- January 2011
Lame Duck tax legislation:
NAW and the NAW-managed 1,000-member Tax Relief Coalition spent much of 2010 (and most of the preceding decade) advocating for permanent enactment of the tax rate reductions enacted in 2001 and 2003. While permanent extension proved unattainable, Congress did pass, and – more surprisingly – the President signed into law, compromise tax legislation that will hopefully remove much of the uncertainty that has impeded economic recovery. Specifically, the tax law included:
Income tax rate reductions: The new law extends for two years all of the tax rate reductions enacted in 2001 and 2003, including those for upper income earners, capital gains and dividends.
Death tax: The legislation prevented the return of the death tax this year at a confiscatory rate of 55% on estates above $1 million; instead providing for a top rate of 35% on estates in excess of $5 million per spouse.
Expensing: The bill included a business-friendly provision permitting 100% first-year expensing for 2011, retroactive to last September 8, with 50% expensing for 2012. This expensing provision was first proposed by the President last September (explaining the retroactivity to that date), but in his original proposal the President called for “pay-fors” – unspecified tax hikes on business to offset the cost of the expensing proposal. Not knowing what taxes would be raised in trade for the expensing allowance, the business community was not receptive to the President’s plan. In what was seen as another example of the Administration’s lack of understanding of how business and free markets work – and the absence of any real business leaders among the President’s economic advisors – the Administration expressed frustration and surprise at the lack of enthusiasm for his proposal in September. But the inclusion of the expensing provision in the December tax bill – without offsetting business tax hikes – was welcome news and should have a positive impact on investment activity.
Payroll tax cut: Effective in January, all wage earners will see an increase in their take-home pay resulting from a reduction in their payroll tax. Specifically, the FICA tax on employees (not on employers) will be reduced by 2% points, from 6.2% to 4.2%. Surprisingly, this payroll tax will apply to all wage earners with no income cap, and is not “refundable” (“refundable” income tax credits are in effect transfer payments made to individuals who do not pay income taxes). A worker earning $70,000 will get a tax cut of about $1400; those earning the full $106,800 subject to the FICA tax will see an increase in their take-home pay of about $2,000. It is hoped that this tax break will increase consumer spending and spur economic growth.
Tax extenders: The December legislation included the annual Congressional “tax extender” legislation, extending more than 50 provisions of tax law set to expire. Some of these are very familiar: the research and development tax credit, subsidies for producing alternative energy, and the annual “patch” to prevent the Alternative Minimum Tax from reaching millions of additional individual taxpayers. Other tax breaks in the bill are a bit more arcane: there’s a tax break for putting up windmills; rebates to Puerto Rico and the Virgin Islands from taxes on rum; a credit for railroad track maintenance; deductions for companies that donate food, books, or computers to specific recipients; a higher write-off for upgrading race tracks; even a tax break for movie and TV producers. And, of course, the package included the usual collection of huge tax breaks for banks and insurance companies and multinational companies that invest overseas.
With the passage of the tax bill in December finally taking off the table – for at least a year or two – the seemingly endless debate on what to do about the expiring Bush-era tax cuts, Congress could well turn its attention to other tax issues, including broad-based tax reform.
Lending strength to the possibility of major tax reform, the Obama-appointed National Commission on Fiscal Responsibility and Reform (Deficit Reduction Commission) submitted its report to the President in December, calling for a significant reduction in corporate and individual income tax rates coupled with reduction or elimination of the “tax expenditures” – preferences and deductions – that clutter and confuse the tax code. In addition, Senator Ron Wyden (D-OR) and just-retired Senator Judd Gregg (R-NH) introduced a similar tax reform bill in the last Congress, and it is expected that Senator Wyden will continue to pursue that agenda in the new Congress.
On the corporate side, advocates are certain to line up to defend specific tax credits and preferences – as they do annually to fight for the extension of even the most arcane elements of the tax extenders bill mentioned above.
On the individual side, obviously impacting S Corporations and other businesses which file income taxes as individuals, the Deficit Reduction Commission report is certain to be controversial, as they take on the “sacred cow” deductions of mortgage interest, employer-provided health insurance and charitable donations.
In principle, tax reform is a worthy goal. There have been a number of stories recently reporting that large American multi-national firms, particularly high-tech firms and pharmaceutical manufacturers, have been able to significantly reduce their U.S. taxes through use of preferences in the tax code, especially foreign tax provisions. According to an April, 2010 Forbes article on “What the Top 25 U.S. Companies Pay in Taxes” both GE and Bank of America paid no U.S. corporate income taxes in 2009, while many others paid far less than the statutory 35% rate (e.g., Ford, 2.3%; Hewlett Packard, 18.6%, Verizon, 10.5%).
