President Releases 2011 Budget
The president released his FY2011 budget yesterday. According to the Office of Management and Budget (OMB), the administration begins with a ten year baseline deficit of $5.5 trillion dollars. Simply put, if Congress and the administration left current laws in place, the deficit would average over $500 billion per year for the next decade.
The president’s proposed policies would raise this deficit to $8.5 trillion. As a result, debt held by the public would increase from $5.8 trillion (41 percent of GDP) in 2008 to $17.5 trillion (76 percent of GDP) in 2019.
It always helps to look at the really big numbers — there aren’t any bigger than when you’re discussing federal budgeting — to put things in perspective. Under the president’s proposed budget:
- Total spending over ten years would be $45.8 trillion. Spending is scheduled to move from 24.7 percent of GDP in 2009 to 23.7 percent of GDP in 2020. The historical average is around 21 percent.
- Meanwhile, total revenue collections would be $37.3 trillion. Taxes are scheduled to rise from 14.8 percent of GDP in 2009 to 19.6 percent by 2020. The historical average is 18 percent.
On the revenue front, the president proposes just over $4 trillion in tax relief — most of which comes in the form of extending the 2001 and 2003 tax relief packages which targeted folks making less than $250,000. On the other side of the ledger, the president proposes a large “grab bag” of tax increases — LIFO repeal, carried interest, black liquor, etc. With the odd baseline the administration is using (see below), we’re not sure exactly what the tax increases total, but it’s somewhere in the neighborhood of $1 to $1.5 trillion.
As expected, the budget calls for allowing taxes on upper-income families (and businesses) to rise back to their pre-2001 levels. As the Wall Street Journal reports this morning,
The two top income-tax brackets would rise to 36% and 39.6%, from 33% and 35% respectively. For families earning at least $250,000, capital gains and dividend tax rates would rise to 20% from 15%. All told, upper-income families would face $969 billion in higher taxes between 2011 and 2020.
For other big ticket items — health care reform and cap-and-trade — the budget includes only cursory references. These placeholders are consistent with the administration’s approach to date of delegating these policy decisions to Congressional leadership.
As we have observed in previous posts, the president’s budget is always an odd duck. The president has no tangible authority to tax or spend — the Constitution reserves that right for Congress, after all — yet there is a leadership quality to any presidential budget that can effectively set the tone for the budget decisions to be litigated through the legislative process.
In the case of this budget, that leadership appears wholly absent. No details on his biggest policy priorities. No meaningful proposals for holding down spending or bringing down the deficit No hints at entitlement reform. There is a proposed deficit reduction commission, but it has no teeth.
Congress this year will face as difficult a budgeting challenge as any in recent memory. The economy has stabilized and a continued financial meltdown is no longer imminent. The biggest threat to economic growth now is the federal deficit and its impact on interest rates and prices. As this budget release makes clear, Congress will be addressing these challenges alone.
Estate Tax Update
On the estate tax front, the president continues to call for making permanent the estate tax rules from 2009 — a 45 percent top rate and a $3.5 million exemption — but you’d be hard-pressed to find much discussion of this policy in the budget. That’s because the administration is using something other than the usual “Current Law” baseline. As Treasury’s Green Book notes:
The Administration’s primary policy proposals reflect changes from a tax baseline that modifies current law by “patching” the alternative minimum tax, freezing the estate tax at 2009 levels, and making permanent a number of the tax cuts enacted in 2001 and 2003. The baseline changes to current law are described in the Appendix. In some cases, the policy descriptions in the body of this report make note of the baseline (e.g., descriptions of upper-income tax provisions), but elsewhere the baseline is implicit.
In other words, they have taken a projection of current policy and modified that baseline to accommodate changes to AMT, Medicare Physician Payment policy and the estate tax. In budget world, no mention of the estate tax in the budget means an extension of current policy. A footnote on page 158 of the budget makes clear the “current” policy they’re referring to for the estate tax is the 2009 policy, not the 2010 policy currently in place. Not exactly a strident endorsement for the 2009 rules, but it’s there nonetheless.
