Senate Finance Committee Considers Extenders, Tax Reform
At a Senate Finance Committee hearing on January 31, witnesses disagreed about whether to extend all expiring tax extenders; however, all the panelists told the committee that fundamental tax reform is sorely needed.
Chairman Max Baucus (D-Mont.) said the stop-and-start nature of year-by-year extenders has been “disastrous” for many industries that rely on the tax code for business decisions.
“Each day that businesses do not know whether tax extenders will be in place this year means less American manufacturing, less production and fewer jobs,” Baucus said.
Baucus said that Congress needs time to work toward fundamental tax reform and that is “time that our recovering economy doesn’t have.”
“So as we work to pass tax extenders through this year, let us also continue the hard work of tax reform,” Baucus said. “Let us consider whether we should retain these provisions, or whether we should use the money to lower tax rates.”
Ranking Member Orrin Hatch (R-Utah) said the “explosion” of temporary tax provisions in recent years is “a very notable and problematic trend.” Hatch noted that number of temporary tax provisions has grown from 42 in 1998 to 154 in 2011 and even those tax extenders that are sound tax policy “lose much of their power due to their temporary character.”
Hatch said that Congress should provide certainty by making permanent provisions that are worthy of remaining in the law, and eliminating those that are not.
“Chairman Baucus and I agree, along with many of our colleagues, that the current tax code demands comprehensive reform,” he said. “In the meantime, before tax reform is accomplished, Congress needs to decide what to do about the tax extender provisions that have expired.”
Rosanne Altshuler, Professor and Chair of the Economics Department at Rutgers University, called on Congress to consider extenders within the context of fundamental tax reform.
“I recommend that instead of arguing about which provisions should be included in an extenders package, we should instead devote our energy to building a tax code that will allow us to face the daunting fiscal challenges ahead,” she said.
Altshuler said that first, Congress should isolate provisions that are fundamental policies of the current tax code and make them permanent.
“It does not make sense for provisions that are more properly considered structural features of our tax system, like the active finance exception, to be temporary in nature,” she said. “If the tax system provides deferral for active business income earned abroad of U.S. corporations in controlled foreign corporations (as it does), it should not single out certain types of active business income and subject it to current taxation.”
Second, Congress should admit that the remaining provisions, however well-intended, should be evaluated along with similar permanent provisions in the context of fundamental tax reform.
“While there are many fundamental reforms that could be considered, a reform that broadens the base would not only raise revenue but would simplify the system, increase transparency, make it less distortive by both allowing for a lower rate and reducing tax-induced biases towards certain activity, and improve the fairness of the system,” Altshuler said.
Jason Fichtner, Senior Research Fellow at George Mason University, said that while the basic goal of tax policy is to raise enough revenue to meet the government’s spending requirements with the least impact on behavior, the U.S. code has “long failed to meet this aim.” Fichtner argued that the code severely distorts market decisions and resource allocation, hampers job creation and impedes both potential economic growth and potential tax revenue.
Fichtner noted that most developed countries are reducing their corporate tax rates and restructuring them to be simpler.
“The very fact that we are here to discuss the dozens of tax provisions that expired last year alone is evidence of the tax code’s complex and temporary nature—two faults that increase both uncertainty and costs for American businesses,” he said. This drives competitive, profit-seeking corporations to minimize their tax exposure and defer income overseas to lower tax countries.
Additionally, Fichtner said that advocates for higher taxes on business should recognize that the United States’ corporate tax rate is among the highest in the industrialized world; “this increases business’ flight to lower tax countries, taking their jobs, money, and tax dollars with them.”
Fichtner argued that a tax on corporations is actually a tax on labor and for economic efficiency, it is important that income be taxed once.
“There is much concern that those who report significant earnings from capital gains or dividends pay a lower tax rate than those with ordinary income. But this fails to accurately reflect the incidence of the corporate income tax,” he said, adding that corporate profits are subject to double taxation through the corporate level and then again at the individual level.
“One of the reasons why we currently have a lower tax rate for individuals on capital gains is to account for the fact that capital gain income received by an individual was first taxed at the corporate level, up to 35 percent,” he said. “Hence, if a corporation first pays the maximum statutory tax rate of 35 percent on each $1 of profit, leaving $0.65 of retained profit to either be distributed as a dividend or realized as capital gain, then combining the individual’s 15 percent tax rate yields a combined tax rate of 44.75 percent.”
Caroline Harris, Chief Tax Counsel and Director of Tax Policy at the U.S. Chamber of Commerce, urged the Committee to extend all the provisions arguing that not doing so has “brought more instability and uncertainty into the economy and has created significant challenges for taxpayers planning for the future.”
Harris said the Chamber supports comprehensive, fundamental tax reform, the Chamber believes that true fundamental tax reform is “still a long way down the road.”