Many argue that the use of foreign tax preferences is justified because the U.S. corporate income tax rate is the second highest among developed nations, putting our companies at a disadvantage against foreign competitors. While that may be true, the result of the extensive use of preferences by some large multi-nationals is that the U.S. companies which do pay taxes at or close to the statutory rate of 35% -- and that includes the vast majority of wholesaler-distributors – bear a disproportionate share of the tax burden. In effect, the companies which reduce or eliminate their U.S. tax obligations cost-shift their tax burden onto the rest of American business.
Meaningful corporate tax reform that significantly lowers the tax rate and removes most or all of the preferences from the code would remove the argument that preferences are necessary because our rate is too high, and at the same time level the playing field and ensure that all companies and industries are treated equally and fairly. NAW would enthusiastically support that reform.
But, as always, the devil is in the details.
For example, both the Wyden-Gregg proposal and the President’s Commission call for repeal of LIFO; full repeal in the case of the Commission recommendation and repeal for the oil industry in Senator Wyden’s bill. As we all know, LIFO is not a tax preference, it is a means of valuing inventory that achieves the same purpose as FIFO – most closely matching cost of good sold with cost of replacement inventory. We would aggressively oppose inclusion of LIFO as a tax preference to be repealed.
Also, there is increasing mention of the inclusion of a Value Added Tax (VAT) as part of reform; a tax that NAW and its coalition partners have consistently opposed.
Finally, tax reform should be advanced as a way to lower rates and broaden the tax base, not as means to increase federal revenue to feed government’s insatiable appetite. Previously enacted reform measures, the Reagan reforms of 1981 and the significant tax reform enacted in 1986, were designed to be “revenue neutral” – to raise the same amount of revenue but create a more even-handed and fair system.
President Obama’s Deficit Reduction Commission, on the other hand, proposed broad reform as a major tax increase, not as a means to achieve a fairer and simpler tax code. In fact, according to a public letter released in December by Americans for Tax Reform, the report “contains a ten-year net tax hike of over $1 trillion and increases tax revenues from their historical 18 percent of GDP to a record and permanent 21 percent.”
The very language of the report is troubling: referring to provisions of the code that reduce taxes as “tax expenditures” suggests that the revenue belongs to the government, and in effect treats tax revenues forgone the same as reductions in Federal spending. Whatever the merits of individual preferences and deductions, the money belongs first to the taxpayers, not to the government, and tax reform should not be pursued as a means to avoid cutting Federal spending.
We will be watching very carefully to see what path Congress takes on this issue.
As you know, LIFO repeal was included in the budgets the President submitted to Congress in both 2009 and 2010, and we expect him to recommend repeal again this year. NAW member companies and the members of our NAW-led LIFO Coalition partners have been aggressive and effective in making the case for LIFO to critical members of the House and Senate, and we believe are largely responsible for the fact that no action has been taken on legislation. Our success in preventing action on repeal is a text-book case of what business can achieve when it fully engages in the legislative process.
Despite the effectiveness of the businesses that worked to defend LIFO, we remain very concerned about possible repeal; that concern was intensified when the Deficit Reduction Commission included LIFO as a “tax preference” and recommended its repeal. In anticipation of the possibility that major tax reform might be considered in this Congress, the LIFO Coalition plans to resume our grass-roots effort, especially with almost 100 newly-elected members of the House and Senate who are unlikely to be very familiar with the issue. As a note aside, the election of Wisconsin Republican businessman Ron Johnson literally doubles the number of accountants serving in the U.S. Senate (the other is Senator Mike Enzi of Wyoming); ensuring that at least two senators will thoroughly understand the LIFO issue.
We also continue to monitor the activity at the Securities and Exchange Commission (SEC) as they move toward a decision on convergence of U.S.GAAP with the International Financial Reporting Standards (IFRS), although recent actions and statements suggest that the convergence to IFRS may no longer be the high priority it once was for the SEC or International Financial Standards Board. As the prospect of SEC action becomes less certain, pressure on Congress to act on repeal in anticipation of that action is alleviated.
Despite the mixed signals on convergence, Coalition leaders met in June with the Chief Accountant and several Deputy Accountants at the SEC to discuss possible regulatory actions to address the “conformity” requirement that would threaten LIFO if the SEC were to move to IFRS. We subsequently met with several staff members at the U.S. Treasury Department’s Office of Tax Policy, and finally with the Assistant Secretary of Treasury for tax policy. The need for immediate regulatory action to deal with the conformity issue was mitigated by signals that the move toward convergence has lost intensity, but we will continue to closely monitor the situation.