The second set of estate tax proposals in the budget looks similar to last year’s budget proposals. There are three, the headings are the same, and the revenue estimates are similar:
1. Require consistent valuation for transfer and income tax purposes: Ten Year Estimate — $1.8 billion (2010 budget); $2.1 billion (2011 budget);
2. Modify rules on valuation discounts: Ten Year Estimate — $19.0 billion (2010 budget); $18.7 billion (2011 budget);
3. Require a minimum term for grantor-retained annuity trusts (GRATS): Ten Year Estimate — $3.3 billion (2010 budget); $3.0 billion (2011 budget).
We spent the past year working on issues related to provision 2 — the valuation discounts. While the write-up of the administration’s proposal refers to “estate freezes” rather than the “family attribution”, we remain wary that restoration of the old “family attribution” approach is part of the policy mix being discussed at Treasury and on Capitol Hill. With that in mind, we will continue our work to educate policymakers on why family attribution is a really bad idea.
Regarding work on an estate tax compromise, the Finance Committee has been working with key offices to come up with some sort of process to move a compromise forward in the next couple months. They appear to be still working on what that compromise might look like, even at this late date. Possible policies range from restoring 2009 rules to implementing a more business-friendly compromise centered around a 35 percent top rate and $5 million exemption.
The bottom line question for everyone involved remains the same — is there a proposal out there that can garner 60 votes? If not, expect to see the current repeal stay in place through the rest of the year, followed by the restoration of the old pre-2001 rules. The longer this process takes, the more likely that is the final outcome.
Extenders Advance
Following a series of votes on alternatives, the Senate adopted a $150 billion package of tax extenders yesterday by a vote of 92-5. The key components of the package include:
- A one year extension of the higher exemption amount under the Alternative Minimum Tax. This provision will prevent about 20 million taxpayers from getting sucked into the AMT when they file their taxes this April.
- An extension of expired and expiring personal and business tax provisions, including the state sales tax deduction and R&E tax credit, though 2009.
- Several new provisions, including making the refundable child tax credit more valuable to low-income families and mental health parity provisions.
- Disaster relief for Hurricane Ike.
- A $17 billion package of energy extenders and new provisions, including an extension of the Section 45 production tax credit and a new credit for plug-in hybrid vehicles.
The big break-though was the decision by Senate leadership not to insist on offsetting the revenue impact of extending the AMT relief and other expired and expiring provisions. Of the total $150 billion revenue impact, only $42 billion is offset.
The package now moves to negotiations with the House, where its future is uncertain. The House today is expected to take up a smaller, $43 billion package of extenders fully offset with the same tax increases included in the Senate package.
All this action masks the fact that the underlying question remains the same — will House Democrats set aside their demand that all extensions of existing tax provisions be full offset, or will they accept the Senate compromise? With only a few days left before Congress leaves for the elections, we’ll know the answer in a couple of days.
Futures on Tax Rates
In the past, we have discussed how tax policy changes depending on who is the next President. Our assessment is that while there will be marginal differences, the final polices enacted under a McCain or Obama presidency will be more similar than not, with a strong bias for higher rates.
Greg Mankiw, former Chairman of the CEA, takes a more rigorous approach, but comes up with a similar conclusion. As posted on Greg’s blog:
What kind of tax policy will we get if John McCain is elected President? He says he wants to make the Bush tax cuts permanent. But is he likely to deliver that outcome in the face of a presumptively Democratic Congress? We can get some insight into this question using Intrade betting and some basic rules of conditional probability.
First, who knew the Intrade Prediction Markers tracked tax rates? Well they do, and using the current Intrade betting, Greg comes to the following conclusion:
That is, according to the Intrade betting, we are likely to see a significant hike in the top income tax rate even if McCain is elected President.
Bailout Proceeds
Estimating what will happen with the Treasury bailout plan is complicated by all the noise from Members of Congress expressing their opposition, advancing alternatives, and proposing additions like caps on executive compensation and changes to bankruptcy rules.
