- April 2014
For the first time in several years, Congress – and the taxpayers – began 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 in January, 2013, have now been in effect for a year, but the filing of 2013 taxes this month no doubt reminded 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. While both the Senate Finance Committee and the House Ways and Means Committee are currently debating these tax extenders, the two committees are moving in different directions.
The Senate Finance Committee is moving forward with a bill that would again temporarily extend the expiring provisions. The House Ways and Means Committee is moving a series of individual bills that would make permanent, rather than again temporarily extend, many of the expired provisions; other items in the extenders package they would effectively repeal. It is unclear how – or whether – the two committees will resolve their differences and deal with the expiring provisions.
With the final permanent disposition in January, 2013, of the 2001 and 2003 tax provisions, attention in Congress turned to comprehensive tax reform.
Comprehensive 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). With the nomination of Max Baucus as U.S. Ambassador to China, Ron Wyden (D-OR) has assumed the chairmanship of the Senate Finance Committee, and he has introduced his own tax reform legislation in recent Congresses.
Congressman Camp is term-limited and could not have remained Ways and Means Chairman in 2015 without a waiver of the term limit requirement. In any event, Mr. Camp recently announced that he will retire from Congress at the end of this year, clearing the path for either Congressman Paul Ryan (R-WI) or Kevin Brady (R-TX) to assume the chair next January.
Presumably because of the limited time remaining to him as Chairman, Congressman Camp has aggressively pushed his tax reform agenda in this Congress.
Throughout 2013, the Chairman conducted public hearings on tax reform, appointed task forces in his committee to review the issues in the debate, invited and reviewed comments and input from taxpayer stakeholders, etc.
Then, last fall, after a year of transparent public dialogue, Chairman Camp initiated a series of closed-door, totally off-the-record meetings with Republican members of his committee. Even the staff of the Republican committee members was excluded. And the Chairman asked his colleagues to keep completely confidential the specifics of what they were considering.
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 the House GOP leadership, making it clear to them that he was determined to produce a detailed legislative tax reform proposal, despite the Leaders’ reported lack of enthusiasm for that effort. The Chairman and the members of his Committee remained intensely tight-lipped about the content of their proposal, and the lack of information about what that legislation would contain heightened the apprehension in the business and advocacy communities.
Finally, in late February, the much-anticipated “Chairman’s Draft” was released. In announcing his proposal, the Chairman acknowledged that it failed to achieve one major and fundamental goal – tax rate parity between the corporate and individual tax codes. The Chairman said he had made the decision that his proposal would be revenue and distributionally neutral: that his bill would raise just as much revenue as the current tax code, and that the percentage of taxes paid by each income group would remain the same. By imposing those rules on his own tax package, the Chairman severely limited his options and was forced to produce a bill that falls well short of the fair, comprehensive reform and simplification that was promised.
Broadly speaking, the corporate tax reform in the Camp proposal can be seen as a step toward a better and more competitive tax code, and would lead to a more level playing field in terms of effective tax rates among corporations. As promised, the top corporate income tax rate would be reduced to 25%, a more territorial international tax system would be imposed, and hundreds of special interest tax provisions would be repealed.
Among the other provisions of note on the “business tax” side of the ledger:
- The R&D Tax credit is made permanent but amortized over 5 years
- Accelerated depreciation (MACRS) is replaced with longer straight-line depreciation
- Section 179 first year expensing is made permanent at $250,000
- Corporate AMT is repealed
- Section 199 domestic production deduction is repealed
- LIFO is repealed
- An excise tax is imposed on large banks
- Like-kind exchange is repealed
There are obviously provisions here that are commendable, as well as some that are hugely objectionable – LIFO repeal of course being the most objectionable.
Unfortunately, it is difficult to find much to like in the proposed reform of the individual side of the code, especially in terms of the 30 million pass-through businesses which pay taxes as individuals.
The Chairman had promised to achieve tax rate parity, and that the individual rate as well as the corporate rate would be reduced to about 25 percent. When he released his draft proposal, he initially claimed that he had in fact reduced the current multiple individual tax brackets to just two, 10 percent and 25 percent, with a “surcharge” on upper income earners. He later modified his statement acknowledging that there were in fact three brackets – 10 percent, 25 percent and 35 percent.
The 35 percent top individual rate obviously imposes a measurably higher tax burden on pass-through businesses than on C Corporations. A February 26th story in Politico noted the concern about the disparate rate expressed by the pass-through community, and reported a very disappointing response from Chairman Camp. According to Politico: “Asked about small businesses who may face that 35 percent levy, Camp said they could convert into corporations to get the lower rate. `They can always become C-corporations — there’s nothing to prevent that,’ he said.”
Not surprisingly, the Chairman’s suggestion that the 30 million pass-through businesses become C Corporations to take advantage of the lower rate the 1.9 million C Corps will pay was not well-received.
Moreover, analyses of the provisions of the Camp proposal by several tax policy groups produced a much more troubling result, with a top effective individual tax rate of closer to 45 percent for many individuals and pass-through businesses. In fact, the Tax Policy Center, affiliated with the centrist Urban Institute and Brookings Institution, claims that for some unfortunate taxpayers, the real effective tax rate could reach 67 percent.
