On August 2, President Obama signed into law the Budget Control Act of 2011 (BCA), which sets spending levels for fiscal year 2012 and grants the President the authority to raise the federal debt ceiling. Business tax deductions and credits and passthrough entity taxation are likely to be affected by the report and deliberations of the new Joint Select Committee on Deficit Reduction (JSC) established by the BCA. Due to its extraordinary authority, the JSC has been called a “Super Committee.”
Joint Select Committee on Deficit Reduction
The BCA creates a powerful new 12-member committee with the authority to write tax legislation that will get an up or down vote in the House and Senate, bypassing the usual requirement for 60 votes to limit debate in the Senate and the requirement for a special rule for consideration of a bill in the House. The House and Senate leaders have now each selected three members, and seven of the 12 members will be needed to report legislation. But, even if the JSC fails to reach an agreement, its report will be made public and will likely become the basis for further negotiations.
The JSC is tasked with writing legislation that will cut federal spending and increase tax revenue by a combined total of $1.5 trillion in the next 10 years. The Congressional Budget Office projects $41 trillion in federal spending during this period, so the $1.5 trillion target amounts to about 3.5 percent of federal spending during the decade.
If the JSC fails to report legislation by a majority or Congress fails to pass it into law, the debt-ceiling bill calls for deep across-the-board budget cuts (sequestration) in all federal programs except a few low-income support programs. These cuts would go into effect in October 2012, unless Congress takes action to reverse them earlier in the year.
The chairs of the House and Senate tax writing committees — Michigan Representative Dave Camp and Wyoming Senator Max Baucus — are represented on the committee, and so are five other current and former members of the tax writing committees of Congress. The heavy representation on the panel by tax writing committee members suggests that the JSC won’t shy away from its tax jurisdiction. And, the selection of more recently elected members of the House and Senate such as Senator Rob Portman (R-OH), Representative Chris Van Hollen (D-MD), and Senator Pat Toomey (R-PA) may increase the odds that the JSC will strive to reach a consensus. Michigan is unusually well represented with two members: Mr. Camp and Representative Fred Upton (R-MI).
The ambition of the JSC members to reach an agreement is reflected in their opening statements at the JSC’s first meeting on September 8th. Co-Chair Patty Murray said that the JSC “has the opportunity to show the American people we can still come together.” And, Senator Portman made clear in his remarks that he and other Republicans on the panel are willing to consider “eliminat[ing] unjustified tax preferences” in order to simplify the tax code. Reaching agreement will not be easy by any means, but contrary to conventional wisdom, the JSC is not likely to deadlock over the unwillingness of the panel to consider any tax changes.
JSC members in both parties are acutely aware of the political consequences of failing to reach agreement, and they reportedly will try to exceed the $1.5 trillion goal.
Business Taxes on Committee’s Agenda
One document that sheds some light on the JSC’s tax agenda circulated on Capitol Hill last week. Prepared by the Democratic staff of the Committee on Ways & Means, the leaked document presents a menu of tax revenue raising options that would affect many business and individual taxpayers. Some of the new tax revenue would be set aside for deficit reduction and the remainder would be used to lower the 35% corporate tax rate to make the U.S. more competitive internationally. Among the most significant of these are the following:
- Super Pease — Named for former Congressman Don Pease of Ohio, this new limitation on itemized deductions would take back some of the benefit of a wide variety of tax deductions including the exemption for tax exempt bonds, state and local taxes, and the home mortgage deduction This provision is now the centerpiece of the revenue title of the President’s newly introduced American Jobs Act. It is projected to raise approximately $400 billion over 10 years.
- Carried Interest — Also included in the President’s new jobs bill, this thoroughly debated provision would change the way most partnerships are taxed, denting their popularity as an alternative to regular corporations. The proposal is aimed primarily at investment partnerships that generate capital gain income for their active owners, but it contains language that would impact every Limited Liability Company (LLC) seeking to compensate its employees with equity interests. Unlike incentive stock options, such interests would be taxed currently under the proposal.
