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.
Senate Jobs Bill First Out of the Chute
With health care reform in a state of political limbo, Senate leadership is busy assembling a job-creation package that is likely to be the chamber’s next significant legislative effort.
Just before Christmas recess, the House hastily assembled and adopted a $154 billion spending package. In response, the Senate Finance Committee is working on a package that focuses more on tax relief than the House counterpart. As reported by Dow Jones:
The package would be paid for largely by re-directing funds that were available for the government’s bank bailout program, according to an outline dated Friday of possible measures being considered for inclusion in the bill.
The Senate document put the total cost of economic stimulus measures in the bill at $82.5 billion. A Senate Democratic aide cautioned that the document doesn’t reflect the most recent conversations among leaders about the plan, and some elements may change considerably.
A broad outline pitched to the Democratic conference today included pension relief, SBA lending provisions, energy efficiency tax credits, export promotion (IC-DISC users take note) and a proposal that would “provide a tax credit for between 10%-20% of increased payroll—to encompass both hiring of new workers and increasing part-time workers to full-time status.”
Tax policy veterans should recognize the employment tax credit idea from years past. Among others, Senator Kerry offered something similar as part of his Presidential platform in 2004. The proposal has been always been viewed skeptically, however, over concerns that it is poorly-targeted and only rewards those businesses that would hire new workers anyway.
Regarding timing, it’s still up in the air but we anticipate a Finance Committee markup in the next two weeks followed by floor consideration after the President’s Day holiday.
So what are your S-CORP takeaways? First, there’s an incredible amount of pent-up demand for tax policy in the Senate, and we expect this legislation to open the floodgates. It’s a tax vehicle, after all, so how can Chairman Max Baucus and Majority Harry Leader Reid keep extenders, energy tax incentives, and (perhaps less so) an estate tax fix on the sidelines once it starts moving?
Second, lots of other items are likely to catch a ride as well. Extended UI and Cobra benefits expire at the end of February, as does the temporary Doc Fix for Medicare payments. The timing of this package suggests those provisions stand a good chance of being included.
Finally, expect lots of message amendments regarding the expiring Bush tax relief. It all goes away at the end the year, after all, and none of the provisions listed above address this underlying policy challenge.
CBO Updates Budget Outlook
The CBO issued its outlook for 2010-20 today. Here’s the CBO on the short-term outlook:
CBO projects, that if current laws and policies remained unchanged, the federal budget would show a deficit of $1.3 trillion for fiscal year 2010. At 9.2 percent of gross domestic product (GDP), that deficit would be slightly smaller than the shortfall of 9.9 percent of GDP ($1.4 trillion) posted in 2009. Last year’s deficit was the largest as a share of GDP since the end of World War II, and the deficit expected for 2010 would be the second largest. Moreover, if legislation is enacted in the next several months that either boosts spending or reduces revenues, the 2010 deficit could equal or exceed last year’s shortfall.
And the longer term outlook:
Under current law, the federal fiscal outlook beyond this year is daunting: Projected deficits average about $600 billion per year over the 2011–2020 period. As a share of GDP, deficits drop markedly in the next few years but remain high—at 6.5 percent of GDP in 2011 and 4.1 percent in 2012, the first full fiscal year after certain tax provisions originally enacted in 2001, 2003, and 2009 are scheduled to expire. Thereafter, deficits are projected to range between 2.6 percent and 3.2 percent of GDP through 2020.
And the impact on debt:
Under current law, the federal fiscal outlook beyond this year is daunting: Projected deficits average about $600 billion per year over the 2011–2020 period. As a share of GDP, deficits drop markedly in the next few years but remain high—at 6.5 percent of GDP in 2011 and 4.1 percent in 2012, the first full fiscal year after certain tax provisions originally enacted in 2001, 2003, and 2009 are scheduled to expire. Thereafter, deficits are projected to range between 2.6 percent and 3.2 percent of GDP through 2020.
And none of this includes the cost of health care reform, the so-called Medicare Doc fix, extending some or all of the Bush tax relief, the new stimulus provisions, or any of the other expiring provisions. Ouch.