With a plan this large — and really, there’s nothing larger than giving Treasury $700 billion to save the economy – your S-CORP team prefers to step back and look at the forest.
Is the leadership in Congress willing to tell Treasury Secretary Paulson and Federal Reserve Chairman Bernanke “No” and take the risk — and responsibility — that the economy goes into free-fall? The answer is no, which means Congress will adopt some version of the Treasury plan with the core provisions intact.
The sausage making process will take a few days; it won’t be pretty, and many less than attractive provisions will be added to the legislation, but we believe it will get done.
By the way, Intrade agrees — the odds of Congress passing the package before the end of the month skyrocketed from yesterday’s close of 55 percent, to 80 percent this morning.
Bailout Takes Center Stage
Our friends at the Treasury spent the weekend working primarily with the House Financial Services Committee to refine the Administration’s emergency plan to purchase hundreds of billions of dollars worth of mortgage backed securities.
According to Bloomberg, the scope of the proposal has expanded to include other troubled assets, including credit card debts and car loans. Members of Congress are also weighing in, seeking to add additional provisions such as limits on executive compensation and the cramdown of loan balances under bankruptcy.
The goal of these talks is to get a relief package through Congress and implemented before Congress leaves for the elections at the end of the week. As you can imagine, adding this 800 pound legislative gorilla to the existing long list of must-do items on Congress’ calendar has the potential to push the current session well into next week. At this point, Congress simply cannot leave without taking some form of action on this issue.
That’s not to say it’s a done deal. There is focused opposition to the expansive scope of the Treasury proposal that gives the Secretary of the Treasury unprecedented authority to purchase private sector securities and other assets. The broad nature of this authority should be viewed both as an expression of the enormous scope of the problem as well the size of the obstacle of getting it enacted.
How will this plan impact S corporations? A couple of thoughts:
Liquidity: The rational for the bailout is that the subprime contagion afflicting Wall Street was spreading to Main Street, infecting local banks and insurance companies and threatening your business’ line of credit, insurance policies, pension funds, retirement plans, and bank accounts. Presumably, the government purchase of these securities would cure the financial world and allow the sector to return to health.
It had better.
As we have discussed with our S Corp friends on the Hill and over at Treasury, after this plan, Treasury and the Fed will have used every tool they have, and several new ones they had to invent, in their efforts to restore confidence and order to the financial markets. Once some form of this proposal is enacted, there is no Plan B.
Tax Bills: While the ultimate cost of the proposed bailout to taxpayers is unclear (the taxpayer could actually see a profit when the multi-year process is complete) the initial cost of the plan will act as a massive drain on the budget.
A similar effect occurred during the Thrift bailout in the late 1980s and early 1990s. The ultimate cost of the bailout to taxpayers was around $150 billion, but Treasury had to spend many times that amount initially to pay off insured depositors of failed Thrifts. In later years, money from the sales of foreclosed properties resulted in revenues coming in to the Treasury. The net effect was a significant increase in deficits in the early years of the bailout and just as significant decrease in deficits as the process wound down
The deficit for 2008 is already projected to rise dramatically, from $161 billion to over $400 billion. Adding hundreds of billions of bailout expenses — or even a fraction of those costs, depending on how the CBO chooses to score the plan — will drive the deficit to records levels over the next couple years. These record deficits will squeeze Congress’ ability to move other priorities like extending portions of the Bush tax relief, stemming the growth of the AMT, or increasing federal spending for health care and other items.
The current setup reminds your S-CORP staff of the 1992 election, when candidate Clinton ran on a package of middle class tax cuts, but President Clinton pushed through tax increases instead. At the time, he argued that the deterioration in the budget made the tax hikes necessary. While there’s some debate over just how badly the deficit deteriorated between 1992 and 1993, there will be no debate next year. This bailout has the potential to double the federal deficit or more.
