Last night’s presidential debate marked the beginning of the final phase leading to November’s presidential and congressional elections. To be sure, the next six weeks will be filled with speeches, policy proclamations, a wave of positive and negative advertisements, and plenty of politics.
But, at the same time, the 2016 election will have serious implications for the future. A change in elected and appointed policymakers resulting from a new president, administration, and Congress, will significantly impact the trajectory of a wide range of issues, including tax, financial services, immigration, trade, education, energy, and health care.
While it appears that the Republicans will maintain control of the House of Representatives and Representative Paul Ryan (R-WI) will remain speaker, Senate control is up in the air. Senate Republicans are defending 24 seats this term, currently holding a 54-46 advantage over the Democrats (including the two Independents that caucus with the Democrats). Democrats are targeting Republican incumbents in Illinois, Wisconsin, Indiana, Pennsylvania, New Hampshire, North Carolina, Missouri, Florida, and others, while defending Nevada (following current Minority Leader Harry Reid’s retirement). A Democratic pick-up of four seats, combined with a Hillary Clinton – Tim Kaine win (where Kaine would be the tie-breaking vote in the Senate), would give the Democrats control and would make Senator Charles Schumer (D-NY) the next Majority Leader. Should the Republicans hang on, however, Senator Mitch McConnell (R-KY) would remain the Senate Majority Leader.
The following alert, which is the first in a Steptoe series, highlights a few of the key public policy areas that a new administration and Congress (regardless of who controls the Senate) will grapple with. Please join us on November 10 as we break down the election and offer our analysis on what it means for you and your industry.
Small Business Tax Issues
Taxes were hotly debated last night by the two presidential candidates. One issue that will be central to any movement next year on tax reform is the treatment of small businesses. Currently, many small businesses are organized as passthroughs, such as partnerships, S corporations, and LLCs. These businesses do not pay tax at the entity level, but instead pass the income through to the individual owners to be taxed on the individuals’ income tax returns at individual rates. Obtaining the support of small businesses will be key to the political viability of any tax reform plan.
House Republicans have put forth a blueprint for tax reform that proposes a 25% rate on passthrough income. This is higher than their proposed rate for corporations (20%), but corporations would still be subject to a double tax at the corporate and shareholder levels. The proposal’s main significance is that it would delink the rates on passthrough businesses and individuals, which are currently taxed at a top rate of 39.6%. This change to the treatment of passthroughs reflects a push, mainly among Republicans, to tax all businesses similarly, regardless of how they are organized.
Donald Trump has put forth several versions of his tax reform plan that contain proposals to address the treatment of passthroughs. In prior versions, he also proposed to delink passthroughs and individuals and would tax all business income at 15% - a rate lower for both corporate and passthrough income than the House GOP blueprint. Unfortunately, his most recent proposal is less clear on how he would treat passthrough income. Originally, it appeared that he had dropped the proposal to include passthroughs in the lower business rate, perhaps in reaction to concerns about the cost (including passthroughs in the lower rate has been estimated to cost $1.5 trillion over a decade) or concerns about tax avoidance (it would encourage individuals to run all their income through passthroughs to obtain the lower rate). However, the Trump campaign has also stated that the proposal does include passthroughs, winning support for the proposal from the small business group, the National Federation of Independent Business (NFIB). But there have been further suggestions that the proposal might be a hybrid approach—passthroughs would pay the 15% rate on income retained in the business and then the individual owners would pay tax on their individual returns when the income is distributed to the owners.
Interestingly, if Mr. Trump’s intent is indeed to add a second layer of taxation on passthroughs, his proposal has moved away from the House GOP blueprint and appears more similar to a proposal by the Obama Administration. The Obama Administration’s 2012 Framework for Business Tax Reform proposed an option to raise revenue to pay for a lower corporate rate by creating greater parity between passthroughs and corporations through an entity-level tax on large passthroughs.
Hillary Clinton has not addressed structural changes to the way passthroughs are taxed, though she has proposed changes regarding how individuals are taxed,which, under the current system, directly impacts the tax on passthrough income. Her proposals include increasing taxes on certain high-income individual taxpayers as well as creating a new standard deduction for small businesses and increasing the deduction for start-up expenses. She has also proposed to allow small businesses to immediately expense up to $1 million in new investments and to simplify the accounting rules for small business.