With a deficit outlook like this, the Obama Administration is being pushed in two directions these days. They face demands to increase federal spending in the short run to help the economy while also being told they need to cut spending in the long-term to address the deficit and debt.
One way to deal with this conflict is to substitute smaller, less expensive proposals for the broad, macro reforms that have characterized the Administration’s agenda. President Clinton adopted this approach for many of his State of the Union addresses. As CNN reported after his 1999 address:
President Bill Clinton’s 1999 State of the Union address was classic Clinton. It was another long laundry list of proposals, some conservative, some liberal… Clinton’s 77-minute speech was so overflowing with proposals that by the time it ended it was almost hard to remember that Social Security was the first and most important proposal of the evening. In previous years, commentators criticized Clinton for this approach, complaining that the State of the Union should be more focused. But this year, most commentators simply gushed.
So did viewers, who typically gave Clinton’s annual State of the Union speeches higher marks than professional commentators.
President Obama’s proposal to increase the child credit is a worthy successor to the Clinton approach. The proposal would increase the value of the credit, but not as much as one might expect. It’s not going to be refundable, which means most families with children would not benefit until their incomes rise above $40,000 or so. And it’s capped, so families above a certain income level don’t get it either. Nonetheless, offering middle class families extra child care assistance sounds great in a speech.
Given the current economic and deficit picture, we expect tomorrow’s State of the Union address to place more emphasis on proposals like the child care credit expansion, and less on health care reform and cap and trade.
Tax Outlook for 2010 — Starting in a Hole
The economic fear that gripped folks in the Fall of 2008 has resulted in a historic collapse of federal revenues.
Revenue collections since 1960 have stayed in a relatively tight pattern centered around 18 percent of our GNP. Considering the range of tax policies we’ve imposed on taxpayers during that time, the steadiness of the 18 percent mean is remarkable and suggests some sort of political or economic boundary is in effect.
That steadiness was broken last year when federal collections fell to their lowest level since 1950. Meanwhile, Washington’s response to the crisis has driven federal spending to levels not seen since World War II. Record low revenues and record high spending means record high deficits.
While record high deficits are obviously a negative, what your S-CORP team finds most troubling is the long-term outlook. For the next decade, the trend is definitely not our friend.
Once we get past the immediate effects of the “fear” and revenues move back to their historic mean, deficits of 4 or 5 percent GNP will persist. And when revenues move well above their historic mean? Deficits of 4 or 5 percent will persist.
And this is the baseline! It doesn’t include expensive policies that are either set to expire or those that are simply politically unsustainable.
Obama 2009 Tax Proposals vs. CBO Baseline Deficit
The chart above takes CBO’s September deficit estimates and superimposes CBO’s June estimates of President Obama’s 2009 tax proposals. Not exactly kosher, but the underlying point is undiminished: even the President’s modest policies to extend just part of the Bush tax relief would add hundreds of billions to the deficit each year.
“Unsustainable” is the word that comes to mind. Herb Stein once observed that unsustainable trends will not be sustained, which suggests these projected deficits are unlikely to become a reality, but that just means something has to give. Stuck between a rock (record deficits) and a hard place (a weak economy), there are simply no easy answers.
For S corporations, the challenge is to spend the next year demonstrating to taxwriters the economic importance of our community, especially as Congress grapples with the “too big to fail” concept for financial services.
S corporations were created to fight economic consolidation. They move economic power and decision-making away from Wall Street and on to Main Street. If policymakers want proactive policies that reduce the incidence of systemic risk, empowering closely-held businesses is a sure-fire means of doing so.
Health Care Pay-Fors
Health care reform is in the final stages of its legislative journey — last half of the fourth quarter perhaps? — and while the pro-reform team has plenty of momentum, exactly what tax items make it into the final package remain undecided.
Of most concern to S corporations are the marginal rate increases included in both bills. In the House, it is the 5.4 surtax applied to individual incomes above $500,000, while in the Senate it is the 0.9 percent HI tax increase applied to individual incomes over $200,000.