The net result is that once enacted, this bailout reduces the chances that Congress will act next year to reduce taxes or increase spending. The deficit, just like in the mid-nineties, will take center stage in budget and economic politics, placing additional pressure on tax rates to rise over the next couple years.
Tax Policy and Small Business
Earlier this week, the Wall Street Journal reviewed the most recent comments by Senator Barack Obama regarding his plans for tax policy.
As we noted in the past, the bias is for higher tax rates beginning sometime in the next Congress. This bias stems from the make-up of Congress and the scheduled expiration of the 2001 and 2003 tax cuts and exists regardless of who becomes President.
That said, the S corporation community should pay particular attention to some of the proposals put forward by the Obama campaign – specifically, his plan to raise marginal tax rates on households with incomes above $250,000.
Just how would this hurt S corporations? Critics argue that the number of businesses affected, and the potential economic impact by extension, is small.
But our friends over at American’s for Tax Reform have pointed out that the actual percentage of affected business income is quite large. According to IRS statistics, 80 to 90 percent of all S corporation and partnership income is reported by households with incomes above $200,000.
Combine that statistic with the fact that most business income is taxed at the individual rates, and the potential damage to the economy of raising taxes on these households becomes clear. As the WSJ concludes:
The reality is that the creators of new jobs in the economy are more likely to be rising entrepreneurs or filers under Subchapter S, who typically pay taxes at individual rates. Hanging three or four tax millstones around their productive necks in January if the economy is weak will likely produce unimpressive growth and job numbers in the first year of the new Obama Presidency, and likely beyond. That in turn could drag down the Democrats in Congress who will get credit for voting these higher taxes into law.
So Much to Do, So Little Time
Congress returned this week to a long list of must-pass items, but only a few weeks to get them done and little consensus on how to do them. The list includes:
- Energy
- Tax Extenders
- Appropriations
- Continuing Resolution
- American with Disabilities Act
- Second Stimulus
- Media Shield 1st Amendment Legislation
Given the length and composition of this list — the Media Shield bill alone is worthy of several constitutional conventions — the odds of a lame duck session are growing by the minute.
On the tax front, the stalemate over whether to offset tax relief or not continues. Early this week, House Majority Leader Steny Hoyer (D-MD) took the Senate to task for failing to move on extenders, especially those targeting at renewable energies.
About the same time, Senator Baucus indicated that the Congress may leave for good this year without extending many of the tax provisions that make up the extender package, including the R&E tax credit. He did say that a one-year extension of the AMT patch will likely pass, perhaps as part of the continuing resolution.
Senator Baucus then joined Senator Grassley in introducing a comprehensive, $40 billion package of energy tax provisions, including a three-year extension of the Production Tax Credit.
The plan for both the House and the Senate is to consider comprehensive energy bills early next week, but it’s unclear anything will pass.
All this focus on energy means there’s less time and less attention being paid to the broader tax challenges faced by S corporations and other businesses. If Congress does adjourn permanently prior to the elections, these issues will be waiting for the new Congress when it organizes in January.
Happy 50th, S Corps!
Today marks the 50th birthday of the S corporation! As you can imagine, here at the S Corporation Association we’ve got the cake and candles ready.
Perhaps more importantly, at a time of economic and political uncertainty, the story of the S corporation and its role in making the American economy more diverse and flexible is worth reviewing.
The S corporation was born at a time when the economy was slowing, Americans were losing their jobs, and an unpopular Republican President was being accused of practicing “trickle-down economics” by a Democratic Congress.
President Eisenhower embraced the S corporation — originally an idea proposed by the Truman Treasury Department — as a means of burnishing his Main Street credentials while addressing concerns of Republicans and Democrats alike that too much economic control was being consolidated into the hands of too few wealthy Americans.
Congress passed the provision as a small part of a much larger miscellaneous tax bill and the President signed on September 2, 1958 while on vacation up on Cape Cod.
Over the past fifty years, the S corporation has helped diversify the American economy while becoming an increasingly important player in the lives of millions of Americans.
