- April 2015
For the first time in several years, Congress – and the taxpayers – began a year without facing any significant changes in the tax code. The Fiscal Cliff tax changes enacted in January, 2013, have now been in effect for another full year, and as tax returns were filed this month, a lot of upper bracket individual and pass-through taxpayers were reminded about the tax increases that took effect that year.
Comprehensive tax reform in the last Congress:
Former House Ways and Means Committee Chairman Dave Camp (R-MI) was a strong champion of comprehensive tax reform, and was joined in that commitment by Senate Finance Committee Chairman Ron Wyden (D-OR) and Ranking Republican Orrin Hatch (R-UT).
In February, 2014, Chairman Camp released a tax reform “Chairman’s Draft” – the result of months of open hearings and public comment followed by months of closed-door negotiations. While there were commendable provisions in the “Chairman’s Draft,” his proposal failed to deliver on his promise to achieve tax parity between the 1.6 million C corporations and the more-than-30-million businesses organized as pass-through entities which pay taxes on the individual side of the tax code. Under the Camp proposal, the corporate tax rate would have been reduced to 25%, while the top effective rate facing pass-through businesses would have been over 40%.
As a result of the unfair treatment of pass-throughs, along with a number of additional unpopular and controversial provisions, the Camp draft received very little support from the business community, or from taxpayer advocacy groups, and it quickly moved to the back burner in Washington.
Prospects for reform in the 114th Congress:
The key tax-writing players in the new Congress have all changed. Former House Budget Committee Chairman (and Vice Presidential candidate) Paul Ryan (R-WI) has taken the reins at the House Ways and Means Committee. Former Senate Finance Committee Chairman Ron Wyden (D-OR) is now that Committee’s Ranking Democrat and veteran Senator Orrin Hatch (R-UT) is the new Senate Finance Committee Chairman. All agree on the need for comprehensive tax reform. Chairman Ryan outlined the tax reform that is needed in his previous House Budgets. Senator Wyden has twice offered bi-partisan tax reform proposals, once with former NH GOP Senator Judd Gregg and then with Indiana GOP Senator Dan Coats. And in December Senator Hatch released a lengthy (340-page) “Comprehensive Tax Reform for 2015 and Beyond.”
One thing that has been missing from the recent debate on tax reform, however, is the active participation of the Administration. The last time comprehensive tax reform was successfully considered – in 1986, almost 30 years ago – President Reagan and his Treasury Department were fully committed to achieving reform, offered a series of concrete proposals, and worked with Congressional Democrats to get it done. On Capitol Hill, Democrat House Ways and Means Committee Chairman Dan Rostenkowski (D-IL) was both committed to reform and willing to work with the Republican Administration to make it happen.
President Obama has shown little interest in working with Congressional Republicans on tax reform unless they are willing to do reform on his terms. Unfortunately, the tax reform agenda offered by the Administration is a far cry from the kind of reform that is needed – or that one would expect Congressional Republicans to accept. While agreeing that the corporate tax rate should be reduced, the president has absolutely rejected comprehensive reform – tax reform that would address individual as well as corporate tax rates and therefore achieve something close to rate parity for pass-through businesses.
The President would also repeal LIFO, impose a one-time tax of 14% on all US corporate earnings kept abroad and a 19% tax on future foreign earnings, eliminate stepped-up basis on inherited assets, increase the capital gains tax, impose a bank tax, and cap investments in tax-deferred retirement accounts. And he continues to demand that tax reform raise significant new tax revenue.
Recently, House Ways and Means Committee Chairman Paul Ryan (R-WI) and Senate Finance Committee Chairman Orrin Hatch (R-UT) have indicated they are willing to deal with the President on business tax reform on his terms, accepting his demand that only corporate tax rates be reduced. Corporate-only reform would of course leave pass-through businesses with a top statutory tax rate of almost 40% while the corporate rate would be reduced to 25-28%. Both Chairmen said they would attempt to find other tax changes – increased expensing, cash accounting, expanded use of the Section 199 domestic production deduction – to attempt to offset a 12-15 point tax rate differential between the top corporate and pass-through rate; but both said they would accede to President Obama’s demand that the statutory rate that pass-through businesses pay not be reduced.
The Washington business community was very surprised by the Chairmen’s move, especially since they, like former Chairman Camp, had long promised equitable treatment for the pass-through community. Even more surprising was their hardly-credible offer of a two-step process in which corporate reform would be done now and the individual tax code would be reformed after the 2016 elections, if Republicans recapture the White House and retain control of the U.S. Senate – less than certain bets in both cases, especially since there are 24 Republican Senate seats up in 2016 and only 10 Democrat seats.