Moreover, recent stories on possible compromises should raise S corporation eyebrows. As first reported in CongressDaily, negotiators are considering expanding the Medicare HI tax beyond wages to include all types of income, including S corporation income.
According to JCT, applying the existing 1.45 percent payroll tax to investment income, including capital gains, taxable interest, dividends, estate and trust income and income from rents, royalties, S corporations and passive partnership income, to those earning above the $200,000/$250,000 thresholds would raise $111 billion over a decade.
S-CORP has a long history of fighting efforts to expand payroll taxes beyond, well, payrolls. Payroll taxes like the HI tax were designed to resemble private insurance premiums on the premise that Medicare and Social Security were “earned” benefits. This proposal would blur the line beyond taxes on labor and taxes on capital, undermine the notion that Medicare is an “earned” benefit, and should be of considerable concern to the business community.
GAO Releases S Corporation Report
In response to a request by Senators Max Baucus (D-MT) and Charles Grassley (R-IA), the Government Accountability Office spent the last year looking into tax compliance by the S corporation community. The GAO presented its findings in a report released yesterday.
Reports like this always carry with them a large degree of headline risk. Words like “noncompliance” and “misreported” jump off the first few pages. Look beyond the first couple pages, however, and the GAO has compiled a comprehensive review of the challenges S corporation face when calculating their taxes.
Questions covered by the GAO include why some businesses choose to be S corporations, what are the types of S corporation non-compliance, and what are the options for improving S corporation compliance. To answers these questions, the GAO interviewed numerous stakeholders, including the S Corporation Association, and, in their just-released report, came to the following conclusions:
- Congress should require S corporations to calculate and report the basis for their shareholders’ ownership shares;
- The IRS should research options for improving the performance of professional tax preparers;
- The IRS should provide additional guidance to new S corporations on calculating basis and compensation; and
- The IRS should require examiners to document analysis of compensation, and provide more guidance on compensation.Having given the report a first read, what is our reaction? First, the S corporation was created to encourage private enterprise, not avoid lawfully-owed taxes. We don’t support or help those taxpayers who knowingly avoid paying their taxes.
Second, the legislative recommendation included in the report is for Congress to require an entity-level basis calculation. According to the GAO, this proposal would help address the problem of shareholders claiming losses beyond their basis in the firm. This recommendation is new to S-CORP and we have asked our advisors to weigh-in on its merits.
Third, we’re glad to see the GAO agrees with us that the IRS has tools to address one of the larger areas of non-compliance. Some S corporation owners who work in their business underpay their salaries in order to reduce their payroll tax obligations. As the GAO notes, the IRS needs to do a better job of both defining the existing “reasonable compensation” standard in its guidance, and applying the standard in its examinations.
As to the headline risk, last summer the IRS reported that tax compliance by S corporations likely was as good, and possibly better, than taxpayers’ compliance in general. Meanwhile, the SBA reported last year that S corporations shoulder the highest effective tax burden of any business type. As an investor, as an employer, and as a taxpayer, S corporations are a valuable component of America’s business community. The GAO has given us some suggestions on how we can do better.
Value-Added Tax Coming to America?
Two weeks ago, the Senate Finance Committee released its summary of options to pay for health care reform. As expected, the list was long and could be divided up any number of ways. One item missing from the list, however, is a source of revenue folks are talking about for health care reform and other spending priorities too — a value added tax (VAT).
The Finance Committee summary followed the release of papers on improving health care delivery and expanding coverage. The key to all three papers is that, while they give the reader a sense of where the Committee is headed, the exact plan remains shaded by options and generalities. So are the costs.
Exactly how much will health care reform cost? Some advocates — including the Obama Administration’s top economists — argue that a properly structured plan would save the taxpayer money, but that’s mere rhetoric. Expanding health care coverage to more Americans will cost money. Lots of it.
