updated February 2010
Legislative Issue Update - January 2010
Congress closed out 2009 with a barely-noticeable whimper on the tax front. The House passed a tax bill in mid-December that extended about $31 billion in expiring tax provisions and provided the annual Alternative Minimum Tax (AMT) “patch” to prevent the tax reaching deeper into the middle class in 2009. Most of the provisions in the bill were applicable to individual taxpayers, but the bill did include an extension of the popular Research and Development (R&D) tax credit, the extension of which has become a ritual at the end of each Congress.
However, the Senate adjourned on Christmas Eve without acting on the House bill or passing its own extenders legislation, leaving the fate of those provisions to the new session of Congress. The Congress could take up the tax extender legislation relatively early in the new session and, as they have done before, pass the extenders retroactively to the 2009 tax year. While the uncertainty of that extension makes business planning difficult, the very great likelihood is that the legislation will be enacted in sufficient time for the filing of tax returns.
The one issue on which the failure of Congress to act could have serious consequences is the “death tax.” As we have reported before, gradual repeal of the Federal estate tax, 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 could last for only one year – 2010 – after which the tax is set to recur at the pre-2001 level of 55 percent on all estates over one million dollars. We have been reporting this for eight years, and for eight years repeal advocates in Congress have been unable to garner sufficient votes to either permanently repeal or permanently reduce this hated tax.
We assumed from the beginning of last year that Congress would not permanently repeal the death tax – the position long advocated by NAW and several business and tax coalitions – but that some action would be taken to prevent full repeal from taking effect this year. At minimum we expected at least a temporary extension of the 2009 law – a 45 percent tax on estates over $3.5 million. Permanent enactment of the death tax at 2009 rates was also considered a possibility, while some key members of both houses of Congress advocated enactment of a 35 percent tax rate on estates over $5 million. Our crystal balls told us that opponents of death tax repeal would NEVER allow full repeal to take effect in 2010, since it would then be politically very difficult to reinstate the tax in 2011.
But as Congress adjourned sine die in December, that is exactly what happened. The Senate earlier in the year passed an amendment to the Budget resolution calling for a permanent death tax at a 35 percent rate on estates over $5 million per spouse. However, the budget resolution is not signed into law by the President so the vote, while important, was symbolic. The House passed legislation in December calling for permanent enactment of the 2009 tax levels; Republicans believed the provisions were insufficient to adequately protect small business from the tax so opposed the legislation.
The Senate spent December deeply immersed in health care debate, so did not consider the House bill; even had they done so, it was not expected to get the 60 votes necessary to overcome objections from senators who prefer a lower rate and larger exemption.
To prevent full repeal taking effect January 1st of this year, House and Senate leaders worked to find a compromise – likely a short extension of 2009 law – that could quickly pass both houses of Congress, but were unsuccessful in that effort. Finally, Senate Finance Chairman Max Baucus (D-MT) asked for unanimous consent to pass a two-month extension of existing law to give the tax-writers a little time in 2010 to take action without repeal taking effect, but Republicans objected, and both houses of Congress adjourned. As of January 1st this year, there is no Federal death tax for 2010.
Leaders in both houses of Congress have pledged to act quickly in 2010 to reinstate a Federal estate tax, and some have said they plan to make it retroactive. However, serious questions have been raised about the viability or constitutionality of retroactively imposing a tax triggered by a death; many doubt the tax could realistically be assessed against an estate which had already settled.
Whether or not they can impose a death tax retroactively, Congress is certain to attempt to act quickly on this issue. It is almost certain that any measure considered by the Senate will require 60 votes to succeed (unless they once again put death tax legislation into a reconciliation bill, requiring only 51 votes, but setting in motion again the prospect of the death tax law not being permanent); the need to act quickly and garner 60 votes may provide the proponents of the 35 percent/$5 million exemption their best chance ever of success since they appear able to block passage of other proposals.
Tax agenda in 2010:
There has long been a philosophical debate in Washington between those who believe that reducing taxes – particularly on businesses and investors – stimulates economic growth and job creation, and those who make the classic “class warfare” argument that higher taxes should be imposed on upper income earners to create a more “fair” economic outcome.
That debate was part of last year’s health care deliberations: the House included a significant surtax on upper income earners to finance their health care reform bill; the Senate rejected that tax and replaced it with their preferred tax on high-value health insurance plans. The difference between these two tax approaches remains a point of contention in negotiations over a final health care reform bill.
While Congress didn’t act on major tax legislation last year, it is likely they will do so in this session. Proponents of tax hikes will argue that they are needed to address the mounting Federal deficits and debt; opponents will make the case for tax cuts to stimulate economic growth and job creation.