While the S corporation has always been a successful vehicle for facilitating private enterprise and innovation, its growth accelerated dramatically in the last thirty years as marketing, communication, transportation and other transaction costs for small firms shrank along with the marginal tax rates they paid.
Lower transaction costs means smaller, more diversified firms and a stronger Middle America. Today, there are over four million S corporations, employing millions of workers and contributing significantly to our national income.
As Congress reconvenes next year and considers what to do with the tax code and how to address concerns of economic concentration, it should keep in mind that the S corporation was created by a Democratic Congress intent on countering economic concentration. It worked, as four million businesses spread throughout communities around the country can attest.
Happy 50th, S Corps and many returns!
The Game of LIFO
More movement on the LIFO front. Last week, the Securities and Exchange Commission approved for comment a roadmap to convert US accounting rules for public corporations over to EU rules.
The transition would take place over the next eight years and include numerous steps, including a decision by the SEC in 2011 on whether to proceed, but the bottom line is the accounting community and the people who regulate them are continuing to move away from rules that allow for LIFO accounting.
As S-Corp readers know, a move to eliminate LIFO for book accounting has implications for tax accounting as well, since the tax code requires companies to use the same broad inventory method for both.
While LIFO accounting debates may appear too technical to matter, this issue has the potential to impose a massive tax increase on manufacturers, retailers and wholesalers around the country. A recent revenue estimate for eliminating LIFO suggested it would raise taxes on these businesses by more than $100 billion over the next ten years.
A tax increase that size is bound to be noticed. It threatens a double hit on businesses that would be forced to pay back taxes on accumulated LIFO reserves while also being hit with higher tax levies in future years.
Tax issues were not a major part of the SEC discussion, although the Commissioners are aware of the tie between book and tax accounting on LIFO and suggested maybe the IRS could do something to fix it. Maybe. But, Congress still needs to find revenues over the next couple of years to offset a very expensive agenda of tax relief and spending increases. Whether the IRS comes to the rescue or not, we expect this issue to be debated in Congress beginning next year.
Extender Picture Muddy as Ever
With energy issues on the front lines, a group of 16 Senators has joined together to support a package of energy provisions that includes, well, just about everything — nuclear, drilling, renewables, and an extension of the production tax credit and other energy tax items.
Looking at the past votes on extenders, if you add the Republican members of the Group of Sixteen to the 55 or so Senators who supported the most recent extender package — the one with revenue offsets — Senate Majority Leader Harry Reid now has a roadmap to getting the necessary 60 votes and help take energy issues off the table before the elections.
What does this mean for the broader tax package, including the AMT relief, R&E tax credit and S corporation charitable deduction expansion? It is not entirely clear, but adoption of the very popular production tax credit and other energy tax provisions separately may ease pressure on Reid to move the larger extender bill.
Broad Business Coalition Supports BIG Relief
There are increased reports in the media about a potential stimulus package to be considered when Congress returns in September (here and here). If Congress does consider another stimulus package and wants to target help at the small business community, it should act to increase the ability of S corporations to access the capital they already own.
A broad and powerful coalition of 14 trade associations is asking Congress to do just that. A letter sent to congressional leaders today makes the case for reforming the built-in gains (BIG) tax as a part of any effort the help our flagging economy. As the letter states:
“Every year, tens of thousands of small businesses elect S corporation status for the first time, which means that hundreds of thousands of S corporations nationwide likely are sitting on billions of dollars in locked-up capital that could be used to grow the business and hire new employees.”
The built-in gains tax forces S corporations to hold on to appreciated assets for the decade after they convert to S status. Given today’s dynamic business environment and the on-going challenges smaller businesses face in accessing capital, shortening this holding period makes imminent sense and would help free up capital at a time when the economy badly needs it.
