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Debt Limit Deal
The BIG news over Memorial Day was the debt limit deal reached by President Joe Biden and Speaker Kevin McCarthy. While the package is an obvious compromise, the result is a big positive signal for the long-term budget picture that should not be overlooked. It’s also a signal that, with tensions high and a hostile press, the government can still operate as it is supposed to.
The deal centers on a suspension of the debt ceiling through calendar year 2024. We did a deep dive last week on what a default would look like, but the takeaway was that those are uncharted waters no one wants to explore. Hence the urgency on both sides to get something done.
In exchange for extending the limit, Republicans received a number of spending cuts and other reforms, including caps on nondefense discretionary spending, rescissions of unspent Covid relief funds, and a $1 billion reduction in IRS funding. (Both sides agreed in principle to repurpose another $20 billion in IRS funding over the next two fiscal years, but the CBO did not include this deal in its scoring.) The legislation also ends the pause on student loan payments starting August 1, implements new work requirements for welfare recipients, and reforms the permitting process for certain energy projects.
The CBO estimates total savings at around $1.5 trillion over the next decade. That’s far less than Republicans’ original proposal, which cut nearly $5 trillion, but notable given that Democrats were calling for a “clean” debt limit bill until just a few weeks back.
Prospects
Will the package pass both the House and the Senate? Sure appears like it. While members of the conservative House Freedom Caucus have spoken out against the plan, as have some progressive Democrats, it appears there are sufficient numbers of members in the middle to produce a majority in the House.
On the Senate side, the bill’s prospects are also somewhat murky, with opposition on both sides and the chance certain members seek to extend consideration through procedural roadblocks and multiple amendments. But the deal is backed by Leaders Schumer and McConnell and it’s hard to see a scenario where the two can’t cobble together at least 60 votes, so overall the prospects look good.
Timing
In terms of timing, the House Rules Committee adopted the package last evening and the House is set to take up the bill later today. If it succeeds, the Senate would begin consideration either later tonight or early tomorrow and start the process of closing out debate through at least one or, more likely, a series of cloture motions beginning tomorrow or Friday.
Several Senators have made clear they intend to run the clock on the process in order to get votes on their favored amendments and/or voice their opposition, but those efforts often fizzle once the Senate demonstrates it has 60-plus votes necessary to move forward.
So expect the House to complete its work tonight and the Senate to work into the weekend, with final passage coming sometime Saturday or Sunday. Or just prior to the current June 5th “drop dead date” announced by Treasury Secretary Yellen.
Take-Aways
Assuming it all works out, what should the S-Corp community take away from this process?
- Size: The budget savings may be smaller than what some wanted, and tiny compared to the long-term problem, but they should not be discounted. As the saying goes, even the longest journey starts with a first step. This a good first step.
- IRS Funding: If IRS funding is indeed reduced by $20 billion, that’s both significant and, well, maybe not that important. On the surface, a $20 billion reduction of the total $80 billion provided in the Inflation Reduction Act is a 25-percent cut — nothing to sneeze at. As others have noted, however, the IRS’s early spending and hiring plans already are limited by a shortage of qualified workers and other obstacles, so we are unlikely to see much difference over the next couple years either way.
- Focus on Spending: One reason these savings are a “good first step” is they move in the right direction by focusing on the real problem – spending. Federal spending has grown dramatically in recent years, easily outpacing revenues and resulting in trillion-plus deficits “as far as the eye can see.”
- Spending Caps: Most of the budget savings comes from new caps on discretionary spending, which have a mixed history of success. Critics argue that Congress has a bad habit of repealing the caps every time they start to bite. There is some truth to this, but it’s also true that spending caps are better than nothing, which is what we have right now.
For Main Street businesses who already pay combined federal and state rates of around 50 percent, the prospect of future tax hikes is daunting. This package may not be as big as some wished, but it moves federal budgeting in the right direction. It’s a welcome development which should be applauded by the business community.
