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By Bob Van Heuvelen
and Diane Major of VH Strategies.
Overview:
At the outset of President Barack Obama’s second term, Washington
is again engaged in battles to determine the size and scope of government. Both
sides agree about the need for comprehensive tax reform. The prospect for such
reforms, however, remains unlikely in consideration of the current legislative
environment.
President Obama spoke about the need to reform the tax code
in his 2013 State of the Union address, which was a key theme of his 2012
speech as well. Further, the nation’s top tax writers, Senator Max Baucus
(D-MT), the Chairman of the Senate Finance Committee, and Congressman Dave Camp
(R-MI), the Chairman of the House Ways and Means Committee, have forged ahead
in hopes of reaching an agreement. In a symbolic move, House Speaker John
Boehner (R-OH) and Congressman Camp announced that the HR 1 slot had been
reserved for a tax rewrite, prompting Rep. Camp to state he has a “green light”
for tax reform. In addition, Camp went on reiterate his goal of having his
committee act on a bill this year.
In spite of this recent activity, comprehensive tax reform
remains elusive. While both sides agree the tax code should be simplified,
there is still a wide gulf between the parties on how to apply the potential
savings associated with the elimination of so-called “tax expenditures,” or tax
loopholes. For instance, Republicans assert that the funds should be devoted to
lower rates for corporations and individuals, and Democrats propose using the
funds to eliminate or delay certain budget cuts, e.g. sequestration. At this
juncture, neither side appears willing to compromise on its stated position. Background 2011 - 2012:
The past two years have been dominated by the Budget Control
Act of 2011, which raised the U.S. Treasury’s borrowing limit past the 2012
presidential election and created the Joint Select Committee on Deficit
Reduction (“the Super Committee”). The budget measure dictated that, should the
Super Committee fail to achieve its deficit reduction target by January 1,
2013, an amount equal to $1.2 trillion would be automatically “sequestered” over
10 years. The savings would be divided between two core areas of government
spending: defense and domestic discretionary spending, along with a reduced
amount to Medicare (including certain exemptions, e.g. military personnel
salaries, but not civilian salaries).
At the end of 2012, Congress passed the American Taypayer
Relief Act to avert a host of expiring tax policies collectively referred to as
“the fiscal cliff.” Among the provisions in this bill were the following:
· Permanent extension and modification of the 2001
and 2003 tax cuts passed by President George W. Bush, with an exemption for the
top income brackets;
· Permanent extension of the Alternative Minimum
Tax patch;
· Temporary extension of a number of expiring
business tax provisions collectively known as “tax extenders;”
· Temporary extension of certain tax provisions
originally included as part of the American Recovery and Reinvestment Act;
· One-year delay of the enactment of cuts to
the Medicare Sustainable Growth Formula, also known as the “doc-fix;” and
· A three-month delay of the implementation of the
first year of sequestration.
The fiscal cliff package notably did not include an
extension of the payroll tax holiday of 2% enacted in for 2011 and 2012.
Current Outlook 2013 - 2014:
Coming out of the fiscal cliff agreement, the prospect for
comprehensive tax reform remains closely tied to a series of self-imposed
legislative deadlines, including:
· March 1: Sequestration begins to take effect;
· March 27: Continuing Resolution funding federal
government operations expires; and
· May 18: Statutory debt limit imposed on Treasury
is reached; “extraordinary measures” available to the Secretary are expected to
allow borrowing until at least August.
Democratic proposals to avert the sequester have centered around
core principles of tax reform. President Obama proposed an additional $1.5
trillion in deficit reduction to replace the sequester permanently, evenly
split between spending cuts and revenue generated through the closure of
certain tax expenditures. Initially, Republicans raised concerns about the
across-the-board reductions but now are resigned to allow the cuts to take
effect on the basis that the executive branch has the authority to reprogram
critical areas where necessary.
The discussion of tax reform is caught in the middle of
these budget debates. Attention that may have been paid to a comprehensive
discussion is being subsumed by these upcoming legislative deadlines. Congress
was expected to have used this spring to evaluate corporate and individual rate
tax proposals but instead, they are mired in last-ditch efforts to avert
sequestration and keep the government operational. In the context of
budget-related bills going through Congress, some industries are also eyeing
opportunities to repeal other tax provisions, such as the medical device
tax.
Chairman Max Baucus of the Senate Finance Committee and his
counterpart, Chairman Dave Camp of the House Ways and Means Committee, have
both expressed reservations about taking a piece meal approach to tax reform in
the context of the ongoing budget issues. Most recently, Senator Baucus and
Congressman Camp have continued to pursue a parallel process in hopes of
passing tax reform through regular order, out of both committees of
jurisdiction. Congressman Camp unveiled 11 bipartisan Ways and Means Committee
Tax Reform Working Groups in the Ways and Means Committee, ranging from small
business to energy. Senator Baucus has been working with other members of the
Finance Committee to develop a white paper with options for tax reform, which
could be reduced to draft legislation that could be released as soon as the
spring.