Even more surprising than their acceptance of the demands of a President whose policy objectives have little in common with those of most Republicans – and the highly dubious concept of a two-step process – is their assumption that they could pass what they are proposing: a business tax reform proposal that gives the 1.6 million C corporations a significant competitive advantage over the more-than-30-million pass-through businesses.
In reality, corporate-only tax reform is politically unattainable. Any proposal to reduce the tax rate for C corporations only will certainly be aggressively opposed by pass-through businesses. That opposition would doom tax reform politically: there is no more powerful and effective grass roots force than the small- and mid-sized businesses that are a critical part of every electoral constituency, and if they are energized against tax reform it would have little chance of passing.
The business community in Washington has communicated – clearly and repeatedly – to the Committee Chairmen that attempting to pass corporate-only reform would doom any chance of passing anything at all. There are a number of coalitions advocating for corporate tax reform, and many of those coalition leaders also know that their goal of corporate reform cannot be achieved if it is aggressively opposed by the pass-through community. While the likelihood of tax reform being passed and signed into law in this Congress is small, we continue to work with both committees to attempt to persuade them to pursue comprehensive tax reform that addresses the concerns of all businesses and all taxpayers.
Other issues in the tax arena:
Business-equivalency tax: In an attempt to address the concerns of the pass-through business community while avoiding the political difficulty of lowering the tax rate on upper-income individuals, recent discussion has turned to the possibility of taxing all business income at close-to the same rate, regardless of the source of that income. One option proposed by the Grant Thornton firm would have pass-through income reported in a manner similar to the way capital gains are reported today, and have that income taxed separately at the corporate income tax rate on the taxpayers’ individual tax returns. There is no broad support at this time for any business-equivalency tax proposal, and the devil will of course be in the details, but we will be following this issue closely.
Effective vs marginal rates: Related to the debate over individual versus corporate income tax rates is the issue of effective versus statutory tax rates. This issue has increased in intensity in the last few years 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 statutory 35 percent rate – some actually get U.S. tax refunds.
The inescapable result of some corporations reducing or eliminating their U.S. tax liability is a cost-shifting from those with low effective rates to those 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 have much more in common with high-rate-paying S-corporations than with large corporations with very low effective rates.
Dynamic vs Static Scoring: All legislative tax proposals are reviewed by the Congressional Joint Committee on Taxation, which analyzes the proposals to determine whether each proposal will increase or decrease Federal revenue. Traditionally, Joint Tax uses a “static” score – they add and subtract revenue numbers on the assumption that no economic behavior will change as a result of the new tax policy: tax rate increases raise revenue and tax rate cuts lose revenue. “Dynamic” scoring assumes that economic activity will change in response to tax policy. For example, a reduction in the capital gains tax rate will prompt some taxpayers to sell assets they otherwise might hold, thereby increasing tax revenue and reducing the revenue loss that a static score would assume. The issue of how tax proposals are “scored” has been debated for years. Some conservatives have argued that tax cuts “pay for” themselves, raising as much revenue from increased economic activity as would be lost under a static score. Historic analysis has not supported that claim, but has clearly shown that there are behavioral changes in response to tax policy, and that static scores are inaccurate. Republicans have argued – with historical data to back up their claim – that tax cuts that spur economic growth will not result in as much revenue loss as static scoring projects. With Republicans in control of both houses of Congress now, the debate over dynamic scoring has already intensified.
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.
And we are adding a new coalition to the mix – in response to the renewed push for corporate-only reform – to advocate for comprehensive reform that achieves relative rate parity for all businesses regardless of how they are structured or their specific industry. This coalition is so new it doesn’t yet have a name, but it is expected to be up and running quickly.
NAW also organized and manages the LIFO Coalition. NAW 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 remains threatened today. LIFO repeal has been proposed in every Obama budget, and was proposed last year by the Democratic Senate Finance Committee, and the Republican House Ways and Means Committee, despite a multi-year aggressive lobbying effort to prevent repeal.
The LIFO Coalition redoubled its effort, mapping out a strategy to convince tax writers to remove repeal from subsequent tax reform proposals.
In addition to our continuing grass roots lobbying effort, the Coalition raised the funds necessary to enable us to hire a consulting firm to develop and implement a grass tops campaign. This effort is on-going, and has resulted in numerous very helpful contacts with key members of Congress, in their home states and districts, by business constituents, explaining the importance of LIFO to their businesses.
We expect LIFO repeal to again be a part of the tax reform debate in this Congress, but are fully committed to continue our so-far-successful 9-year effort to prevent repeal.