That’s why President Obama’s budget set aside $326 billion in tax increases to help pay for health care reform, but that may not be enough. Most observers believe the ultimate price tag will be several times higher while many of President Obama’s proposed pay-fors are simply non-starters with Congress. Enter the latest idea of a pay-for — the value-added tax. The Washington Post reported last week:
With budget deficits soaring and President Obama pushing a trillion-dollar plus expansion of health coverage, Some Washington policymakers are taking a fresh look at a money-making idea long considered politically taboo: a national sales tax… A recent flurry of books and papers on the subject is attracting genuine, if furtive, interest in Congress. And last month, after wrestling with the White House over the massive deficits projected under Obama’s policies, the chairman of the Senate Budget Committee declared that a VAT should be part of the debate.
The story points out that, in addition to several well-placed congressional advocates, there are a few folks within the Obama Administration who support a VAT, such as Office of Management and Budget health advisor Ezekiel Emanuel (who also happens to be White House Chief of Staff Rahm Emanuel’s brother).
While this proposal is clearly far from becoming a reality, it is indicative of just how hungry Washington is for money these days that perhaps the most feared of all taxes — the VAT — is being floated as a possible revenue source.
How Progressive is Progressive?
The American economy is remarkably dynamic, with a large percentage of folks moving from one income group to another every couple years. This movement is often the product of life-cycle earnings, where workers earn little when they start out and then slowly increase their incomes until they reach their peak earnings years of around 40 to 65.
It stands to reason that mature job-creating businesses are highly profitable too. If they are structured as S corporations, then their income is subject to the effective tax rates illustrated above. Something to think about as the unemployment rates approaches 10 percent.
Canada Runs Surpluses
Who knew Canada was running surpluses these days? How did they do it?
First, they cut spending at the Federal level from more than half of their national income to less than 40 percent. That, in turn, produced budget surpluses that were used to pay down their national debt.
What’s the lesson here for S corporations? While Congress and the new Administration search the tax code for new revenues to offset new spending and reduce the deficit, the experience of Canada and others demonstrates that deficit reduction begins with spending restraint — not tax increases.
The Washington Post Discovers Small Employers
The Washington Post this week reported on an issue that shouldn’t come as a surprise for S-CORP readers: President Obama’s tax plans could hurt many of America’s small businesses. Small business owners who report their business profits on their personal income returns (like most small business owners do) are suddenly finding themselves classified as the “richest” Americans, and thereby subject to Obama’s tax increases. The Post explains:
Across the nation, many business owners are watching anxiously as the President undertakes expensive initiatives to overhaul health care and expand educational opportunities, while also reining in runaway budget deficits. Already, Obama has proposed an extra $1.3 trillion in taxes for business and high earners over the next decade. They include new limits on the ability of corporations to automatically defer U.S. taxes on income earned overseas, repeal of a form of inventory accounting that tends to reduce business taxes, and a mandate that investment partnerships pay the regular income tax rate instead of the lower capital gains rate.
The Washington Post is catching up to what S-CORP and its friends have been pointing out for a while now — if your goal is to reinvigorate the economy, placing additional burdens upon the very business that can help pull us out of this crisis is the wrong way to go. The example used by the Post — Gail Johnson of Richmond, Virginia — should give S corporation shareholders pause:
Johnson declined to say whether she voted for Obama. But she said she ignored his tax plans until her husband, who handles real estate and construction for the schools, mentioned it one day. “I’ve since talked to my accountant,” she said. “And, oh, my gosh!”
In a typical year, Johnson’s federal tax bill would be about $120,000. But starting in 2011, the higher marginal rates would add about $13,000 a year, Hurst said. Capping the value of itemized deductions at 28 percent would add another $10,000, for a total increase of $23,000.
And Johnson’s tax bill stands to grow dramatically if Obama were to revive a plan to apply Social Security tax to income over $250,000 instead of capping it at the current $106,800. Because Johnson is an employee and an employer, she would have to pay both portions of the tax, Hurst said, tacking another $30,000 onto her bill.
That’s a potential $50,000 tax increase for a small employer whose family earns about $500,000 a year, including the income from her business. It’s hard to see how increasing her federal tax bill (this does not include state and local taxes) from around $120,000 to $170,000 would not harm Gail’s plans to invest in her business and hire additional employees.
