The Senate Finance Working Groups reports are done and publicly available! Many congrats to the Committee members and their staff for continuing the progress on tax reform. You can check out the reports here. The Business Income Tax report drafted by Sens. John Thune (R-SD) and Ben Cardin (D-MD) is the one of most interest to us. We have to admit, the first few pages were bit a disappointing, as the introduction could lend the impression that pass through taxation (multiple business entities) is somehow a bad thing.
Our tax system also promotes inefficiency by incentivizing businesses to make decisions based on tax considerations, rather than for business reasons. This has manifested itself in the area of business entity choice. Consider that over the past few decades, since enactment of the Tax Reform Act of 1986, there has been movement en masse away from C-corporation status to status as an LLC, S corporation, partnership, or other pass-through business.
With the experience of our members behind us, we actually see that businesses don’t change their behavior to choose an entity type; they choose an entity type so they don’t have to change their behavior. S corporations would stop paying dividends if they were forced into the double corporate tax. C corporations would scramble for funding if they lost the ability to access public markets. Partnerships would rewrite their ownership agreements if they lost the ability to formalize complex ownership relationships. Having multiple structures in which to organize your business is a positive aspect of the tax code.
The report then embraces number of principles for tax reform. We were disappointed to see that the number one principle wasn’t lower tax rates for all employers, but focused specifically on lowering the corporate tax rate.
Simply put, the U.S. corporate tax rate needs to be competitive with the nations with whom we compete in the global economy. The OECD median statutory corporate tax rate is 25 percent, a reduction of 5 percentage points since 2004.
The term “corporate tax rate” is mentioned more than a dozen times in the principles. The higher tax rates many pass through business pay are not mentioned at all. There is one reference to pass through businesses in the principles section – highlighted as a ‘distortion’, but only to suggest “that pass-through businesses are not harmed by efforts to lower the corporate tax rate.” That’s a pretty low bar. Simply not harming pass-through businesses should not be confused with actually improving the tax code to make those businesses more competitive.
Other parts of the report reference the need for pass through businesses to “benefit” from tax reform, which is clearly helpful, as is the accurate reflection of our basic challenge:
To summarize, pass-through businesses fear that they could find themselves with the worst of both worlds: no rate reduction combined with higher effective tax rates from base-broadening efforts. This is a valid concern and one that any business tax reform effort needs to consider with the utmost seriousness.
The Working Group summed up their debate over pass-through businesses in this way:
“Members of the Business Income Tax Working Group were not able to resolve the treatment of pass-through businesses in business tax reform, one of the most vexing challenges in business tax reform, given the constraints the group faced. However, members of the group believe that any tax reform effort must fully take into account the concerns and opinions of America’s pass-through businesses. Business Income Tax Working Group members strongly urge the chairman and ranking member to examine the options above, in addition to any other approaches the committee may consider, to ensure that pass-through businesses are treated equitably, should the Finance Committee decide to move forward on business tax reform.”
The “constraint” faced by the working group is the Obama Administration’s total opposition to reducing tax rates for individuals. The “options above” referred to the list of alternatives considered by the working group in lieu of individual rate cuts, including the Grant-Thornton business equivalency rate idea. We examined this proposal at length previously and, of all the alternatives to individual rate cuts, to us it appears the closest to embracing the pass through principles endorsed by more than 100 trade groups earlier this year.
So, all in all, a mixed bag. The working group makes clear the challenge pass through taxation poses to the goal of overall tax reform, but they failed to recognize that pass through taxation is also the key to the solution. Taxing business income once, when it is earned, and at a reasonable rate is the way we should tax all business income. The sooner we embrace that model, the sooner we can achieve the more competitive business tax structure policymakers are seeking.
Highway Funding & International Tax Reform
The outlook for highways and international tax reform is coming into focus. Senate Majority Leader Mitch McConnell announced that the Senate will take up a short-term highway bill as soon as next week, but downplayed pairing the extension with more aggressive international tax reforms and completely ruled out raising gas taxes.
