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Annette Nellen
Annette Nellen

Many questions about the "Path to Prosperity"

What does the House Budget Committee's fiscal plan mean for business tax reform?

April 26, 2012
by Annette Nellen, Esq., CPA

Last month, the House of Representatives passed a budget resolution (H.R. Con. Res. 112, 112th Congress (3/29/12)) that included a general call for tax reform along with a few specific reforms. A week earlier, the House Budget Committee voted favorably on a budget proposal that also endorsed the report of Chairman Paul Ryan, R-Wis., titled, The Path to Prosperity (3/21/12 committee vote). This article provides an overview of the tax aspects of this budget resolution and observations on what is missing from the proposals. (For a comparison of President Barack Obama’s and former Massachusetts Gov. Mitt Romney’s corporate tax proposals, see Christian, “Corporate Tax Overhaul Proposals: Obama vs. Romney,” Corporate Taxation Insider (April 26, 2012).)

The budget resolution

The following is an excerpt from the House report, H.R. Rep’t 112-421, 112th Cong., 2d Sess., Concurrent Resolution on the Budget: Fiscal Year 2013 (3/23/12), which highlights how the resolution is both specific (by specifying the rate structure) and too general (discussing the “burdensome tangle of loopholes”):

Individual tax reform: The current code for individuals is too complicated, with high marginal rates that discourage hard work and entrepreneurship. This budget embraces the widely acknowledged principles of pro-growth tax reform by proposing to consolidate tax brackets and lower tax rates, with just two rates of 10 and 25 percent, while clearing out the burdensome tangle of loopholes that distort economic activity.

Corporate tax reform: American businesses are overburdened by one of the highest corporate income tax rates in the developed world. The perverse incentives created by the corporate income tax do a lot of damage to both workers and investors, yet the tax itself raises relatively little revenue. This budget improves incentives for job creators to work, invest, and innovate in the United States by lowering the corporate rate from 35 percent to a much more competitive 25 percent and by shifting to a territorial system that will ensure a level playing field for American businesses. [H.R. Rep’t 112-421, p. 10]

More specifically, but still with many missing details, the House report to H.R. Con. Res. 112 notes the following proposed tax changes:

  • Repeal all tax increases included in the 2010 health care legislation (p. 148).
  • Social Security reform to “prevent severe cuts in future benefits.” The report notes that lawmakers must work together to ensure solvency of the program (p. 103). It observes that a bipartisan approach is possible and refers to the proposal of President Barack Obama’s National Commission on Fiscal Responsibility and Reform that released a report in December 2010 (p. 103).
  • “Responsible” reductions to the IRS to accompany creation of a simpler tax system (p. 112).
  • Extend the 2001, 2003, and 2010 tax cuts (p. 148).
  • “Simplifying the Tax Code and Promoting Job Creation and Economic Growth” (p. 124):
    • Reject the president’s tax increase proposals.
    • Move to a 10% and 25% rate structure for individuals.
    • Reduce the top corporate rate to 25%.
    • Repeal the alternative minimum tax (AMT).
    • Broaden the income tax base to generate revenue at the appropriate level designated in the budget resolution for the next 10 years and at 18% to 19% of GDP thereafter.
    • Move from a worldwide to a territorial system, in which companies are taxed on the income earned in the taxing jurisdiction rather than on their worldwide income.
  • A 20% deduction for small businesses (p. 148).

Ryan’s 99-page report, The Path to Prosperity, is similar to the House resolution and provides reasons for the proposals.

Observations

Details missing:
As with most current calls for tax reform, many details are missing from H.R. Con. Res. 112 (see Nellen, “President Obama’s Business Tax Reform Plan,” Tax Insider (March 8, 2012), and “Pushing for Specifics on Tax Reform Proposals,” Tax Insider (Nov. 10, 2011)).

Small business taxation:
H.R. 9, the Small Business Tax Cut Act, passed the House by a vote of 235-173 on April 19, 2012. It would add a new Sec. 200 to allow all small businesses, regardless of entity form, a special deduction for the first tax year (only) beginning after 2011. A small business is one with fewer than 500 full-time equivalent employees in either calendar year 2010 or 2011. Per the House report, H.R. Rep’t 112-425, 112th Cong., 2d Sess. (4/10/12), accompanying H.R. 9, the purpose is to “help free up additional resources allowing small businesses to create more jobs” (p. 5).

Unlike H.R. 9, which provides that the special deduction is just for one year, H.R. Con. Res. 112 may intend for the 20% small business deduction to be permanent. If so, it increases complexity for many businesses. The dissenting views included in H.R. Rep’t 112-425 note that the special deduction applies to 99.6% of all businesses (p. 38). H.R. 9 includes, though, a deduction limit tied to W-2 wages paid. Thus, the 99.6% applicability rate seems high, as sole proprietors without employees appear to be ineligible for the new deduction.

Sec. 200, which would operate in a similar manner to the Sec. 199 manufacturing deduction, is almost 2,000 words long and intersects with several other Code sections, most notably those that define modified adjusted gross income (MAGI). Any gross receipts considered in computing the Sec. 200 deduction may not be considered for Sec. 199 purposes. Thus, many small businesses will have multiple calculations to determine which is more advantageous--Sec. 199 or Sec. 200.

The 20% small business deduction also raises the complexity issue of the many ways that “small” is defined in the tax law. The dissenters to H.R. 9 note that using measures of revenues or assets, many of the covered businesses would not be labeled as small. Can tax reform also include eliminating multiple definitions for the same term? (See Nellen, “The Many Sizes of ‘Small,’” Corporate Taxation Insider (Oct. 28, 2010).)

Sec. 200 violates the transparency principle in tax provisions in that the deduction is not for a specific expenditure, but instead is intended to lower tax liability. It is a disguised rate reduction that will make it difficult for businesses to know their marginal tax rate for planning purposes.

If there is a desire or need to provide a lower-than-25% rate for small businesses, why not provide for it via the rate structure for individuals and corporations?

Revenue:
What will be the short-term and long-term effects of H.R. Con. Res. 112 on the deficit and debt?

Looking forward

For tax reform to occur, a significant issue to resolve is how the Obama Administration and Congress will handle conflict resolution. H.R. Rep’t 112-421 to the recent budget resolution includes language that illustrates the challenge in finding bipartisan agreement on how to reform the tax law. Per the report (p. 123):

The outline for corporate tax reform released by the administration in February . . . falls woefully short: the rates are too high; the tax base is too narrow (and used as a tool to provide political favors); and the international reforms are anti-competitive.

By contrast, the principles of reform outlined in this budget ensure a simpler, fairer tax code not just for large corporations but for small businesses and American families as well. Unlike the administration’s plan, it improves the competitiveness of American workers and businesses in the global economy.

Thus, tax reform faces not only technical and economic challenges, but perhaps the more difficult issue of finding a way to work together to fix problems such as a broken tax system.

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Annette Nellen, Esq., CPA, is a tax professor and director of the MST Program at San José State University. She is an active member of the tax sections of the AICPA, ABA, and California State Bar. She chairs the AICPA’s Individual Income Taxation Technical Resource Panel. She has several reports on tax policy and reform and a blog.