Budget Plan Finished
On that note, perhaps the most frustrating aspect of the tax increases outlined above is that they simply will not be enough. Federal deficits are going sky-high and higher taxes on the middle-class are all but inevitable. House and Senate negotiators this week put the final touches on the budget outline for next year. For S corporations, three major items stand out: total deficit estimates, the estate tax and the inclusion of reconciliation instructions for health care.
The Congressional Budget Office estimates that the Obama budget, if enacted, would result in deficits of $1.8 trillion, $1.4 trillion, $1 trillion, $658 billion, $672 billion, and $749 billion over the next five years. That’s a cumulative of $4.4 trillion over five years, or $1.7 trillion more than if we simply did nothing over the next five years and maintained current law.
The U.S. government has never run deficits of that magnitude and exactly how the debt will be financed is an open question. To put these five-year numbers in perspective, over eight years of President Bush — who is rightly criticized for not paying more attention to holding down spending – debt held by the public increased by $2.4 trillion. The budget offered up by conferees this week has deficit estimates that are smaller than the Obama budget, but not enough to address the question of who is going to finance all that debt.
Regarding the estate tax, the budget agreement calls for maintaining the 2009 rates and exemption levels of 45% and $3.5 million per spouse. While the Senate’s original budget allowed for higher exemption levels and a lower rate, the House ultimately prevailed and stuck with freezing the 2009 rules.
On the reform front, the resolution will include “reconciliation instructions” for health care reform. As S-CORP readers know, reconciliation is valuable to the majority in the Senate because it allows for controversial items to pass the Senate with a simple majority rather than the usual 60 votes.
There are limitations, however, because bills brought to the Senate floor under reconciliation may not increase the deficit outside of the budget window, which means whatever they enact under this budget would have to be sunset after five years.
S corporation shareholders know how these sunsets work — we have been dealing with the uncertainty of the estate tax repeal sunset for a decade now. How effective could broad-based health care reform be if it goes away in just five years?
Moreover, reconciliation bills may not include provisions with no or little impact on revenues and spending. The core provision in most health reform plans is to create a health insurance “exchange” similar to the Connector up in Massachusetts. This may or may not be a good idea, but it doesn’t have a significant impact on either revenues or spending and would likely fall outside of reconciliation. For a full review of these issues, we recommend reading the analysis of S-Corp ally Keith Hennessey.
Bottom line: Attempting to reconcile health care reform could cost the majority more than it’s worth, especially with Senator Specter now aligning himself with the Democratic Caucus.
Middle-Class Tax Increases on the Horizon
Last Wednesday’s The Hill included a comprehensive overview of the exploding spending and deficit picture and calls into question President Obama’s ability to live up to his long-held promise not to raise middle class taxes. It’s worth a look.
For the past half-year, your S-CORP team has focused on President Obama’s long-stated goal to pay for health care reform and his other spending priorities by raising taxes on American families making more than $250,000 per year, all while cutting taxes for middle-class families.
With the Federal deficit approaching $2 trillion this year, however, just how does one expand government, reduce the deficit, and cut taxes for a large swath of taxpayers – all financed by less than five percent of the population? As The Hill reports, skepticism that the Administration can pull it off is on the rise:
“President Obama’s proposed changes to the tax code, combined with exploding entitlement costs, will lead to ever-growing debt, according to independent estimates. The big question for Obama and his economic team will be whether he can meet the rising costs with increased tax revenue only from small slices of the electorate…Many economists, including some who voted for Obama, do not believe that he can indefinitely avoid imposing tax increases much further down the income scale — on the middle class.”
It is becoming increasingly obvious that taxes on the middle class – not just the “wealthiest” – will need to go up to pay for the Obama Administration’s ambitious goals. Exactly what sort of taxes? Len Burman at the Tax Policy Center thinks a value-added tax is inevitable. Just like France. Great.
CBPP to States — Tax Your Way to Prosperity
If higher taxes at the Federal level weren’t enough, the folks over at the Center on Budget and Policy Priorities (CBPP) have a novel recommendation for states hurt by the current recession — balance your books by taxing job creators!
