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Taxes

Legislative Issue Update - October 2007

Updated June 2007

The Republican Congress enacted significant tax cuts during President Bush’s first term; tax cuts which played a great part in ending the last recession and promoting strong economic growth and job creation. Most of these tax cuts were enacted as Congressional “Reconciliation” bills under which process no permanent law can be enacted; all Reconciliation tax cuts were set to expire within a few years. In each subsequent Congress, the expiring tax cuts have been “extended” so that now all the critical pro-business tax cuts – reduced marginal tax rates, reduced rates on capital gains and dividends, death tax repeal, and increased small business expensing among them – are scheduled to expire in or before 2010.

Prior to the last election, incoming House Ways and Means Committee Chairman Charlie Rangel (D-NY) said that none of the President’s tax cuts had merit and that all of them were “on the chopping block” (as reported by Congressional Quarterly). Changing his tune after the election, Rangel and other Congressional leaders have said that they do not intend to attempt to repeal the Bush tax cuts, or at least not all of them.

Congressman Rangel has now made overtures to business groups in Washington to discuss tax policy to see if common ground can be found. However, he has also suggested that he would like to raise additional revenue without raising tax rates, which could be accomplished by lowering the income thresholds that trigger the upper income tax brackets, thus subjecting more taxpayers with lower incomes to the highest income tax rates, and obviously impacting the thousands of small businesses which file as individuals.

The tax issues will be front and center in the 110th Congress.

Status of the 2001 and 2003 Tax Cuts [updated June 2007]:

Congressional Budget writers claim that they do not plan to allow the tax cuts enacted in 2001 and 2003 to expire in 2010, and that their Budget does not include tax increases. House and Senate rules and the Budget Resolution they just adopted make that claim disingenuous at best.

Congressional Budget Resolutions must include 5-year “revenue estimates” – estimates of the amount of tax revenue they expect the government to collect in each of those five years. Therefore, if Congress assumed that the 2001 and 2003 tax cuts would be extended, their revenue estimates would reflect that extension. It does not. The Congressional Budget assumes an increase of tax receipts in 2011 of $750 billion. That revenue increase can only be generated by the repeal of the reduced tax rates enacted in 2001 and 2003.

Also, both Houses of Congress adopted new rules this year called “pay-go” which will require that any tax cuts enacted by Congress be offset – or “paid for” by increases in other taxes to generate the same amount of revenue. Under pay-go rules, should Congress decide to extend the expiring tax provisions in 2010, the resulting loss of tax revenue would have to be offset, and about $750 billion in OTHER taxes would have to be raised.

To put this into numbers, under the Congressional Budget, this is what would happen in 2011 if the expiring tax provisions are not extended in 2010:

  • the 35% tax rate would increase to 39.6%;
  • the 15, 25, 28 and 33% rates would increase to 28, 31, and 36%;
  • the 10% rate would increase to 15%;
  • the top tax rate on dividends would climb from 15% to 39.6%;
  • the capital gains tax rate would increase from 15% to 20%;
  • the “death tax” rate would revert to 55% (from zero in 2010).

Democratic Congressional leaders say they would not insist that these specific tax cuts be allowed to expire. But if these tax cuts are extended, the pay-go rules would require that $750 billion in other new taxes be raised. Denying that this Budget proposes a tax increase – the largest in American history! – simply does not pass the “straight face” test. Anticipate major battles ahead as these issues take legislative form.

LIFO (last-in, first-out) Repeal [updated April 2007]:

LIFO repeal was introduced in the Senate last May by then-Majority Leader Bill Frist (R-TN). His proposal called for repeal of LIFO to raise new tax revenue to offset, or “pay for,” a one-time tax rebate of $100 to some taxpayers in response to the very high gas prices at the time.

LIFO repeal would change a 70-year old accounting procedure used extensively by wholesaler-distributors; approximately $80 billion in wholesale distribution inventory is currently classified under LIFO. The repeal measure was introduced to finance what most believe was a meaningless $100 gesture, and without any consultation with affected industries. Business response was swift and angry, and within four days the proposal was withdrawn.

