- January 2014
For the first time in several years, Congress is – and the taxpayers are – beginning a year without facing the expiration of the many temporary so-called Bush-era tax provisions enacted in 2001 and 2003. A year ago, Congress finally enacted permanent law to deal with those long-expiring provisions. The good news is that Congress removed the uncertainty that has been the mainstay of our tax policy for more than a decade; the bad news is the permanent solution included a $600 billion tax hike.
The Fiscal Cliff tax changes enacted last January have now been in effect for a year, but the filing of 2013 taxes will certainly remind a lot of upper bracket individual and pass-through taxpayers about the Fiscal Cliff provisions. Top marginal tax rates increased to pre-2001 levels, capital gains and dividend tax rates went up, personal exemptions and itemized deductions were phased out…then add in the Obamacare 3.8 percent tax on investment income and .9 percent Medicare surcharge on upper income earners.
A few tax provisions important to business, particularly bonus depreciation and Section 179 small business expensing, were extended for a year in the fiscal cliff bill, but not made permanent. These two provisions are among the 55-or-so expiring tax provisions that Congress allowed to lapse when it adjourned last December. It is unclear whether Congress can or will retroactively extend some or all of those tax provisions.
With the final permanent disposition of the 2001 and 2003 tax provisions, attention in Congress turned 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 was joined in that commitment by Senate Finance Committee Chairman Max Baucus (D-MT) and Ranking Republican Orrin Hatch (R-UT). Both Chairmen have an added incentive for pushing for tax reform now: neither will remain chair of his respective committee after this year.
Congressman Camp is term-limited and cannot remain Ways and Means Chairman in 2015 without a waiver of the term limit requirement. Since there are already several Ways and Means Committee Republicans who have expressed interest in succeeding him as Chairman such a waiver is highly unlikely.
The situation in the Senate is even more unsettled. Very few other Senate Democrats supported the Baucus push for tax reform, and the senator was referred to as “a caucus of one” in his tax reform mission. But Senator Baucus has effectively taken himself out of the picture completely. He had already announced that he would retire at the end of this year, making himself a lame duck chairman, but then the President announced that he would nominate the senator to be U.S. Ambassador to China. The nomination has effectively removed Senator Baucus as a player in the tax reform debate.
The most likely successor to Baucus, Oregon Democrat Ron Wyden, has pushed his own tax reform legislation in the past, so could well be a more effective advocate for Senate action on reform than was Senator Baucus. However, it could take at least a couple of months for the Senate Foreign Relations Committee to confirm the Baucus nomination, and Senator Wyden (or a different successor Chairman if Democrat Leader Harry Reid (D-NV) unexpectedly chooses not to give Wyden the gavel) simply may not enough time in the Chair to move a bill this year.
In addition, the push for tax reform in the House met some resistance toward the end of last year. In the early fall, Ways and Means Committee chairman Camp initiated a series of meetings with Republican members of his committee to talk about the specifics of tax reform. These were closed-door meetings, with even the staff of the Republican committee members excluded, and the Chairman asked his colleagues not to discuss with others the specifics of what they were considering.
The Chairman’s discipline was remarkably successful, with very little substantive information about the discussions reaching the business community. However, the tax reform process became much less transparent as a result of the closed-door meetings, resulting in a significant concern in the business community that decisions on tax reform that would directly impact their business or that of their member companies were being made behind closed doors rather than through a process that permitted comment and debate.
Late in the fall the Chairman met with and briefed the House GOP leadership on his tax reform package, but most GOP House members remained in the dark about the bill. Given the certainty that there will be political resistance to most substantive tax changes – every tax deduction and credit has a constituency that will fight its repeal – briefing the other members of the GOP conference became the next step in the reform process, and that briefing process is expected to continue into this year.
Whatever the eventual outcome, NAW is very closely watching this process with our partners in the LIFO Coalition and the Coalition for Fair Effective Tax Rates.
Possible components of the tax reform debate:
Taxing the rich: Despite the tax rate increases already enacted, the President and some Democrat leaders continue to call for tax increases on upper income earners. However, 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 10 percent paid 70.6 percent of taxes, and the bottom 50 percent of earners paid only 2.4 percent. The tax hikes enacted in the Fiscal Cliff bill a year ago will almost certainly increase the percentage of taxes paid by upper income earners, and Congressional Republicans have vowed to oppose any additional tax hikes.
Corporate vs. individual tax reform: There is a strong push for a reduction in the U.S. corporate income tax rate, since ours is the highest among developed countries. However, corporate-only tax reform would leave pass-through businesses out of the reform equation, since pass-throughs (Subchapter S corps, partnerships, sole proprietorships and limited liability corporations) 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. Tax reform that reduces the corporate income tax rate while repealing business deductions and credits could well impose massive tax increases on Subchapter S corporations and other pass-through entities.
There are now about 30 million pass-through entities in the U.S., and only about 1.7 million C corporations (Tax Foundation data). 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 recent study 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.
Given those statistics, it is clear that corporate-only tax reform would meet very strong opposition. In addition, Chairman Camp has been a strong and vocal champion for comprehensive reform.
Effective vs. Marginal tax rates: Related to the debate over individual versus corporate income tax rates is the issue of effective versus marginal 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 U.S. tax obligations. Many of these multi-national firms pay effective corporate income rates in the U.S. far below the marginal 35 percent rate – some actually getting U.S. tax refunds.
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, not just statutory 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 helped form and helps manage the Coalition for Fair Effective Tax rates, which is and will remain actively involved in the tax reform debate, urging that reform be seen through the lens of effective, not just statutory, tax rates.
NAW also 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 was included in each of the budgets the President has submitted to Congress, in the recommendations of the President’s Deficit Reduction Commission in its December 2010 report to the President, and in a Democrat debt limit extension proposal last year.
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 to date. 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 consistently work to defend LIFO, a draft tax reform outline released last fall by Senate Finance Chairman Baucus included LIFO repeal, and we are reliably informed that LIFO repeal will be included in a Ways and Means tax reform outline if one is proposed. As a result, the LIFO Coalition has stepped up 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 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, in July, 2012, 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.)