The budget introduced in the House today calls for a couple broad items on the tax front. First, it calls for extending all the tax provisions set to expire January 1st. That’s the rate cliff we’ve been warning S corporations about for the past couple months. Marty Feldstein made the case clearly this week in the Financial Times as to why Congress needs to act:
But the most important cloud on the horizon is the large tax increase that will occur next year unless legislation is passed to block it. The Congressional Budget Office predicts that, under current law, the revenue of the federal government will rise from $2.4tn in the current fiscal year, which ends in September, to $2.9tn in the following fiscal year. That increase of $512bn is equivalent to 2.9 per cent of GDP, bringing federal revenue as a share of GDP from 15.8 per cent this year to 18.7 per cent next year.
The higher revenue would reflect an increase in personal tax rates, higher payroll taxes, as well as higher taxes on dividends, capital gains and corporate incomes. Revenue would continue to rise in future years - as a share of GDP it would increase to 19.8 per cent in 2014 and would stay above 20 per cent for the remainder of the decade.
A sustained tax increase of that magnitude would push the US into a new and deep recession next year. So, it is important to recognize that legislation is required to prevent such a tax rise.
Second, the budget calls for comprehensive, budget-neutral reform of the tax code, with a goal of getting the top rates on both corporate and individual income down to 25 percent, fully offset by eliminating tax expenditures to broaden the base. Here again, the budget anticipates the concerns the business community has raised regarding tax reform. Recall our three key principles for doing tax reform right, endorsed by 45 business groups in D.C.:
- Make it comprehensive;
- Keep the top corporate and individual rates the same; and
- Continue to reduce the double tax on corporate income.
Where the Obama corporate-only reform plan failed each of these three principles, the reform outline included in the Ryan budget embraces each of them — its comprehensive, the top rates are the same, and it reduces the burden of the double corporate tax. Here are the major reform points from the budget:
- Consolidate the current six individual income tax brackets into just two brackets of 10 and 25 percent.
- Reduce the corporate rate to 25 percent.
- Repeal the Alternative Minimum Tax.
- Broaden the tax base to maintain revenue growth at a level consistent with current tax policy and at a share of the economy consistent with historical norms of 18 to 19 percent in the following decades.
Rates are the same, its comprehensive, and lowering the corporate rate helps to reduce the double tax on corporate income. Check, check, and check. Now this is what we were talking about.
S-CORP’s Crystal Ball
It’s tough to predict, particularly about the future.But web�ll try.
With the introduction of the House Republican budget today, the budget process in Congress appears to be done. Members of Congress and the media will fight over the details of the Ryan budget for the next couple days, and the House will have to vote on it next week, but those are mere trees. The forest is simpler. The President produced a budget. House Republicans produced a budget. The Senate will produce nothing.
That means no overriding statement of congressional priorities on spending and revenue. It also means no reconciliation instructions in the Senate, which means it would take 60 votes to move the tax legislation described above through that body, rather than 50 plus the Vice President if they were moving the bill as a reconciliation bill created by the budget resolution. Those ten votes make a big difference in the odds something could pass, and they pretty much doom the Senate to inactivity on tax issues until after the elections. They may have the votes for a small business extender bill — we hope so — but probably little else.
Lame duck session and another debt limit fight, here we come.
That’s the consensus in D.C. — lots of debate on tax issues but nothing actually happens until after the elections. After the elections, motivated by the pending expiration of all the current tax policies and the need to raise the debt limit again, Congress acts either in the six weeks between the elections and Christmas or, even more frightening, waits until early in 2013.
In the meantime, the business community looks to be stuck without the R&E tax credit, bonus depreciation, shorter built-in gains holding periods, and other small-business-friendly provisions that expired at the end of last year. Business owners will also have to plan for paying taxes in 2013 without knowing what those rates will be. Neither situation is healthy, and it’s bound to have an effect on hiring and investment decisions moving forward.
We hope we’re wrong, and that the House and the Senate take up legislation to address the business-friendly extenders and the expiration of all the tax rates soon. The sooner they begin discussing these challenges, the sooner they can come to a solution.
Buffett Rule Tax Score
The Joint Committee on Taxation released its revenue estimate for legislation implementing a version of the so-called Buffett Tax. This estimate is in anticipation of the Senate voting on this idea in the near future.
The bill, S. 2059, was introduced by Senator Sheldon Whitehouse (D-RI) earlier this year and would impose a new tax equal to 30 percent of a taxpayer’s AGI less a modified charitable deduction for taxpayers with incomes exceeding $1 million. The impact of the tax is phased in for taxpayers making between one and two million to avoid a massive rate cliff when somebody’s earnings rise one dollar from $999,999 to $1 million.
Even so, as S-CORP Advisor Tom Nichols pointed out in testimony before the Ways and Means Committee several weeks ago, taxpayers would still face marginal rates well in excess of 30 percent as their business incomes rose from $1 million to $2 million.
The score itself, $47 billion over ten years, is extraordinarily small for such a broad-reaching policy. There are a couple reasons for this. First, the most obvious reason is that most people making more than $1 million a year are already expected to pay a substantial amount of tax, particularly if marginal tax rates go up as scheduled under current law. (That tax burden doesn’t include their share of corporate taxes paid, either.)
The second reason is that the Alternative Minimum Tax (AMT) is already in place as a second tax code. It looks back at the tax burden of families and makes those whose tax burden is too low pay more. Sound familiar? We already have a Buffett Rule tax, and it’s broken – it reaches down and raises the tax burden not just on millionaires, but on families making $75,000 or less. Since the Whitehouse bill thresholds are not indexed, over time this migration into the middle class would happen with his bill, too.
The Obama Administration hinted in their budget documents and subsequent testimony that they would like to use the Buffett Rule tax to replace the current AMT. Their actual budget, however, includes neither the Buffett Tax nor a repeal of the AMT. This is a policy the President talks about nearly every day, yet somehow it didn’t make it into his budget proposal. The reason for this is simple math. There’s no way the revenues raised by the Buffett Rule could ever replace the revenues gathered by the AMT over the next ten years. As the Obama budget estimates, merely holding the AMT to its current size and reach reduces revenues by $1.9 trillion over the decade!
So what we have is the worst of all worlds – the Senate is considering layering on a third tax income tax (fourth really, if you include payroll taxes) onto the two we already have. All this despite the fact that the United States already has one of the most progressive tax codes in the world. It’s the movie “Animal House” all over again.