If a serious effort to engage in comprehensive tax reform
does get underway, proposals will likely focus on the following areas of tax
policy:
Tax Expenditures
On February 1, the Joint Committee on Taxation released its
annual report on corporate and individual tax expenditures for the years
2012-2017, estimating that these tax expenditures will cost the United States
$1.3 trillion over that period. This estimate includes $1.1 trillion in
individual deductions, and $200 billion in corporate deductions.
In the abstract, these figures represent tax policy ripe for
reform. As the chart below makes clear, these provisions cost significant amounts
of money, add lots of complexity to the code, and could be applied toward some
larger goal of reform. However, nearly all of these provisions are politically
difficult if not impossible to target for removal. See below for a list of the
largest tax expenditures for FY 2011:
A large-scale reform effort that targeted a significant share
of this revenue is unlikely at this time under the advisement that someone’s
loophole is someone else’s income. A Congressional Research Service report on
tax expenditures from last year argued, “given the barriers to eliminating or
reducing most tax expenditures, it may prove difficult to gain more than $100
billion to $150 billion in additional tax revenues through base
broadening.”
There are several politically vulnerable tax breaks that
have received great attention in recent legislative proposals. Earlier in
February, Senate Democrats partially paid for their proposal to avert
sequestration by proposing to repeal tax breaks for oil and gas exploration and
a deduction for moving expenses for companies that move jobs overseas. Sources
among key Republicans report that the elimination of certain tax exemptions may
be able to garner Republican support, most notably the elimination of the
carried interest deduction. While not included in the Senate Democrats’
proposal to avert sequestration, major revisions of the carried interest
provisions were also proposed by President Obama in several of his past budget
proposals. In his State of the Union address, President Obama highlighted other
vulnerable provisions, such as tax deductions for corporate jets.
Corporate Tax Reform
In recent years, there has been a growing consensus about
the need for comprehensive corporate tax reform as both a potential source of
revenue and means to ensure the competitiveness of US companies in a global
economy. Statutory corporate tax rates in the United States are among the
highest in the world. The conceptual framework of a majority of the
proposals has been to achieve revenue-neutrality by eliminating tax
expenditures and broadening the base to provide for lower corporate tax rates.
There remains disagreement, however, about what the corporate rate should be
and how profits generated in other countries should be taxed.
Elements of corporate tax reform proposed by President Obama
include: following the traditional notion of lowering corporate rates and
broadening the base by eliminating certain tax expenditures. Others, including
Ways and Means Committee Chairman Dave Camp have suggested even more robust
reforms, calling for a move away from the current system of corporate taxation
to a purely territorial system. Camp’s proposal would tax US companies only on
income earned in the United States, which proponents argue would increase
American competitiveness and give an incentive to repatriate profits at home.
Opponents dispute the incentives for repatriation in a territorial system and
suggest it would enable further tax avoidance.
The prospect for corporate tax reform remains largely
dependent on a re-writing tax laws for individuals. It is important
to note that corporate and individual tax reforms are inextricably linked. Tax
writers fear that moving to lower corporate rates without addressing
individuals will result in an unintended consequence: the widespread creation
of tax shelters through various corporate entities.
Individual Tax Reform
American taxpayers collectively paid upwards of $1.2
trillion to the U.S. Treasury last year, according to the Joint Committee on
Taxation. As discussed in previous sections, there is a potential for sizable
revenues to be realized through the reduction of certain tax preferences. These
efforts are unlikely to succeed in such a politically charged environment.
Moreover, the enactment of the American Taxpayer Relief Act
effectively closes down the possibility for additional base broadening.
Individual tax rates were “settled” for the foreseeable future, raising taxes
on top earners making over $400,000, and families earning over $450,000.
Additionally, in consideration of the corporate elements of any reform package
and the impetus for deficit reduction, we see additional movement on individual
rates as unlikely. While Democrats have proposed implementing the so-called
“Buffet Rule,” which would require a minimum effective tax rate for certain
high-income individuals, Republicans have continued to oppose any further
increases. As Senate Minority Leader Mitch McConnell (R-KY) stated shortly
after the bill’s passage, “the tax issue is finished, over, completed.”
Recent comments from Senator Lindsay Graham (R-SC) and
Congressman Scott Rigell (R-VA) in support of new revenue as part of a larger
fiscal agreement suggest that this issue may not be entirely “over.”
However, the Republican leadership has continued to maintain its hardline revenue
position, rejecting any new revenue increases and insisting that tax
expenditures only be considered in the context of comprehensive tax
reform.
Conclusion
The current political environment will make enactment of a
significant reform package this Congress very difficult, although a smaller
package is potentially viable. This kind of proposal would eliminate
politically vulnerable tax preferences, and plow the savings into a deficit
reduction effort. Other marketable ideas include “simplification” of the tax
code, aimed at improving the efficiency of several tax provisions, like the
consolidation of tax advantaged savings accounts or the refinement of tax
preference for charitable giving. It remains possible that tax writers will
choose to use the revenues from the reform package to lower corporate rates,
though we deem this to be less likely.
The prospects for a “Grand Bargain,” however, are
limited. The notion of a large deficit reduction package that addresses
both taxes and spending may be enticing enough politically to both parties such
that they would be willing to make the hard choices involved with significant
tax reform. Absent this vehicle, tax reform is even less likely in such a
divided Congress.