In addition to the S Corporation Association, those groups signing on to the letter include the Associated General Contractors, the Association For Manufacturing Technology, the Independent Community Bankers, the National Association of Convenience Stores, the National Association of Manufacturers, the National Beer Wholesalers, the National Federation of Independent Business, the National Funeral Directors Association, the National Small Business Association, the Plumbing-Heating-Cooling Contractors-National Association, the Printing Industries of America, the Tire Industry Association, and the U.S. Chamber of Commerce.
Senate to Consider Extenders Again
We are seeing some movement on the tax extender front as well. Majority Leader Harry Reid (D-NV) announced yesterday the Senate would make another run at taking up a $120 billion extender package, this time however with two significant changes.
First, the package would include both the AMT patch and the more traditional extenders such as the R&E tax credit, but would only seek to offset the revenue cost of the traditional extenders. This is a half-step towards the no-offsets position of the Administration, Senate Republicans, and a handful of Senate Democrats.
Second, the package may include some additional provisions that would attract new votes, such as tax relief for states affected by the flooding in the Midwest.
As before, Senator Reid plans to bypass the Senate Finance Committee, bring the bill directly to the floor, and see if he has the 60 votes necessary to move the bill through the Senate.
With both the House and the Senate choosing not to take up the dozen or so annual spending bills this year, finding a solution to the AMT/extender impasse is one of the few remaining obstacles between Congress and adjourning prior to the November elections. The vote next week on this new extender package will be a good indicator on whether Congress will have to come back for a post-election, lame duck session in November or December.
S Corporations and Income Distribution
We previously have written about the growth of the flow-through business community in the past three decades and the distortion that growth has on personal income distribution tables. Here’s a really good illustration from our friends at the Tax Foundation and PWC that makes the point.
Today, more business income in the United States is taxed under the individual income tax code than the corporate code. Congress needs to keep this in mind as it considers major changes to the tax code in the next two years.
S Corp Testifies in the House!
This week the House Committee on Small Business held a hearing to consider reforms that would promote equality and growth for S corporations. Rick Klahsen, a member of the S Corporation Association’s Board of Advisors testified on our behalf.
Rick’s testimony reviewed the dramatic growth of S corporations over the last half-century and identified critical reforms Congress should consider to improve the S corporation rules and level the playing field with LLCs.
As S Corp readers know, we are fortunate to have active champions in the House and Senate ready to make the case for S corporation reform. One of those champions, Representative Ron Kind (D-WI), also submitted testimony making the case for his legislation, HR 4840, the “S Corporation Modernization Act of 2007.”
Both Chairwoman Melissa Bean (D-IL) and Ranking Member Vern Buchanan (R-FL) have small business backgrounds and demonstrated a detailed understanding of the challenges ’s small business community faces in coming years. We look forward to working with them and the other members of the Small Business Committee to see these important reforms enacted.
More Tax Bills in the House and Senate
Congress had another busy week debating tax bills in the House and Senate, but it in the end it likely came to naught.
On Wednesday, the House Ways & Means Committee approved legislation to protect millions of taxpayers from paying the Alternative Minimum Tax. This legislation is expected to be taken up by the full House next week and should pass by a large, albeit partisan, margin. From there, however, its future is shaky.
Under the Committee-passed bill, AMT exemption levels would increase to $46,200 for individuals and $69,950 for couples, protecting approximately 20 million taxpayers from having to pay the AMT this year.
In another indication of tax fights to come next Congress, the bill is fully offset with half-a-dozen tax increases, including raising tax rates on so-called “carried interest,” excluding large oil companies from using the section 199 manufacturing deduction, and requiring credit card companies to report transactions by small businesses.
As with past efforts, the members of the Senate and the White House have made clear they oppose offsetting the cost of extending current AMT policy.
As if to confirm that point, the Senate failed to get the necessary 60-votes on Tuesday to move legislation that combined the AMT patch and an extension of expiring tax and energy provisions. Once again, the main points of difference in the 52-44 vote were the provisions to offset the revenue impact of the bill. Competing press releases sent out by Senators Baucus and Grassley do an excellent job of identifying the impasse.