While the first presidential debate did not focus on financial regulation, regardless of the presidential election outcome, Dodd-Frank Act implementation will continue, meaning a range of regulations will progress at the SEC, CFTC, Federal Reserve, and Consumer Financial Protection Bureau. At the same time, more controversial pieces, including the CFPB’s organizational structure and oversight, as well as the Department of Labor’s fiduciary duty rulemaking, will be the subject of ongoing scrutiny and criticism from Republicans on Capitol Hill.
Regardless of the outcome of the Senate elections there will be a change in the leadership of Senate Banking Committee. Current chairman Richard Shelby (R-AL) is term limited in his chairmanship and the gavel will go to either his Republican colleague Michael Crapo (R-ID) or, if the Democrats obtain a majority, Sherrod Brown (D-OH). A new chair will bring significant change in the priorities of the committee, which could have a profound impact on the legislative process and, importantly, the role of Congress overseeing the work of financial regulators.
The Financial Stability Oversight Council, established by the Dodd-Frank Act, will likely continue its work related to systemic risk oversight and systemically important financial institution designation, including oversight of asset managers, orderly liquidation authority, money market reform, global over-the-counter derivatives markets, and high-frequency trading. And, depending on who next occupies the White House, Glass-Steagall, tax reform, international trade, transaction taxes, and other issues could be the focus of attention in 2017.
The inauguration of a new administration means that there will likely be new leadership at the Treasury Department and other Cabinet-level offices, as well as independent regulatory agencies like the SEC and CFTC. Each of these positions will require Senate confirmation, which makes control of the US Senate even more important for the next administration. If the Senate and the White House are held by the same party, installing a slate of officials is a much easier task than if the Senate is led by the president-elect’s opposing party.
Senate Energy Chairman Lisa Murkowski (R-AK) and Ranking Member Maria Cantwell (D-WA) are proceeding with their House Energy & Commerce Committee counterparts, Chairman Fred Upton (R-MI) and Ranking Member Frank Pallone, Jr. (D-NJ), to complete the first major energy policy reform package in nine years. On September 8, Senate and House conferees met in an open meeting regarding S. 2012, the Energy Policy Modernization Act of 2016 and continue their work to arrive at consensus legislation that can be signed by the president.
In a dramatic show of cooperation, Majority Leader Mitch McConnell (R-KY) and Senator Sheldon Whitehouse (D-RI) are featured on S. 3179, Senator Heidi Heitkamp's (D-ND) carbon capture tax credit legislation, otherwise known as 45Q. This bill, if passed, would extend and expand the tax credit provisions found in 45Q of the tax code offered to qualifying energy producing facilities that implement carbon capture, utilization, and storage technologies to reduce CO2 emissions. It is expected that tax credits for geothermal energy and other 48C recipients would be added to the legislation at the request of Senate Minority Leader Harry Reid (D-NV) prior to any passage, either as a standalone bill or attached to a spending bill where many tax extenders are found in recent years.
Finally, in a surprise turn earlier this year, the president's climate change agenda hit a speed bump when the Environmental Protection Agency’s (EPA) Clean Power Plan was referred to a panel of federal appeals court judges for review. During the stay, legal experts on both sides of the argument were given time to prepare their case now set to be argued later today. At issue is the administration's executive actions to limit carbon emissions. Lawyers will argue whether the president's executive authority extends to requiring that states set forth plans to meet goals set out by EPA and in line with the December 2015 Paris climate conference agreement (COP21). Any judicial decision will have a significant impact on the energy policy platforms for the next president regarding executive branch constitutional authority and climate change policy.
Presidential Nominations and Senate Confirmation
Under legislation enacted in 2010 and amended in 2015, each presidential campaign already has in place a “presidential transition team” that has started to vet potential appointees for cabinet and other key positions in the new administration. In the past, these transition activities were conducted more or less secretly, in order to avoid charges that the presidential candidate was “measuring the drapes”; now, the campaigns are taking at least tentative steps to anticipate the need to stand up an administration, following Inauguration Day, with hundreds of political appointees eager to undertake presidential appointments.
Vetting executive branch appointees has become both a political and a technical challenge. From a technical perspective, elaborate regulatory rules, broadly described as “government ethics,” pose significant obstacles and require expertise and a thorough understanding of multidisciplinary standards. Each potential nominee must navigate through various “filters,” including security background checks, reviews of financial holdings for potential conflicts of interest under applicable criminal law, and an audit-like analysis of multiple years of tax returns in order to determine whether the nominee has complied with his or her tax obligations.
This vetting process takes place in the context of heightened scrutiny and in a politically charged atmosphere that encourages even relatively minor technical infractions to be used to challenge the new administration, and to threaten reputational damage to individuals who seek to serve in the new administration.