- Passthrough Entity Payroll Tax — Under this proposal, the owner of an S corporation or LLCs whose earnings is “based on the reputation and skill of three or fewer individuals” would be subject to payroll tax on all earnings from the business. It is a common practice for highly compensated professionals to form LLCs or S Corporations to hold their businesses, and this has the potential to increase Medicare taxes on business earnings. Capital intensive service businesses could be impacted severely if this provision is enacted into law.
- Minimum Term for Grantor-Retained Annuity Trusts (GRATs) — This proposal is aimed at discouraging a common estate tax planning technique. It would require GRATs to have a term of at least 10 years and some remainder value.
In addition to the proposals listed by Democratic Ways & Means Committee staff, the JSC is likely to continue the work of its predecessors on business tax reform. The blue print for these efforts is likely to be the December 2010 report of the President’s National Commission on Fiscal Responsibility and Reform (the Bowles-Simpson commission).
Among the more popular recommendations of the Bowles-Simpson commission was to replace the current system of international business taxation with one where businesses are taxed only on their United States earnings. This territorial approach to business taxation is more consistent with the tax regimes of our major trading partners. A number of the JSC’s members, including Chairman Camp and Chairman Baucus, are believed to favor a change in this direction.
Joint Select Committee Process and Timeline
The statutory deadlines established by the Budget Control Act will make it difficult for the JSC to consider outside views or accommodate the detailed staff work that goes into sweeping changes to the tax code. The JSC is required to obtain a budget score from the Congressional Budget Office and the Joint Committee on Taxation prior to its ultimate vote in November. According to at least one JSC member (Senator Kyl), the Committee is practically required to deliver a set of recommendations to the budget scorekeepers by the end of October to meet the November 23 deadline. That will leave only four weeks when Congress is in session for deliberations or consideration of alternative plans. In practice, this will force the JSC staff to rely heavily on the work of the Bowles- Simpson panel and the talks chaired by Vice President Biden.
Here are the JSC’s statutory deadlines and major milestones:
September 9 — Committee adopts rules at organizational meeting.
September 13 — First hearing entitled “History & Drivers of the Nation’s Debt.” Congressional Budget Office Director Douglas Elmendorf was the sole witness.
September 22 — Second hearing entitled, “Overview: Revenue Options and Reforming the Tax Code.” Witness Thomas Barthold, Chief of Staff, Joint Committee on Taxation. Future hearings announced 7 days in advance.
October 14 — Deadline for House and Senate tax writing committees to report their deficit reduction recommendations to the JSC.
End of October — Informal deadline for JSC staff to deliver a package of recommendations to Congressional budget scorekeepers.
November 23 — Deadline for the JSC to vote on a staff recommendation to achieve the $1.5 trillion goal. The report must win support from at least seven of the 12 members, or else the JSC dissolves.
December 2 — Assuming the report wins a majority, implementing legislation is introduced in the House and Senate and referred to the committees of jurisdiction for one week of review.
December 9 — Deadline for all committees, including Senate Finance and Ways and Means, to review and approve or disapprove the legislation. The committees are not authorized to make changes. If they fail to report the legislation, the bill is automatically discharged or becomes subject to a discharge petition.
December 23 — Deadline for passage in the House and Senate. If the bill is not passed into law by this date, the BCA provides for $1.5 trillion in across-the-board cuts, beginning in FY 2013.
October 1, 2012 — Deadline for Congress to avoid across-the-board cuts in federal spending by enacting a JSC bill or some alternative.
As Congress returns to work this fall, there has been a surge of lobbying activity by businesses seeking to protect tax breaks that could be on the chopping block before the JSC. Intelligence about what changes JSC is considering seriously will be critical.
Even if the JSC fails to reach an agreement, the report it considers on November 23 is likely to have a strong influence on future tax reform legislation. If the JSC does reach the required 7 vote majority and approves a recommendation, the BCA will sweep away procedural hurdles, assuring an up or down vote on implementing legislation in the House and Senate.