Talking Taxes in a Truck Episode 27: “We’re Not Sure, But It’s Probably Not Good”
For today’s Debt Ceiling-themed episode, we’re joined by repeat guest Joe Lieber, Director of Research at Washington Analysis, an institutional research firm that closely tracks the goings-on in Congress. Joe offers his thoughts on the debt limit negotiations and the odds of a deal being reached, the surprising dynamics within the House Republican caucus, and which provisions are likely to emerge from a potential deal. Later he breaks down how Wall Street and Main Street are reacting to the impasse, what a default on US debt would look like, and the broader implications of growing debt and deficits to S corporations and other taxpayers.
This episode of the Talking Taxes in a Truck podcast was recorded on May 24, 2023, and runs 35 minutes long.
Main Street Tax Certainty Act
Good news for Main Street! Long time S-Corp champion Senator Steve Daines from Montana plans to introduce his “Main Street Tax Certainty Act” later today. Cosponsored by more than a dozen of his colleagues, the bill would prevent rate hikes on America’s individually and family-owned businesses by making permanent the Section 199A 20-percent deduction. This deduction was created by the Tax Cuts and Jobs Act but is scheduled to sunset at the end of 2025.
The introduction of this legislation was widely anticipated in the business community, with more than 140 trade associations representing millions of Main Street businesses, including NFIB, the National Restaurant Association, and the American Farm Bureau Federation, adding their names to a strong letter of support. As the letter states:
Individually- and family-owned businesses organized as pass-throughs are the backbone of the American economy. They employ the majority of private-sector workers and represent 95 percent of all businesses. They also make up the economic and social foundation for countless communities nationwide. Without these businesses and the jobs they provide, many communities would face a more uncertain future of lower growth, fewer jobs, and more boarded-up buildings.
Despite this, Section 199A is scheduled to sunset at the end of 2025, even as the businesses it supports continue to recover from the COVID-19 pandemic and the price hikes, labor shortages, and supply chain disruptions that followed.
199A permanence is necessary to balance out the tax treatment of pass-through businesses with the lower, 21-percent tax rate paid by C corporations. As our work with EY comparing effective rates demonstrates, absent the 199A deduction, pass-through businesses would be subject to tax rates nearly one-third higher than comparative C corporations.
Making 199A permanent has implications for jobs and growth too.. At a time when businesses of all sizes are confronting rising prices and interest rates, supply chain disruptions, and a possible recession later this year, ensuring that these businesses are not going to see higher rates in the future will help them plan for growth with more certainty. As the letter notes:
Making the Section 199A deduction permanent will help Main Street during this very difficult time, leading to higher economic growth and more employment. Separate studies by economists Barro and Furman, the American Action Forum, and DeBacker and Kasher found that making the pass-through deduction permanent would result in significantly improved parity and lower rates for Main Street businesses.
So congratulations to Senator Daines and his cosponsors on the bill’s pending introduction. This legislation is necessary for Main Street businesses and the communities they serve, and we look forward to working with him and our other allies in Congress to see it enacted.
A Post-Disinflationary World
Today’s meeting between Congressional leaders and the President is the first of many to come in what might be termed the post-disinflationary world.
Interest rates peaked at 16 percent in the early 1980s and, following the Volker rate hikes and a nasty recession, the US embarked on an unprecedented 40-year disinflationary period where rates went from record highs to record lows.
Well, that’s over. Rising prices and record deficits are back and, absent a change of course, they are not going to get better. Hence the importance of today’s meeting.
Debt and Interest Rates
The debt situation is not good. Debt held by the public is right at 100 percent of our GDP and scheduled to grow sharply in the coming decade, up to 118 percent by 2033, which is right about the time the Social Security trust fund runs out of money. Meanwhile, the cost of interest on that debt is growing even faster, as rising interest rates compound the effect of rising debt levels.