The higher-than-advertised top tax rate is a result of how the upper income 35 percent tax bracket is applied, and what income is taxed. The 35 percent rate is not just a 10 percent surcharge, as the Camp documents initially claimed. Rather, it is – as described by someone at the S Corp Association – an entire new tax code for upper income earners. Specifically, the top rate would apply to a new Modified Adjusted Gross Income (MAGI), including in taxable income whole categories of income that are non-taxable at the lower rates.
Specifically includable as MAGI taxable income are employer health care contributions, contributions to qualified retirement plans, tax-exempt interest, contributions to Health Savings Accounts, and the portion of Social Security benefits excluded from gross income.
Further, for those upper income earners and businesses: personal exemptions, itemized deductions (except for charitable contributions), the standard deduction, and the benefit of lower income brackets are all phased out.
While the top effective individual and pass-through income tax rate is by far the most troubling part of Mr. Camp’s bill, there are other provisions of concern. Specifically:
- The bill provides a 25 percent top tax rate for pass-through manufacturers, but not for pass-through businesses in any other industry;
- Long term capital gains and dividends, subject to a 40% exclusion, would be taxed as ordinary income, raising the cost of capital;
- Active shareholders in an S-corp or partnership would be permitted to treat only 30% of their combined compensation and pass-through income as return of capital; 70% would be subject to payroll taxes.
Regrettably, the Camp tax plan is similar to, and in some ways worse than, tax increase proposals from the Obama White House: the Obama plan’s “Buffett Rule” imposed a surcharge on incomes in excess of a million dollars; Camp would impose an even greater surcharge on less than half that income. Given the President’s constant rhetoric about “taxing the rich,” proposals that punish success are expected from his Administration. A Republican tax proposal that taxes success and raises the cost of capital was unexpected, and disappointing. Especially concerning is the treatment of small businesses, which is inconsistent with the traditional Republican support for the small business community.
It is noteworthy that Mr. Camp claims that his proposal would create economic growth, and in fact for the first time the Congressional Joint Tax Committee has done a macroeconomic “dynamic score” of the impact of the legislation. As a result, the Ways and Means Committee staff are insisting that companies demonstrate that they have factored that growth into their analyses of the impact of the tax increases on their business when they come to talk to the committee about the bill.
However, that kind of analysis cannot be done. The Joint Tax Committee estimates that the economic growth that the Camp proposal would create would produce additional revenue of between $50 billion and $700 billion in the ten-year period after enactment. Depending on which of the JCT scoring models is used, GDP would either be 1.6% higher or just .01 percent higher. It is obviously not reasonable to expect a company to factor into its business plan economic growth that might fall anywhere in that wide range – or that might not impact that company at all.
Moreover, a number of respected economists and tax analysts dispute the entire JCT dynamic score, primarily arguing that a tax bill that significantly raises the cost of capital cannot produce economic growth and increased revenue. For example, the well-respected Tax Foundation predicts the exact opposite result from the Camp tax bill: “Ultimately, the plan’s effects on reducing capital formation will translate into lower wages for workers, lower economic growth, and, finally, lower tax revenues for the federal government.”
Not surprisingly, the Camp draft received very little support from the business community, or from taxpayer advocacy groups. In fact, vocal and public opposition has been growing, starting with statements and letters from the small business community, the energy industry, the LIFO Coalition, and – of course – the banking industry.
It is generally understood that the Camp tax proposal has no chance of becoming law this year, and probably will not even be marked-up in the Ways and Means Committee. Nonetheless, the proposal is of great concern. This is the first broad and comprehensive tax reform bill that has been proposed in Congress in decades, and there is therefore a very strong chance that the Camp proposal will become the starting point for reform measures in the next Congress. And although Congressman Camp is retiring and will not be in Congress next year to push his bill, he has announced that he intends to remain engaged in the process and advocate for reform next year. Taxpayer stakeholders should take the Camp proposal very seriously, and begin now to talk to lawmaker about what they believe reform should look like in the next Congress.
NAW Tax Coalitions:
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.
NAW also organized and manages the LIFO Coalition. Our member companies and the members of the 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.
However, LIFO is more threatened today than it has ever been. LIFO repeal has now been proposed by the Obama White House, the Democratic Senate Finance Committee, and the Republican House Ways and Means Committee, despite a multi-year aggressive lobbying effort to prevent repeal.
Most troubling is the repeal proposal in the Camp tax reform bill, because their justification for repeal demonstrated a complete misunderstanding – or deliberate mischaracterization – of what LIFO is and what it does. What was clear is that for the tax-writers on the Camp staff, LIFO repeal became a source of $80 billion in new tax revenue, and the impact of repeal on the businesses which rely on LIFO was dismissed or ignored.
The LIFO Coalition is now redoubling our effort, mapping out a strategy to convince tax writers to remove repeal from subsequent tax reform proposals, and interviewing consulting firms to assist with our mission.
The LIFO Coalition sent a comprehensive letter to Mr. Camp and all members of the House of Representatives responding to the multiple errors and misinformation in their justification of repeal. If you are interested, you can access that letter here: