- May 2013
Fiscal Cliff Tax Provisions:
The fiscal cliff compromise legislation enacted in early January was predominately a tax bill, raising hundreds of billions in new revenue and significantly altering the tax landscape going forward. While there was a lot to dislike about both the tax bill and the unseemly process that led to its passage, the legislation did contain some very good provisions. Most important, many of the tax changes in the bill were permanent changes, removing in those cases the uncertainty that taxpayers have faced during the 12-year drama of expiring tax rates.
Among the most significant provisions:
- Marginal income tax rates are permanently extended for taxpayers earning up to $400,000 for singles and $450,000 for married couples (unfortunately, the reduced rates for earners above those thresholds will return to the pre-2001 level of 39.6 percent);
- Capital gains and dividends tax rates are permanently extended at 15 percent up to the $400,000/$450,000 income levels and permanently set at 20 percent above those incomes (note that under the previous law dividends would be taxed at the taxpayers’ individual tax rates of up to 39.6 percent -- before the ObamaCare 3.8 percent Medicare surtax on investment income and .9 percent Medicare tax increase take effect);
- The Death Tax is permanently set at 40 percent of estates over $5 million per spouse, and current policy on portability and unification were made permanent;
- The phase-outs of the personal exemption and itemized deductions (PEP and Pease) were permanently repealed for earners under $250,000 (single) and $300,000 (married) (but these phase-outs are reinstated for upper income earners);
- The Alternative Minimum Tax (AMT) was permanently “patched” and indexed to inflation;
- The temporary payroll tax cut was allowed to expire;
- Bonus depreciation (50 percent) was extended for one year; and
- Section 179 small business expensing was extended at $500,000 through 2013 (after which the amount is scheduled to revert to the pre-2001 level of $25,000).
Literally dozens of additional tax code provisions were also extended for one or two years, including many business tax credits and deductions generally packaged together as an “extenders bill.”
With so much of the uncertainty removed from the tax code, attention has now turned on Capitol Hill to comprehensive tax reform.
Prospects for tax reform:
House Ways and Means Committee Chairman Dave Camp (R-MI) has long been a strong champion of comprehensive tax reform, and is joined in that commitment by Senate Finance Committee Chairman Max Baucus (D-MT) and Ranking Republican Orrin Hatch (R-UT). Ironically, both the temporary and permanent extensions in the tax bill enacted in January provide some incentives for enacting comprehensive tax reform in this Congress.
First, comprehensive tax reform would be expected to be permanent – not another 10-year hodge-podge of temporary and expiring tax law. And given our spiraling debt, a reform package would be expected to be either revenue-neutral or to raise more revenue. In that context, the importance of the permanence of the extensions enacted in January cannot be exaggerated: extending the individual income, capital gains and dividend tax rates “scores” as a revenue loss of $1,052.273 trillion (over ten years), and “patching” AMT and indexing it to inflation costs a staggering $1.815 trillion. Had those provisions been temporary rather than permanent, legislators crafting comprehensive reform would have had to find sufficient revenue to cover the permanent enactment of those provisions, before they even began considering other reforms of the code.
(There is of course a down-side to these tax provisions being permanently enacted without offsets in the fiscal cliff legislation: the Congressional Budget Office (CBO) reported that the legislation will increase the federal deficit by more than $3.5 trillion. There will have to be an accounting for that increased deficit as Congress tackles the next fiscal reform effort, but at least it can be considered in context of overall fiscal policy and spending, not automatically come from the tax/revenue side of the equation.)
Second, the fact that the new law extends only temporarily dozens of expired or expiring provisions means that all of those provisions are now set to expire yet again at the end of 2013 or 2014. The irrational moving target of temporary tax law creates taxpayer uncertainty and inspires creative tax avoidance – both of which can be eliminated by enactment of comprehensive tax reform.
Ways and Means Committee Chairman Camp earlier this year named members of his committee to serve on “Tax Reform Working Groups” covering about a dozen varying aspects of the coming tax reform debate, including small business, international tax law, manufacturing, and energy. The working groups are collecting comments provided by various constituent groups, but are not expected to announce any specific policy proposals.
Senate Finance Committee Chairman Max Baucus (D-MT), who meets weekly with Chairman Camp, is releasing “Senate Finance Committee Staff Tax Reform Options for Discussion” on various aspects of the coming tax reform debate.
While few are optimistic that tax reform will be enacted this year, both Committee Chairmen are committed to moving the process forward, and to pursuing reform in a transparent, open process in each house of Congress.
Components of the tax reform debate:
Taxing the rich: Despite the tax rate increases already enacted, the President continues to insist that additional tax revenue be raised by raising taxes on upper income earners – asking the rich to “do a little bit more” and to “pay their fair share.” President Obama’s claim that the rich do not pay their “fair share” is simply and unarguably false, as tax distribution tables clearly prove. According to IRS data analyzing the 2010 tax year, the top 1 percent of income earners paid 37.4 percent of income taxes; the top 5 percent paid 59.1 percent of taxes; the top 10 percent paid 70.6 percent of taxes, and the bottom 50 percent of earners paid only 2.4 percent.
More important in the context of tax reform, there simply is not enough revenue available from the top tax bracket payers to finance tax and fiscal reform, even if we were to enact completely confiscatory tax rates. As the CATO Institute’s Dan Mitchell wrote in a Wall Street Journal article in January, 2012:
“[T[here aren't enough wealthy people to finance big government. According to IRS data from before the recession, when we had the most rich people with the most income, there were about 321,000 households with income greater than $1 million, and they had aggregate taxable income of about $1 trillion. That's a lot of money, but it wouldn't balance the budget even if the government confiscated every penny—and if it did, how much income do you suppose would be available in year two.”