The debt limit standoff is not helping. Last week’s Treasury auction of 30-day notes that mature after the current debt limit deadline demanded a record rate of 5.84 percent. It’s difficult to conceive of rates that high on short-duration bonds given that just a few years ago, 30-year mortgage rates were less than 3 percent.
We also need a new way to describe the inverted yield curve. The nearly 200-basis-point differential in yields is unlike anything we’ve seen in the past.
Can Congress use the next decade to constructively address our fiscal imbalance and the pending bankruptcy of Social Security?
Deficit Politics
What’s interesting politically is that when interest rates were high and monetary policy was tight, the deficit had some political punch. Voters – not all but some – voted based on the fear that unchecked deficits threaten our future. They could see how federal deficits impacted them directly through higher borrowing costs and taxes.
That potency went away with the financial crisis, as the monetary and fiscal response to the collapse of the mortgage markets was so massive it rewrote the books on what was possible. And it stayed away as we spent the next ten years not raising rates, not reducing the Fed’s balance sheet, and not cutting deficits, all without any apparent repercussions. The more the budget scolds warned about deficits and rising prices, the lower prices went. It is hard to be Chicken Little when the sky’s not falling.
But now the sky is falling. We have ten years to get our budget house in order. Expect to see deficits and rates take center stage again. From our perspective, today’s meeting is the first to test the resolve not of those who want to address the challenge, but those who deny there’s anything to worry about. Whatever cautionary tale is the opposite of Chicken Little, that’s where we are at.
Debt Limit
Where do things stand? House Republicans defied expectations two weeks ago and successfully adopted a package to 1) raise the debt limit sufficiently to keep things running for another year, and 2) reduce the deficit by nearly one-half trillion dollars though a package of spending caps, recissions of unspent COVID funds, and repeal of the electric vehicle tax credits from the Inflation Reduction Act. (There’s been lots written about just how expensive those credits will be – here, here, and here – way more than Congress originally estimated.)
The Administration, on the other hand, has repeatedly called for adopting a clean debt ceiling increase, arguing that the country’s finances should not be held hostage to a procedural vote. As White House Press Secretary Karine Jean-Pierre put it:
Business leaders and economists have warned that the threat of a default risks the livelihoods of American small businesses, retirees, and working families and would hand a massive win to China — and recent events underscore the need for Congress to address the debt limit as soon as possible. It’s time for Republicans to stop playing games, pass a clean debt ceiling bill, and quit threatening our economic recovery. The President welcomes a separate conversation about our nation’s fiscal future.
If we are right that deficit politics have regained their potency, then the fact that the House successfully passed a credible deficit reduction package increases the odds the ultimate package will include deficit reduction provisions. Survey results from the Winston Group back this up:
“Similar to what we saw in March, 48% of voters believe the President should negotiate with Congressional leaders while only 14% support the President in refusing to negotiate and insisting on a “clean increase” without conditions.”
The ball now is in the Senate’s court and all eyes are looking to the White House to see what President Biden will support.
Implications for S Corporations
For the business community, the challenge is clear. We have a ten-year window to address this and the earlier Congress acts, the less pressure there will be to raise taxes. In an environment where tax policy is driven by a misguided desire to target large employers and family businesses, there’s never been a more important time to get our fiscal house in order. A clean debt limit might make Wall Street feel better, but it only makes our ten-year challenge worse.
Talking Taxes in a Truck Episode 26: “Testifying Ain’t Easy”
Fresh off of her triumphant visit to Capitol Hill we’re joined by Lynn Mucenski-Keck, an S-CORP Advisor and Principal at top-25 public accounting firm Withum. Lynn recaps her appearance before the House Small Business Committee, including the specific tax provisions discussed, her back and forth with some of the panel’s members, and her thoughts on the whole experience. Later we discuss IRS funding, advice for aspiring CPAs, and how Artificial Intelligence might shape the accounting profession in the years to come.
This episode of the Talking Taxes in a Truck podcast was recorded on April 21, 2023, and runs 27 minutes long.