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Dean Zerbe: The Debt Ceiling — Tax Increases Off The Table (7-25-11)

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As we head into the final turn of the debt discussion – while there is uncertainty about the final result (and when that result will take place) – there is growing clarity on the issue of taxes. What is the clarity on taxes? There will be no increase of taxes above current tax policy as part of the debt deal.  

Despite abuse from much of the press, demands from the administration and the threat of withholding cocktail party invitations from the chattering classes in Georgetown — the House Republicans have shocked Washington by ultimately holding firm against any tax increase above current tax policy as part of the debt ceiling.
 
Why do I say current tax policy? Because there has been a significant amount of hide-the-ball in discussions of tax policy with some – the Six Senators Proposal comes to mind — with discussions of a tax cut but within the framework of current tax law. Recall that under current tax law almost all the Bush/Obama tax cuts expire (yes, Obama added a fair amount to the Bush tax cuts when he came into office). So the proposals of cutting taxes from current law means in reality a result of hundreds of billions of dollars in tax increases over what individuals and businesses are paying today – current tax policy.   I don't know why people don't trust Washington.
 
For a useful discussion of the difference between current tax law and current tax policy and a general distillation of the Six Senators proposal, I suggest reading the following from Keith Hennessey: http://keithhennessey.com/2011/07/20/understanding-the-gang-of-six-plan/.  Regardless, the Six Senators proposal is going nowhere.
 
So what is going to happen? The tea leaves are still stirring in the cup but both Speaker Boehner and Leader Reid are now drafting proposals that will reduce spending and with no tax increases above current tax policy (with a big dollop of the savings probably coming from assumptions on ending/drawing down military actions in Afghanistan and Iraq). The symmetry of a debt ceiling increase equal to the spending reduction (i.e. reduce spending by a trillion, get a trillion dollar increase in the debt ceiling) has a good deal of appeal and salability. The administration is keen not to repeat this joyous exercise of the debt ceiling prior to the election but it is difficult to say the sky will fall if the debt isn't increased and then refuse to sign legislation because it only delays the sky falling for a few months.
   
However, it seems that Reid/Boehner should be able to find savings that will get everyone through the next 17 months (the election) and put the debt ceiling to bed until then.   Look for how much savings will be in year 1 – I'm always impressed by the mindset of Washington – “why do something today when you can do it tomorrow.”
 
Don't forget – after the debt ceiling is over Washington then comes back in September to another joy – the continuing resolution for spending which will basically take up most of the Fall. Look for House Republicans to make a strong push for immediate reductions in discretionary spending. Perhaps somewhere in there the Congress and the White House can look at doing a jobs bill – the tax provisions in the small business jobs bill passed in the Fall of 2010 would be a good starting point. 
 
Some tax issues of particular interest:
 
LIFO.  I had thought the LIFO (last in first out accounting) proposal would have been considered last Congress given the administration's support for it in the budget and the feeling of inevitability with the international accounting standards and conformity. Given the administration's hard push for LIFO reform, I would expect it to be part of future discussion – perhaps in tax reform or as a revenue raiser to offset a jobs bill. If the small and medium businesses press, it may be possible to have the LIFO repeal provision limited to just C Corporations – or perhaps provide a longer phaseout period for pass-thrus.
 
Carried Interest. As Eliza Doolittle would say: “Show me.” When the Democrats in the Senate and White House can actually agree on a carried interest provision I will believe something is going to happen on carried interest. Despite what you may read in the press, the key roadblock on carried interest is not the Republicans, it is Northeast Democratic Senators (and why it didn't pass last Congress). Perhaps the “Show Me” moment will finally happen for carried interest as part of tax reform or as a revenue raiser for a jobs bill – but until then look for speechwriters at the White House typing about stars burning above and carried interest.
 
Tax Reform. There was actually a moment in the sun about three weeks ago when reform was being seriously discussed – this was the Speaker Boehner/President Obama “go big” discussion. However, the sun of tax reform was soon eclipsed by a moon called “House Republicans.” The reality finally hit that tax reform that was really a stalking horse for a net tax increase over current tax policy (and/or allowing the Bush tax cuts to expire for the 200/250k crowd) was going to be a nonstarter with House Republicans.
 
To be clear, most Republicans in the House and Senate are quite comfortable with revenue increases, loophole closers (whatever you want to call them) to offset tax cuts – yes even regarding corporate jets (note: the Jobs Bill in 2004 drafted by Republicans and signed into law by Bush included a tax hit on executive use of corporate jets). However, revenue increases for the sake of revenue increases is a nonstarter for most House and Senate Republicans. Yes, many Republicans supported eliminating ethanol tax subsidies but that is to focus on a small one-time hole instead of the much larger doughnut.
          
Tax reform remains something that is going to take leadership from the White House or a Republican Presidential nominee. The Treasury Department needs to put forward a detailed plan to get this discussion going in earnest – but I fear the window is just about closed for this Congress. The idea that sweeping tax reform would come out of a small meeting between the Speaker and the President and be accepted by everyone else is eye-blinking.
 
As I mentioned in my previous column, I remain extremely concerned that those in Washington who talk about tax reform in the context of getting rid of business incentives, credits and deductions to lower the corporate rate are still failing to understand that if that is “tax reform” it will mean an increase of billions of dollars in taxes for millions of small and medium businesses that are overwhelmingly organized as pass-thru entities (LLC's, S Corp. etc.). Under this idea of tax reform, the small and medium businesses will no longer receive the benefit of the business credits and incentives and will therefore shoulder a greater tax burden – all to make life easier for the Fortune 500.
   
Another tax reform proposal that is being bandied about is to impose a vast new increase in taxes on successful small and medium businesses by requiring them to pay the corporate tax. I am at a loss to understand how a huge increase in taxes on that part of the economy that employs over 50% of Americans is going to create jobs. 
 
The S Corp. Association has a very thoughtful piece on this whole issue of tax reform and how it can mean a tax hike for pass-thrus that you can find here:  http://www.s-corp.org/2011/04/13/links-to-s-corp-study-and-press/. For now tax reform remains something talked about on cocktail napkins.
 
I appreciate your thoughts and views and especially welcome your ideas for tax policy to move the economy forward and create jobs. 
 
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Visit Dean's Blog at:
http://blogs.forbes.com/deanzerbe/ and share your comments!
 
Dean Zerbe is alliantgroup's National Managing Director. Dean was formerly Tax Counsel and Sr. Counsel on the Senate Finance Committee and was a key player in all the major tax legislation passed during his tenure. Dean speaks throughout the country and meets with accounting firms and their clients to discuss the outlook for short-term and long-term changes in tax policy as well as ways accounting firms can help their clients lower their tax bill.
 
Please visit the alliantgroup web site at www.alliantgroup.com