According to the Organisation for Economic Co-operation and Development (OECD), the United States already has the most progressive income tax system in the industrialized world. What the President proposes is not more “fairness” in our code, it is simply more income redistribution. As the President famously told Joe the Plumber, "when you spread the wealth around, it’s good for everybody."
Corporate vs. individual tax reform: While calling for tax increases on the individual side of the tax code – which would include damaging tax hikes on pass-through businesses – the President’s budget calls for revenue-neutral corporate-only tax reform. The tax-writing Committee chairmen are both calling for comprehensive tax reform that will reduce both individual and corporate income tax rates and eliminate deductions and “loopholes” from the tax code.
How this debate plays out is of immense importance to the business community because of the growing predominance of Subchapter S Corporations and other “pass-through” entities (partnerships, sole proprietorships, and limited liability corporations) in the economy today. Pass-through entities, of course, do not pay corporate income taxes, but pass their earnings through to their shareholders, owners, partners, etc., who then pay taxes on those earnings on their individual tax returns.
Pass-through entities are growing at a pace that far outstrips traditional C-corporations. According to the Tax Foundation, there are approximately 1.9 million C-corporations in the U.S. today, and about 30 million pass-through entities. Based on results of a survey conducted of our members, 62.4 percent of NAW member companies are pass-throughs; 37.6 percent are C-Corps. And according to a study completed just last year by Ernst and Young, in 2008 pass-through entities comprised nearly 95 percent of all businesses, and employed 54 percent of the private sector workforce.
If the corporate tax rate were to be reduced without a commensurate reduction in individual rates, the impact on the job-creating successful pass-through entities could be devastating. These businesses could lose the deductions and preferences that would be eliminated through corporate reform, without a compensating reduction in their marginal tax rates. In fact, in addition to the just-enacted increase in the top marginal rate to 39.6 percent, upper income earners will pay an additional .9 percent Medicare tax, PLUS a .3.8 percent Medicare payroll surcharge on their UNEARNED income – a top marginal tax rate of more than 42 percent.
Effective vs. Marginal tax rates: Related to the debate over individual vs corporate income tax rates is the issue of effective versus marginal income tax rates. This issue has increased in intensity in the last year or two as a result of news reports about multi-national corporations taking advantage of deferral of taxes on foreign income, foreign tax credits and the many complex provisions in the tax code that enable them to shift their money from country to country without incurring any US tax obligations. Many of these multi-national firms pay effective corporate income rates in the US of far below the marginal 35 percent rate – some actually getting U.S. tax refunds.
GE was the poster child for this story for many months, but recent stories detailing the tax-avoidance actions of companies like Google, Starbucks, Amazon and Apple have forced GE to share the stage. (To read a recent article describing Google’s tax avoidance actions, go to: http://www.naw.org/files/GoogleArticle.pdf)
The inescapable result of large, multi-national firms reducing or eliminating their U.S. corporate tax liability is a cost-shifting from the multi-nationals with low effective rates to the mostly-domestic companies with high effective rates. Most wholesaler-distributors are high effective rate payers – our survey data shows that NAW C-Corporations have an effective tax rate of 31.9 percent on average – and they and others are bearing an unfair and disproportionate share of the corporate income tax burden.
Tax reform advocates often call for reform that lowers rates, eliminates deductions and broadens the tax base to create a more fair system. For that goal to be achieved, however, it is effective and not marginal rates that have to be considered. In that context, the high-rate-paying C-corporations will have much more in common with high-rate-paying S-corporations than with the large corporations with very low effective rates.
NAW manages the Tax Relief Coalition, which has advocated for pro-business tax policy and lower tax rates since its creation in 2001. TRC today continues to advocate for sound tax policies, includes reform of both the corporate and individual tax code in its mission, and will be closely monitoring movement on the tax reform front this year.
LIFO: As you know, LIFO repeal has been included in each of the budgets the President has submitted to Congress, including his just-released Fiscal Year 2014 budget. In addition, the Deficit Reduction Commission recommended LIFO repeal in its December 2010 report to the President. Most recently, last summer the President and Congressional Democrats recommended that LIFO repeal be included in a debt limit extension package.
NAW member companies and the members of our NAW-led LIFO Coalition 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 repeal legislation. The 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. With increased discussion about major tax reform, the LIFO Coalition has resumed our grass-roots effort, especially with the key members of the tax-writing committees and the Congressional leadership. We are also, obviously, staying in close touch with those members outside the committees who have tax reform proposals of their own.
We have also closely monitored the activity at the Securities and Exchange Commission (SEC) as they considered convergence of U.S. GAAP with the International Financial Reporting Standards (IFRS). However, last summer a long-awaited SEC staff report on convergence made it clear that the Commission will not fully adopt IFRS, noting that there are accounting issues that cannot easily be reconciled, and specifically noting LIFO as a key example. Adoption of IFRS by the SEC was a serious threat to LIFO, since its use is not permitted under the international standards, and elimination of that threat is very good news as it removes one of the incentives for Congress to act on a legislative repeal (in order for Congress to spend the additional revenue that LIFO repeal would generate, there has to be a piece of legislation which the Joint Tax Committee can “score” to determine the amount of revenue it will produce; repeal by regulatory action of the SEC would not be “scored” and therefore the revenue would not be available for Congress to appropriate).