creation and Growth in the United States. The tax code should make America stronger at home and more competitive globally by increasing the incentive to work and invest in the United States. This includes fundamental corporate tax reform. That is why, in addition to these principles, the President is proposing a roadmap for corporate tax reform that will make America more competitive and create jobs here at home.
- Observe the Buffett Rule.
Several of these principles sound great, but the descriptions don’t seem to match up with the actual policies promoted by the President. For example, nearly every tax policy expert in Washington agrees with the general idea that we should broaden the income tax base by eliminating many deductions and exemptions and couple that with lower rates. Principle 1 enjoys broad support on both sides of the aisle.
But how does the Administration couple that principle with Number 3, which argues for raising tax rates on anybody making more than $250,000? Or Number 2, which argues for making existing deductions and exemptions more valuable for a majority of taxpayers? First they say let’s broaden the base and reduce rates, and then they say let’s raise rates and narrow the base. All in the same set of tax “principles.”
Regarding the “roadmap for corporate tax reform” there doesn’t appear to be any description included in today’s budget release. Word is, the roadmap will be coming out later this month, and that like the principles outlined above, it will move in a completely different direction than the prevailing tax reform discussion in town. A couple weeks ago, a Bloomberg article hinted at the underlying rationale for this divergence:
John Buckley, a professor at the Georgetown University Law School in Washington and a former chief tax counsel for Democrats on the Ways and Means Committee, said the goal of a tax overhaul is shifting. While Republicans have focused on lowering rates and broadening the tax base, Democrats are tapping into the tension over income inequality and the loss of manufacturing jobs, he said.
“The tax reform debate from the Democratic perspective will focus on equity and the attempt to restore manufacturing jobs,” Buckley said. “The visions are quite different.”
That the President has a different vision is obvious. Whether this vision can be called reform is less so.