Let me just say we’re not going to raise the gas tax. We’re not going to raise the gas tax,” McConnell said. “The environment committee has come out with a six-year bill … but there is considerable skepticism that you could pay for a bill of a six-year duration.
McConnell (R-Ky.) also said he was “skeptical” about the prospect of using a bipartisan plan from Sens. Chuck Schumer (D-N.Y.) and Rob Portman (R-Ohio) to overhaul some corporate taxes as a way to pay for crumbling highways, bridges and public transportation and said it would be too difficult to take on something so ambitious with just three weeks before the deadline.
So short term highway extension this month, but no international reforms. What about the longer term outlook?
On that front, there is a concerted effort to pair highways and international reforms, and that the new international report from Senators Portman (R-OH) and Schumer (D-NY) clearly outlines what they have in mind. As the Examiner reported this week:
Ryan, the chairman of the powerful tax-writing House Ways and Means Committee, said at a breakfast event hosted by Politico in Washington that he was optimistic about a deal to reform international taxation that would include a one-time surge of revenues from deferred taxes of multinationals’ earnings.
Such a deal isn’t possible in the next two weeks before the highway trust fund is expected to be exhausted, the Wisconsin Republican said, and Congress will have to pass a short-term funding patch through the end of the year.
But the agreement on taxing overseas earnings announced Wednesday by Sens. Rob Portman, R-Ohio, and Chuck Schumer, D-N.Y., “gives me a bit of hope” that a six-year infrastructure funding deal can be reached, he explained.
The report itself calls for moving to a territorial tax system, creating a patent or innovation box to incent the development and retention of domestic intellectual property, and taxing existing balances of overseas corporate income to pay for both the international reforms and offset the cost of highway funding. That latter bit has been endorsed by a number of Democrats and Republicans, including Portman and Ryan, while others have expressed strong opposition to using “deemed” repatriation for anything other than tax reform.
The key remaining question is how long the extension considered this month will be – just through the end of the year or through the 2016 elections? Late today, reports surfaced that Rep. Ryan was working on an $8 billion extension that would last through the end of the year. This runs counter to what Senate leaders have supported—an 18-month extension that would push international tax reform into 2017. When discussing the extension in The Hill, Ryan responded to that difference:
“Mitch and I have the same long term goals, we want comprehensive tax reform and we want a long term highway bill,” he said. “They have their body to deal with, we have ours to deal with. We…think we should do a long term highway bill and we think tax reform is the best way.”
Ryan did specify how he plans to pay for his proposed temporary highway funding extension, saying only “I think we’ll be able to put together a package that kind of innocuous, boring stuff that shouldn’t be a surprise to people.
“We’ll post it when we have it ready,” he said.
If this passes, that would mean fewer revenue offsets this month, with an enhanced possibility for the prospect of international tax reforms to gain traction before December. Of course, we’ll be watching the short-term patch closely, particularly to see what Rep. Ryan comes up with to find the needed $8 billion.
Extenders are back under discussion, thankfully. Rumor is that the Senate Finance Committee will take up a 2-year extender package in the next couple weeks, while Chairman Ryan said Thursday that he’s looking for Ways & Means to move extenders in September.
This accelerated time table is good news—at least when compared to last year’s delay in an agreement until the very end of December. Another positive is the emphasis on making at least some of these provisions permanent. There is no reason the R&E tax credit, higher 179 expensing limits, and shorter built-in gains recognition period expire every few months. That said, there is opposition to the House has made to enact these very extensions permanently. According to Politico:
Democrats are opposed to efforts to make extenders permanent, arguing that the revenue losses must be offset. Republicans are quick to note that quirks of legislative scoring allow the cuts to be temporarily renewed — often cumulatively surpassing the 10-year “permanent” scoring window — without counting as a revenue loss.
Bottom line is that we expect to see action on extenders, at least at the committee level, soon. Our hope is that this new activity results in a package adopted by Congress well before the end of the year. Fingers crossed.