Concerned that the issue was not permanently off the table, the D.C. business community organized an on-going campaign against repeal, forming a new, NAW-led coalition to coordinate the efforts. The growing LIFO Coalition now has more than 120 public members, consisting of trade associations, business organizations and issue advocacy groups. A significant number of consultants, attorneys and corporations also participate in the coalition effort.

The Senate Finance Committee held a hearing on corporate tax policy last June, at which one of their witnesses, University of Connecticut Professor George Plesko, testified on LIFO and other matters. Although the professor claimed not to advocate LIFO repeal, his Committee testimony indicated otherwise. The LIFO Coalition submitted a rebuttal to the Plesko testimony which included an authoritative defense of LIFO prepared by Les Schneider, a renowned expert on the issue. Professor Plesko subsequently co-authored a lengthy article for “Tax Notes” calling LIFO a “tax holiday” and openly calling for repeal.

While it appears that coalition members have been successful in our efforts to get LIFO repeal off the table for the near-term, the Finance Committee actions, followed by the defeat of a number of pro-business Republican Members of Congress in last fall’s election, affirmed the decision of the LIFO Coalition to continue organizing for a long-term battle.

This is of course a critical issue to the wholesale distribution industry, since so many distributors warehouse inventories and use LIFO accounting; it is therefore an issue on which NAW expects to continue to invest a significant amount of time and effort.

Alternative Minimum Tax (AMT) [updated June 2007]:

This ill-conceived and poorly-written tax was imposed more than 35 years ago to ensure that very wealthy individuals could not shield all of their income from income taxes. By failing to “index” for inflation the income levels that trigger the tax, however, Congress set in motion a nightmare tax that now ensnares millions of middle-class Americans into a perverse parallel tax structure. Unfortunately, Congress has become accustomed to the vast amounts of Federal tax revenue that the AMT raises, so while they provide one year “patches” every year to prevent the tax from reaching even deeper in the middle class, talk of permanent and full repeal has remained just that – talk.

This year, however, the new Democratic majorities in Congress have made repeal or serious reform of the AMT one of their top priorities. House Ways and Means Committee Chairman Charlie Rangel (D-NY) is working with Committee Democrats on AMT legislation which he says will protect the approximately 23 million middle-class taxpayers who will be subject to AMT if the law is not changed, reduce taxes for additional millions of taxpayers, and comply with “pay-go” rules. We do not yet know the revenue implications of his proposal, but serious reform of AMT would cause a huge revenue loss to the Federal treasury which pay-go would require be offset, so huge tax increases will be a necessary component of any Rangel bill.

Among the proposals reported to be under consideration by the Ways and Means Democrats are:

  • Increased tax rates on capital gains and dividends;
  • Return to higher 2001 tax rates for upper three tax brackets; and
  • A 4.7% income tax surcharge on all incomes over $500,000.

House Ways and Means Committee Republicans, who are not invited to participate in the Rangel discussions, are opposed to reforming AMT by imposing massive tax increases on American individuals and businesses.

The opposition to tax increases to offset AMT is forcefully advocated by Senate Finance Committee Ranking Member Charles Grassley (R-IA), who with Committee Chairman Max Baucus (D-MT) has introduced legislation to completely repeal AMT. While Senator Baucus says he would look for offsets for repeal, Senator Grassley has repeatedly and emphatically insisted that no taxes should be increased to “pay for” repeal of AMT.

He argues that AMT was never intended to affect the millions of middle class taxpayers who might soon feel its bite – a proposition with which no one disagrees – and that therefore Congress should not assume it can continue to receive and spend the revenue generated by the tax. Moreover, he argues that because the tax was never meant to be collected, pay-go rules should not apply to AMT reform/repeal and that taxes should not be increased to keep the government “whole” at the taxpayers’ expense.

The Tax Relief Coalition, for which NAW serves as Executive Secretariat, sent a letter to the Senate (and will send a similar letter soon to the House) supporting Senator Grassley’s position and calling for AMT legislation without offsets.

AMT legislation could be considered by the House Ways and Means Committee as early as July.

Death Tax:

Gradual repeal of the Estate (or “Death”) tax was included in the tax relief bill enacted in 2001, but under the arcane filibuster-proof reconciliation rules of the Congress, the repeal will last for only one year – 2010 – after which the tax recurs at the original 55% tax rate. Because all tax provisions enacted in Reconciliation bills expire within ten years, permanent repeal of the death tax will have to be considered outside of Reconciliation and therefore supporters will have to garner the 60 votes in the Senate necessary to overcome a filibuster.