In a report entitled “Reforming the Tax Treatment of S-Corporations and Limited Liability Companies Can Help States Finance Public Services,” the CBPP provides a blueprint for and encourages states to “consider imposing meaningful levies on S-Corps and LLCs as a source of additional revenue to help close the major budget gaps many of them are facing.” Sure, gaps like those created by the extra unemployment checks for folks laid-off when their over-taxed business closes.
Enough said.
Private Enterprise and Job Creation
On a more positive note, our friends at the Kauffman Foundation have taken the new Business Dynamics Statistics series at the Census Bureau and crunched the numbers a bit.
What they have found is presented in a series of short papers that does a great job of demonstrating the critical importance of start-up businesses to job creation. Key findings include:
- More than 100 percent of all net new jobs in any particular year can be attributed to start-up businesses. Or put another way, absent new business creation every year, employment in the United States would shrink.
- Remaining net job growth comes from firms more than a quarter century old. Their job creation levels are low compared to younger firms, but unlike younger firms, surviving older firms create more jobs than are lost when older firms close.
- States differ substantially on the portion of employment attributed to younger companies (less than 3 years old). In the West and Southeast, it’s up to 12 percent, while in the Midwest and Northeast, it’s about 6 percent.
How does this add to our understanding of job creation and job creators? The important role of start-ups and entrepreneurs has been examined for hundreds of years, but who knew that older, more mature firms were a source of net job creation? Findings like this put the whole estate tax debate and the importance of transferring businesses from one generation to the next into a whole new light.
Your S-CORP team is often amazed at the gulf between the rhetoric over jobs and the actions of some policymakers. Everybody talks about the importance of jobs and job creators, but the policies supported by some folks make you wonder just how deep their understanding and commitment goes.
The work at the Kauffman Foundation gives us critical insight into the job creation process. We hope policymakers — especially those engaged in estate tax discussions — will pay attention.
Congressional Budget Takes Form
Lots of budget related news in recent days with implications for small business taxpayers. First, the Congressional Budget Office weighed in last week with its analysis of the Obama budget outline and estimated that the Administration’s proposals, if enacted intact, would double the overall deficit over the next ten years. The numbers are truly staggering and should scare any reasonable person who plans to be a taxpayer over the next several decades. Starting with a deficit of around $1.8 trillion this year — easily the highest annual deficit since we were defeating Hitler — the ten year total is nearly $10 trillion dollars!
Obviously, deficits of this magnitude will have the effect of restraining efforts to increase Federal spending while placing additional pressure on Congress to raise tax burdens. That’s challenge number one for S corporation owners.
Next, both the House and Senate Budget Committees will take up their respective budget resolutions today, with the goal of getting a final budget in place before Congress breaks for the Easter recess in a few weeks.
For those who have bothered to look, the actual text of a budget resolution is disappointing. It’s primarily a list of budget functions and related spending numbers, most of which have little or nothing to do with the real process of establishing tax and spending policy.
The real meat in any budget is the total amount of discretionary spending allowed (the Appropriations Committee gets to divide it up from there), the overall ceilings on spending and floors on revenue, any reserve funds designed to protect specific initiatives from Budget Act points of order, and finally, and perhaps most importantly, any reconciliation instructions.
Reconciliation allows permanent changes in tax and mandatory spending to be enacted with a simple majority in the Senate, and usually signals what is really important to the leadership in Congress.
This year, the Senate chose not to include any reconciliation instructions while the House included them for health care reform. Cap and trade only got a reserve fund (see below for more on cap and trade), which reinforces the growing perception around town that of the three big reforms on the table — health care, climate change, and tax reform — the Administration and Congress have decided to make health care reform their priority for this year.
Small Business Roundtable
Last week, your S-CORP team spent a morning with House Small Business Committee Chair Nydia Velazquez, several other members of the Committee, and a large percentage of the small business organizations around town.
The point of the meeting was for Committee members to hear directly from small business groups on the issues important to them. Frequently mentioned topics included estate tax reform, LIFO repeal, depreciation and several deductions that are important when businesses have little or no income. Only two groups, your S Corporation team and the National Association of Manufacturers, raised the issue of individual tax rates and how they impact job creators.
