Congressional Legislative Tax Preview 2012: Low Expectations but High Drama

The ensuing year will focus Congressional attention on the national economy and various proposals by both political parties on measures to increase employment, investment and growth. It will also be a crucial year in addressing, or at least, laying a foundation for major revisions of the individual and corporate tax regime. There are apparent and real differences between Republicans and Democrats, which will have a profound impact on the results and accomplishments or lack thereof.

 This preview will identify the major areas of possible action and the politics that influence the process. 

Employment Tax Relief

The House of Representative and the Senate passed H.R. 3630 in late December. The bill is currently in conference and will be the center point of tax legislation for the next month.

 The bill has a number of provisions dealing with unemployment insurance and physician’s Medicare payments. However the biggest piece is the extension of the employee payroll-tax break originally passed in December 2010 to provide a one-year boost to an ailing economy. It was part of a package that also extended for two years the Bush-era tax cuts of 2001 and 2003.

The House bill also contains a number of other revenue items to wit: Extension of increase of bonus depreciation from 50% to 100%; Expansion of election to accelerate alternative minimum tax credits in lieu of bonus; Social Security number requirements to claim the refundable portion of the child tax credit; Excise tax on unemployment compensation benefits of high-income individuals; Repeal of certain shifts in the timing of corporate estimated tax payments.

The employee portion of the payroll tax taxpayer was reduced in 2011 by 2 percentage-points from the old 6.2% to 4.2% (the employer’s rate is unchanged) and was continued in December in a raucous extension until end of February. It is highly likely the tax rate reduction tax will be extended again to the end of 2012. However, the real issue is how to accommodate the revenue loss in a tight budget. Indeed, the conflict is how to “pay for” it along with a number of other non-tax provisions. The challenge for Congress is to come up with approximately $160 billion. In the end, some sort of unsatisfying solution will be found but it is not likely to contain any major revenue increases.

Expired and expiring tax provisions

According to the Joint Committee of Taxation, there are 60 tax provisions that expired in December 31, 2011 and another 41 that will expire at the end of this year. The size and magnitude of these provisions range from several billons of dollars a year to those that for budgetary purposes get an asterisk. The U.S. Senate Finance Committee held a hearing on the long-term fate and philosophy of expiring tax provisions on January 30.

 As a general rule, the extenders have considerable support in Congress. However, these are not normal times. Budgets are tight and deficits are huge. Congress has a number of budget busters on the table including the payroll tax extension, extended unemployment compensation, and physicians’ Medicare payments that will cost the Treasury hundreds of billions of dollars with no agreed way to cover even part of the cost. Expiring provisions have become a sort of orphan child.

As for the extenders, there is no easy legislative path back to life. A stand-alone tax bill in the Senate most likely would bog down and eventually stalled. It is unlikely the House Republicans will roll out their own bill given their track record on these matters.

 The easiest way to extend the expiring provisions would be the employee payroll tax reduction extension in Conference now. However it is unlikely the extenders ride the back of that beast. 

Of course, the mother of all expiring tax provisions are the tax cuts of 2001 and 2003, the Bush tax cuts, which expire at the end of this year. This will be a leading issue during the election campaign.

The “extenders” have no clear path for approval in the next few months and it is a political risk to rely on eventual extension. However because of the political support from divergent Members, these bear following closely.

Recent Administration Proposals

 The State of the Union address on January 24 contained a few proposals by the President. It should be noted the Federal Budget to be submitted on February 13 will contain many more tax proposals, most of them submitted and rejected before by Congress. In a sense, they are mere placeholders to make the numbers look better and everyone realizes the fact.

 The President’s main focus is to urge enactment of high tax levies on the “wealthy”. This has been a constant theme and the President has been consistent in wrapping this mantra in his concept of fairness. This “tax the wealthy” chorus is mostly a political argument of the liberals but the conservatives have also lost their way, which has led to an impasse. Expect the Senate to continue to bring this up over and over.

The President has often criticized the tax treatment of multi-national firms. Instead of attacking foreign tax deferral, he is now proposing a different tact: U.S. companies with foreign operations pay a minimum tax on overseas profits. A company would have to pay a difference between their foreign tax and a new unspecified minimum tax. In this case, the Administration’s goal of trying to encourage jobs and domestic expansion by U.S. companies is understandable but this proposal is misdirected and will not move forward.

The President further wants to deny companies a business expense deduction for costs associated with moving a company’s operations overseas. In a similar vein, the President wants a new tax credit to cover moving expenses for companies closing production overseas that brings jobs back to the U.S. These proposals are largely symbolic as companies make these kinds of decisions based on other factors rather than a business expense deduction or credit. 

Finally, the President proposed to reduce tax rates for manufacturers, with extra breaks for high-tech. Reviving manufacturing is a great goal but in order to do so requires so much than a selective tax break. These companies have shut down, moved overseas for many reasons and the type of proposal made by the Administration will not change that situation.

Tax reform

It is almost universally accepted in Congress the current tax system is a wreck. There has been increased recognition the Code needs simplified, the tax based broadened and rates adjusted. On the individual side, that is about as far as it goes. The differences between the Parties are too great, with Democrats pushing concepts like the “Buffet Tax” on the wealthy and Republicans essentially opposed to increasing revenue at all.  This situation will continue at least until after the election.

However, on the corporate side, there is more support to reforming the Code. Corporate rates are viewed as too high and the proper taxation of multi-nationals is being discussed. The Administration has been working on a corporate tax reform proposal for some time and it could be released this spring.

On the House side, the Ways and Means Committee has released a draft outline of changes, which would drop the top corporate rate to 25%. In addition, it would provide a transition from the current worldwide system of taxation to a territorial one. Under the proposal, 95% of foreign profits would be exempt from U.S. taxation when profits are brought back to the United States from a foreign subsidiary.

Corporate tax reforms will eventually happen-if not this year, then next.  Every corporate business, whether multi-national or not, should be watching these developments very closely.

Small business and Job Creation

Both House and Senate will have proposals to help small business. House Republican will unveil their package next month. The Administration released its own ideas this week. It is a popular notion and some action may occur. However, with many of these job creation ideas, the cost to the Treasury is a real hindrance to enactment.

Political

 The House Way and Means Committee has been much more active than its Senate counterpart, the Senate Finance Committee. Chairman Camp has been pushing corporate tax reform and works closely with the House Leadership to move tax proposals, most of which are never taken up in the Senate. Senate Chairman Baucus has been reluctant to push his Committee to mark up legislation and bring proposals to the full Senate. In that respect, the power and influence lies more with Majority Leader Reid. 

The tax system has been used and abused in the last 40 years to create incentives, disincentives, pick winners and create losers. In the past, Congress has not been hesitant to cut taxes. However, the situation has changed due to the enormous budget deficits, now projected to be over $1 trillion for each of the last four fiscal years. The concern about these deficits, the expanding roles of government, the “tea party” movement and the class equity populists have changed the rules.

Summary

The budget, deficits, job creation and the economy will dominate Congress this year. Taxes will be at the center of political conflict between liberals and conservative. However, it will be an important year, with an occasional opportunity, to lay the groundwork to act and react once the election has passed.