While there has been general debate in recent years over the need for broad tax reform, the debate this year will be driven by current law: at the end of this year the tax cuts enacted in 2001 and 2003 expire, resulting in significant increases in marginal income tax rates, and in taxes on capital gains and dividends. These tax hikes will take place automatically if Congress does nothing.
Tax increases in the President’s Budget:
The President set in motion the tax debate – and the class warfare debate – in the Budget he submitted to Congress the first week of February. As expected, his budget calls for the expiration of the reduced tax rates on upper income earners, and on the many thousands of affected small businesses which file as individuals. Moreover, his budget calls for additional individual tax increases which, if enacted, would create top marginal tax rates higher than pre-2001 levels. The tax hikes on individual taxpayers and small businesses are estimated at $970 billion, as itemized below with 10-year revenue estimates:
- The 33% and 36% individual tax rates will increase to 36% and 39.6% ($364 billion);
- Itemized deductions will be capped at 28% even while top tax rates increase to 36% and 39.6% ($291.2 billion);
- Itemized deductions and personal exemptions will be phased out ($208.5 billion); and
- The tax rate on capital gains and dividends will rise to 20% ($105.4 billion
On top of that, the President has proposed almost half a trillion dollars in additional direct business tax hikes. Included in those business tax increases is full repeal of the last in-first out (LIFO) inventory valuation method; an issue of critical importance to many wholesaler-distributors and a tax increase that NAW and the NAW-led LIFO Coalition have successfully fought since 2006.
It’s important to note that Congress does NOT vote on the President’s budget – they introduce and act on their own Congressional Budget Resolution in the spring – but the President’s budget does outline his spending and tax priorities for the year and Congress reviews and responds to the President’s proposals. And it is not certain that Congress will agree to the President’s tax hike proposals. Fortunately for the business community, there is already bi-partisan opposition in the House of Representatives to repeal of the 2001 and 2003 tax cuts.
However, an organized effort from the employer community will be essential if we are to successfully defend against these crippling tax increase proposals. This battle will be a top priority for NAW in 2010, working with the two tax coalitions which we manage; the LIFO Coalition and the 1,000-member Tax Relief Coalition.
The impact of the President’s proposed tax increases on small business:
While the President defends his tax hikes on individuals as effecting only wealthy Americans, those increases will have a direct and damaging impact on small businesses. According to data from the Congressional Joint Tax Committee, more than half of the revenue from the tax increase on wealthy Americans—55 percent – will be paid by small business owners. And according to data from the National Federation of Independent Business and the Small Business Administration, half of the small businesses with 20-239 employees pay income taxes at the top two bracket rates; and these are the small businesses which create the vast majority – as high as 85 percent – of the new jobs each year.
While business would face almost a trillion and a half dollars in tax increases in the President’s budget, they will get very little in the way of tax reductions. The budget proposes to temporarily extend increased small business expensing and depreciation, but those provisions actually produce an increase of $20.9 billion in tax revenue over ten years. The only significant business tax reduction is the permanent enactment of the R & D tax credit, an $82 billion tax reduction that will do little for the small businesses that will bear the harshest burden of the hundreds of billions of dollars in tax increases.
As Senate Finance Committee Ranking Member Charles Grassley (R-IA) put it: “The proposed budget’s $300 billion in tax relief over the next 10 years for individuals, families, and businesses is mostly targeted and limited, often to people who don’t have to pay any taxes. The tax increases in the budget dwarf the tax relief.”
Federal tax distribution tables:
President Obama and some Congressional leaders have argued that increasing the tax rates on upper income taxpayers will make the tax code more fair – that the wealthy have benefitted inappropriately from previous tax cuts and should pay their “fair share.” That argument is not just wrong, it is deceitful. The so-called rich already pay significantly more than their “fair share.” The most recent IRS data on the percentage of Federal income taxes paid by taxpayers at each income level proves the point:
- The top 1 percent of taxpayers pay 40.42 percent of income taxes
- The top 5 percent pay 60.63 percent
- The top 10 percent pay 71.22 percent
- The top 25 percent pay 86.59 percent
- The top half pay a full 97.11 percent of federal income taxes
Looked at the other way, the bottom half of income earners pay only 2.89 percent of federal income taxes. Even more significant, according to the IRS, 47 percent of all wage earners pay NO federal income taxes. Not only does this place an unfair burden on the other 53% of wage earners, it also creates a significant block of voters who have no reason to oppose income tax increases since they would not be affected by them.
LIFO (last-in, first-out) Repeal: [updated January 2010]
(see end of report for detailed summary of past LIFO activity):
After three years with little legislative activity, LIFO repeal moved back to the front burner a year ago when President Obama included repeal in the budget he submitted to Congress. His repeal proposal was “scored” as a $61 billion revenue increase. The proposal was later re-scored by the Joint Tax Committee with a price tag $18 billion higher, for a revenue increase of $79 billion.