Baucus: Senators who voted against this bill have once again disappointed millions of working American families that depend on these tax credits and incentives for protection against the alternative minimum tax, real help in paying high college tuition and otherwise making ends meet. This vote is a disappointment to all corners of the business community that rely on the research and development tax credit and other tax relief that helps them remain competitive at home and abroad.
Grassley: The right thing to do right now is to vote “no” on this cloture motion. The sooner we can get the Democratic leadership to stop driving the truck over a cliff the sooner we can get to work on an extenders bill. That bill, unlike the bill before us now, will pass both houses of Congress and be signed by the President. This law change will protect additional families from being captured by the AMT. Right now, the Democratic leaders are in the driver’s seat. I hope eventually they decide to drive responsibly. Vote no on the motion to proceed. Put the Senate back on a path to a real AMT patch and extenders bill that will become law.
As before, your S-Corp team expects that both the AMT and expiring tax provisions will be addressed by Congress before the end of the year without offsetting the revenue impact. The votes in the Senate over the past months has demonstrated it cannot pass offset bills, and the President has made his opposition clear as well. Just how long it takes to get there, however, is unclear. A post-election session is very much a possibility.
House Passes Marginal Tax Increase
Foreshadowing things to come, the House on Thursday adopted legislation to increase Veterans education benefits by raising marginal tax rates on individuals—including S corporation shareholders—making $500,000 a year or more. As Congress Daily reported:
“The House, as one portion of a three-part war funding supplemental spending package, approved a provision that would pay for a four-year college degree at any public university for veterans of the wars in Iraq and Afghanistan for at least three years. To pay for the increase — $52 billion over 10 years — the House Thursday voted to impose a 0.47 percent tax on individuals with a gross income of more than $500,000 and couples with income more than $1 million.”
This tax-and-spend approach is unlikely to be adopted by the Senate, and the President has issued a veto threat based on his opposition to the tax increase:
“In addition, amendment number three to the bill would impose a tax increase on individuals and owners of small businesses, totaling more than $50 billion over ten years. A tax increase would be harmful to jobs and economic growth, and the President has been clear that tax increases are unacceptable. If the bill presented to the President contains a tax increase, he will veto it.”
Nonetheless, the S Corporation Association expects that efforts like this will be the norm in coming years rather than the exception. Increasing education benefits for Veterans is a worthy cause, but there are an infinite number of worthy causes, and a limited number of taxpayers. Raising marginal tax rates on small businesses is bad tax policy that deserves to be defeated.
House Extender Package Likely Veto Target
The common perception is that lame duck Presidents have little or no role in on-going policy debates, but reality is slightly different.
President Clinton late in his tenure effectively used his veto pen to either kill legislation outright or negotiate significant changes. This President is doing the same. By our count, more than half of the Statements of Administration Policy issued this year contain veto threats (21 out of 36).
We expect another veto threat when the House takes up the tax extender package next week. The bill would extend for one year a number of tax provisions that either expired at the end of 2007 or will expire at the end of 2008. As outlined in BNA and other publications, the bill would also include two revenues raisers affecting the level of US taxes paid on income earned overseas.
Both the White House and the Senate oppose offsetting the extender package in general and do not like these offset in particular, so the long-term tax picture for extenders and AMT remains as unclear as ever.
Tax Reform Hearing in Senate Finance
The Senate Finance Committee held another in a series of hearings on reforming the tax code. As we have indicated in the past, these hearings and those planned in the House Ways and Means Committee are being held to prepare for the major tax reform expected next year.
What caught your S Corp team’s attention was the uniformity of opinion from the witnesses. All four witnesses argued that rates should be flattened and the base broadened. All four argued for lower taxes on capital income. And all four pointed out that taxes applied to businesses are really paid by individuals.
S Corp readers know the expectation for the next Congress is for higher rates on families and businesses. If Congress does nothing, taxes are going up. If Congress acts, taxes are likely to go up. Given that baseline, it was interesting to hear a panel of witnesses uniformly testify against the direction Congress appears ready to go. Maybe we need to rethink our expectations.