The House of Representatives has passed death tax repeal legislation repeatedly since the 2001 bill, and last year the Senate finally brought the issue to the floor for a vote. Unfortunately, a Democrat-led filibuster succeeded, and repeal advocates fell three votes short of the 60 necessary for repeal.

Following Senate defeat of the repeal legislation, Republican Leaders and Committee Chairman crafted a compromise proposal that would eliminate all death taxes for estates of $5 million or less ($10 million per couple), impose a tax equal to the capital gains tax rate (now 15%) on estates between $5 million and $25 million, and a rate twice the capital gains tax rate on estates above $25 million.

Hoping to make the bill more appealing to moderate Democrats, Republican leaders added a minimum wage increase, provisions to extend other expiring tax credits, and several provisions relating to mining and timber issues.

This new tax effort was crafted and moved largely by then-House Ways and Means Committee Chairman Bill Thomas (R-CA), and despite vigorous Democrat opposition, passed the House by a wide margin, sending it to the Senate for further action.

Despite a concerted effort by Republican Leaders in the Senate and death tax coalitions, a procedural Motion to Proceed to the new bill was filibustered by Senate Democrats, and again fell only three votes short of the 60 necessary for success.

Given the strong and consistent Democrat opposition to eliminating the death tax, there is virtually no chance that full repeal will be enacted in this new Congress. However, public support for repeal remains strong, as does the widespread belief that this is a grossly unfair and unjust tax. Some moderate Democrats have suggested that a compromise well short of full repeal might be considered in order to finally and permanently resolve the issue; however, to date the alternatives that they have floated have included an oppressively high rate of taxation and an unacceptably low exempt estate amount.

Closing the “tax gap”:

The Federal Treasury has calculated that an estimated $350 billion a year in taxes are owed but not paid. These uncollected-but-owed taxes are referred to as the “tax gap” and result from both unintentional oversights or errors and direct evasion of tax liabilities. Incoming Senate Finance Chairman Max Baucus (D-MT) has pledged to close that gap, so Finance Committee hearings are certain to take place and voters and taxpayers are likely to hear a lot from Congress this year on the issue.

No one opposes tax compliance; taxpayers should pay what they legally owe, and those law-abiding taxpayers who do so are penalized by having to make up the loss from those who either intentionally or unintentionally underpay or evade payment. But how Congress attempts to close the tax gap bears close watching, especially for small business.

It is presumed that much of the tax gap is a result of “cash transactions” which are unreported and therefore untaxed. These cash transactions are by definition very difficult to trace or identify, and therefore collecting taxes on them poses a possibly insurmountable challenge for the government. Small business advocacy groups worry that government efforts to enforce greater compliance with tax laws will fail to produce much of the missing revenue but will impose significant costs and burdens on tax-compliant small businesses through increased reporting, filing and record-keeping requirements. According to the Office of Advocacy in the Small Business Administration, cost of tax compliance is already significantly higher for small businesses than for their larger counterparts, so the concern is likely warranted.

In addition to increasing IRS oversight, investigations and enforcement (and risking taxpayer revolt against overly-intrusive and aggressive collection efforts), Congress may also look to seemingly good-government collection measures which could have unintended negative consequences. One clear example of this already exists: last year Congress included a provision in a tax bill which will require all Federal agencies to withhold 3% of the payment to all contractors who supply goods and services to the government. The rationale behind the measure was the assumption that many contractors fail to pay the taxes they owe on government payments and that the withholding will force payment. The reality, and the unintended consequence, is that for many government contractors, the amount of payment that the government would be withholding would equal or exceed their profit on the sale or service, thus requiring additional paperwork and burden on the contractor to recover the balance owed by the government. This provision is not scheduled to take effect until 2011 and legislation has already been introduced to repeal it, but it is not clear whether that repeal bill will succeed.

There is also now talk in Congress about repealing or scaling back deductions from income, almost certain to be opposed particularly by the housing industry and those who supply it, and of repealing “corporate tax breaks,” to attempt to address the tax gap.

This is obviously an issue about which little is known or settled, and one which NAW will be following very closely.