Fortunately, the budget that was subsequently adopted by Congress did not include LIFO repeal, and no repeal legislation was introduced in 2009.
However, repeal of LIFO was included by the Finance Committee in its initial health care reform proposal as a possible source of new tax revenue to pay for their reform. Finance Chairman Max Baucus (D-MT) and Ranking Member Chuck Grassley (R-IA) both indicated that they were not advocating LIFO repeal; they just included all of President Obama’s proposed tax hikes in their “options” document as part of a shopping list of revenue raisers to finance health care reform.
The LIFO Coalition initiated an aggressive lobbying effort to make the Committee members aware of the value of LIFO to companies that use it, to make sure they understood why LIFO is an appropriate and accurate measure of the value of inventory and taxable income, and to urge them to oppose repeal. Many of these lobbying meetings were held with Members of the Committee and/or their staffs in their state and district offices, rather than in Washington, where the constituent business voices can be most effective.
The members of the NAW-led LIFO Coalition not only succeeded in keeping LIFO out of health debate, but made significant progress in convincing critically important Committee members that repeal was poor tax policy and should not be included in any subsequent tax legislation. Just as important, the aggressive lobbying campaign became a stark reminder to the business community that they absolutely must participate in the political process to protect their interests, and that when they do so, those efforts can succeed.
That participation by business will be necessary this year as well, as President Obama has again included full repeal of LIFO in the tax increases proposed in his Fiscal Year 2011 budget.
LIFO Background Summary:
LIFO repeal was first considered in the Senate in 2006 when then-Majority Leader Bill Frist (R-TN) proposed repeal 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. Although the Senate Finance Committee held hearings on the issue in 2006, no action was taken on the legislation. However, the threat to LIFO was raised again in 2007 when House Ways and Means Committee Chairman Charlie Rangel (D-NY) included full repeal as one of the “offsets” – tax increases – in his “mother-of-all-tax-reform” legislation. Again, no legislative action was taken on the proposal.
LIFO has also been threatened from the regulatory front. In 2008 the Securities and Exchange Commission (SEC) published proposed regulations (their “roadmap”) to require all U.S. publicly-traded companies to file their financial statements using the International Financial Reporting Standards (IFRS) by 2014, and the international standards do not permit the use of LIFO. The Financial Accounting Standards Board (FASB) would likely follow the SEC’s lead and apply the same rules to privately-held companies. Because of the Federal “conformity” statute requiring companies to use LIFO for both “book and tax” if they use it at all, eliminating LIFO as an acceptable accounting standard de facto repeals its use for tax purposes as well.
In 2008 a small group of leaders of the LIFO Coalition met with officials at the SEC, with the Assistant Secretary of the Treasury for Tax Policy, and finally with then-Treasury Secretary Henry Paulson, asking the Treasury Department to use its statutory authority to create an exception to the “book-tax” conformity requirement and permit companies to continue to use LIFO for tax purposes even if it is removed as an acceptable accounting standard. While we were cautiously optimistic that Treasury would at least consider acting, the collapse of the mortgage and financial markets that September put all other issues on a back burner with the Administration so no action was taken.
While the Wall Street collapse eliminated our chances of getting the LIFO issue remedied by regulation, the collapse also seems to have stalled the SEC’s efforts to move U.S. companies onto IFRS. The international standards are “principles-based” rather than “rules-based” like the U.S. standards (Generally Accepted Accounting Principles – GAAP), and are therefore seen as much less strict and transparent than GAAP. Given the collapse of the U.S. financial markets and the billions of dollars of taxpayers’ money being spent to bail out failed companies, serious doubts are being expressed about the wisdom of moving to the more opaque and looser international financial accounting standards. In addition, the International Financial Standards Board (IFSB) capitulated to political pressure in 2008 to make changes to some of the IFRS rules, raising further doubts in the U.S. about the wisdom of moving U.S. multinational companies onto the international standards.
The belief that US adoption of IFRS was inevitable was a strong catalyst in the legislative move to repeal LIFO. If LIFO use was to be eliminated, Congress wanted the repeal to be legislative so that they could “score” the new tax revenue and have it available to them to spend. Elimination of the use of LIFO through the SEC’s regulatory action would not be “scored” by the Joint Tax Committee so Congress would be denied access to that new tax revenue for other purposes. The growing doubts about the certainty – even the likelihood – that the SEC will adopt IFRS and abolish the use of LIFO has removed the pressure on Congress to act on LIFO quickly. And that has, in turn, given us the opportunity to continue to make the case for the appropriateness of the use of LIFO and in opposition to its repeal – an opportunity that NAW and the LIFO Coalition are aggressively pursuing.