Speaking of baselines, S Corp readers know we have a problem with the baseline accounting Congress uses to score expiring tax provisions. Dr. Foster from the Heritage Foundation included a critique of the current rules:
“The issue arises, of course, because the 2001 and 2003 tax cuts are slated to expire at the end of 2010. This leads some to suggest that extending any or all of the tax provisions, provisions that will then have been in the law for eight or 10 years, is somehow a tax cut. Respectfully to those who make this argument, this is utter nonsense Washington style. Extending current law, or better yet, making it permanent, prevents a tax hike.”
Amen to that.
More Details, Little Clarity on the Tax Front
Just to keep everybody up to speed, there are a couple recent tax items of note.
First, CongressDaily reports the House may take up yet another extender package prior to the Memorial Day recess. This package reportedly includes energy provisions as well as the expired extenders like R&E and the state and local sales tax deduction. An extension of the Alternative Minimum Tax “patch” does not appear to be under consideration.
Regarding the central issue of whether the revenue impact of the package will be offset by accompanying tax increases, Majority Leader Steny Hoyer is quoted saying, “We want it paid for and it will be paid for.”
If that remains the case, then this exercise is similar to those that preceded it—the House passes a tax package with revenue raisers and the Senate rejects them. A similar stalemate kept Congress in session right up until Christmas last year.
As further evidence of the divide, on Tuesday the White House issued a veto threat against a housing stimulus package to be considered by the House yesterday. The veto is tied to both a new first-time buyer tax credit included in the package as well as the tax increase offset used to pay for the package.
With the Senate and Administration drawing a hard line against offsets on the one side, and the House digging in its heels for offsets on the other, we could be in for a long, post-election ride on tax policy.
On a related note, Senate Democrats are working on a package of provisions to provide relief from rising energy prices. At first glance, the package introduced this afternoon is heavy on taxing and regulating oil companies and light on actual relief for consumers from rising energy prices. The bill:
- Repeals the manufacturing deduction for large oil and gas companies;
- Imposes a 25 percent windfall profits tax on certain oil companies;
- Suspends filling the Strategic Petroleum Reserve; and
- Increases certain government regulatory authority over energy pricing and related securities.
Notably absent from the package is the gas tax holiday proposed by the Clinton campaign. It is also unclear what all the revenues from the windfall profits tax and Section 199 repeal would be used for.
As with so many tax bills being considered by either the House or Senate these days, prospects for this legislation moving beyond the Senate appear to be slim to none. Candidates and Capital Gains CNBC had a nice segment Tuesday morning on the Presidential candidates and the capital gains tax rate. Which candidate has the best plan?
The current rate is 15 percent. Candidate Obama would to raise it to 28 percent, Clinton to 20, and McCain would hold it at 15.
Here at the S Corporation Association, we believe the bias in the next couple years is towards higher rates, regardless of who is President. Current law has the rate reverting to 20 percent in 2011 unless Congress proactively passes a different rate. That means 41 Senators opposed to lower capital gains rates (or rates higher than 20 percent for that matter) can block any effort to legislate something different.
So if Obama is President and wants to raise the tax on capital gains up to 28 percent, Senate Republicans will want to block that effort in defense of a 20 percent rate instead. If McCain is President and wants to keep the rate at the current 15 percent, Senate Democrats should have the ability to block that effort and preserve the 20 percent rate instead. If Senator Clinton is President, Congress can just sit on its hands and the rate will revert to her preferred level.
This analysis applies to several other tax items as well, including the lower individual tax rates, the rate on dividend income, and the estate tax. Absent consensus for a particular change, current law has these items reverting back to their pre-2001 levels in 2011.
All of which suggests the any deviation from current law will require Republicans and Democrats to reach some consensus on a compromise package.
What motivation do they have? Lots. Bi-partisan challenges like the growth of the AMT, $1000 child credit, and the on-going challenge of paying for tax extenders should give the leadership of both parties sufficient incentive to work something out.
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