Another S-CORP ally — Bill Rys from the National Federation of Independent Business — did a great job of making the same case on MSNBC the other day:
Visit msnbc.com for Breaking News, World News, and News about the Economy
Chairwoman Velazquez has been extremely proactive in making the small business perspective part of the debate in the House, especially when it comes to tax issues. Legislation she introduced last Congress included a number of small business friendly provisions, including full repeal of the non-resident alien restriction for S corporations (a priority of the S Corp Association).
With so many tax items on the table for this year and next, we expect to see many of the topics raised last week explored by the Committee in future hearings and really appreciate the willingness of Chairwoman Velazquez to reach out and listen to the concerns of the small business community.
Climate Change Coming
There’s the old line that everybody talks about the weather but nobody ever seems to do anything about it. Apparently, our friends over at the EPA don’t understand that it’s supposed to be a joke.
Last week, they sent the White House recommendations to make an endangerment finding for greenhouse emissions under the Clean Air Act. This finding is in response to the Supreme Court decision in Massachusetts vs. EPA.
If the White House signs off on the EPA’s recommendation — and all indications are it will within the next couple months — then that agency will have the ability to regulate an enormous percentage of economic activity taking place in the United States. If whatever you are doing has the potential to emit greenhouse gases into the atmosphere, then the EPA may have something to say about it.
We usually try to stick to tax policy here at the S Corp Association, but this issue is simply too big to ignore. Plus, the solutions being considered in Congress — primarily carbon cap and trade — are market based and would have the effect of placing a tax levy on carbon emissions.
Given the choice between the EPA regulating carbon under the forty year old Clean Air Act or Congress addressing it through a cap and trade system, many folks will choose cap and trade. For that reason, the failure of the Budget Committee to reconcile instructions for a cap and trade bill this year does not mean the issue will not come up. The EPA’s action last week may ensure that it does.
Stimulus Update
The Washington Post reports that the Senate Stimulus bill is short of the 60 votes needed for it to move through the chamber. As the Post noted:
Senate Democratic leaders conceded yesterday that they do not have the votes to pass the stimulus bill as currently written and said that to gain bipartisan support, they will seek to cut provisions that would not provide an immediate boost to the economy.
The vote in the House did not help, with all Republicans and 11 Democrats opposing the House version of the package. The unified Republican opposition in the House will likely empower Republicans in the Senate to stand together as well.
But the opposition rests not just with Republicans. Some Democratic members have expressed opposition as well. $800 billion in new spending and tax relief is a huge package, especially with the deficit already projected to exceed $1.1 trillion in 2009.
So what’s likely to happen? Look for moderates in both parties to put together a list of spending items that need to be cut in order for them to support the remaining package. As the Post reports:
Nelson said he and Collins have agreed to “tens of billions” in cuts, although he said he is skeptical that the effort will reach Collins’s target of $200 billion in reductions. The pair has counted up to 20 allies in their effort, with more Democrats than Republicans at this point.
Whether Senators Susan Collins (R-ME) and Ben Nelson (D-NE) find the right balance, or another group of Senators come to the table, we expect a compromise to be worked out over the next couple days. The Senate may be in this weekend, but it’s unlikely to leave without passing some form of the package first.
S Corps Lose an Ally
The S corporation community lost one of its greatest advocates the other day with the passing of Don Alexander. As our friend Martin Vaughn with Dow Jones reports:
Donald C. Alexander, who served as Internal Revenue Service Commissioner from 1973 to 1977, died Monday night at 87. Besides leading the IRS, Alexander held a wide range of other public service positions, including serving on the Commission on Federal Paperwork and as commissioner of the Martin Luther King Jr. Federal Holiday Commission. He was director of the U.S. Chamber of Commerce for five years in the 1980s. Most recently, Alexander was a partner at the law firm of Akin Gump Strauss Hauer and Feld LLP, from 1993 until his death. He was awarded the Silver Star and the Bronze Star for service in the 14th Armored Division during World War II.
Don was always a southern gentleman, and he was always focused on improving the rules for S corporations. He testified on behalf of the community before Congress many times. Here is just one sample of his views.
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.
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