Harris argued that many of the extender provisions encompass deductions and credits that have been in the Code for many years and have been extended multiple times and despite their expiration dates, such provisions in reality are longstanding deductions and credits that taxpayers have come to rely on when making business decisions.
The uncertainty of expired deductions and credits can have a material impact on a business’ bottom line in certain cases, requiring certain disclosures such as in financial statements filings, which can adversely affect the business more broadly, she said.
Harris pointed to the active financing exception, which she noted mitigates the double taxation of such income, thereby bringing the tax treatment of American worldwide financial service providers into parity with their international competitors.
“This provision was in the Code for 77 years and was repealed by the 1986 Act. The historical treatment was reinstated in 1997 and has been in the Code since then,” she said. “A provision that has been in the Code for 91 of the 102 years it has existed can hardly be considered temporary.”
Harris also argued that newer provisions are also “reasonable and necessary” policy, pointing to controlled foreign corporation (CFC) look-through rules, which are “essential” to mitigating double taxation and allows the U.S. to compete with foreign competitors.
“Inaction on these provisions has real consequences,” Harris said.
Calvin Johnson, Law Professor at the University of Texas School of Law, was scheduled to testify but encountered travel difficulties and did not participate in the hearing. His written testimony can be viewed here. In his testimony, Johnson argued that certain extenders, including active financing, should be allowed to expire.
Question and Answer
Baucus said that there are too many temporary tax extenders and that perhaps Congress should eliminate them, which would allow for a base broadening of the tax code.
Altshuler said that Congress should take two steps to do so: identify certain provisions that should be structural provisions of the code, such as active financing.
She said the rest that are not structural features, in theory, should be considered through cost-benefit analysis to see whether they are necessary or beneficial. “I’m very skeptical that we’re actually going to do that,” she said. Baucus asked why she believed that and Altshuler said she does not think there are resources to do so.
Hatch asked whether it makes sense to extend some or all of the provisions ahead of comprehensive tax reform.
Altshuler reiterated that some should be a part of the structural tax code. Others that have expired, she said, should remain expired as an incentive to undertake fundamental reform.
Fichtner said the bottom line is that the U.S. needs fundamental tax reform. Some provisions, he pointed to CFC look through and other business provisions, are needed, but Congress needs to make clear that it will go forward with fundamental reform.
Harris again argued that all provisions should be extended because businesses are relying on them. However, Congress should “absolutely” have a conversation about fundamental reform.
Fichtner said that whatever extenders Congress does intend to pass should be done sooner than later because businesses might make a decision to not invest in the U.S. because of uncertainty over whether a provision would be extended.
Altshuler added that having a temporary provision already greatly reduces the incentives of that provision because of the added uncertainty of its possible expiration.
Harris added that the global economy is going forward with business decisions and that the U.S. needs to be a part of the global economy.
Sen. Ben Cardin (D-Md.) said that the U.S. pays a price for the uncertainty of tax extenders.
He said he believes there is growing consensus that “we should either make these provisions permanent or that we shouldn’t have an extenders list.”
“I strongly support tax reform, but I want to point out the urgency for us to act on many of these provisions … the consequences of not acting on extenders is well known,” Cardin said.
Sen. Richard Burr (R-N.C.) asked if Congress did fundamental tax reform, would there even be a need for tax extenders.
Altshuler argued that aside from occasional stimulus or disaster reactionary measures, no, there would be no need for extenders.
Sen. Charles Schumer (D-N.Y.) said he wants to include the expired transit benefit to set aside $230 before taxes, currently capped at $125 a month since the provision expired at the end of the year. Cardin also argued for the benefit to be increased.
Sen. Maria Cantwell (D-Wash.) said that while she supports comprehensive tax reform, she does not at the cost of certain extenders, such as the sales tax deduction. Cantwell said the sales tax deduction is about equity for states like Washington, Florida and South Dakota, which do not have income taxes.
“I’m offended when someone thinks that the sales tax deduction is somehow special; it’s not special,” she said, adding it was once in the Code, taken out and has now been an extender for seven years. “And yet every year we have to play this game we about whether or not we are going to have the equity that other states have.”
Cantwell said that extenders are being held hostage by the possibility of fundamental tax reform.
Harris said it is absolutely essential to bring parity for states that rely on sales taxes instead of income taxes, adding that it may deter businesses from doing business in states that do not rely on income tax.
Sen. John Thune (R-S.D.) said that the short-term nature of tax extenders is problematic because of the uncertainty they cause for businesses, but also that they hide the true budget deficit since they are not factored into budget analysis.
Thune asked whether longevity should be a primary criteria for whether a provision should stay in the code.
Harris agreed that longevity could be a factor in that determination. Harris said that active financing is an answer to a changing global landscape. Because the U.S. has a worldwide system of tax and most other countries have moved to a territorial system, active financing was put in place to fix the possibility of double taxation.
For more information about this hearing, please click here.
At a Senate Finance Committee hearing on January 31, witnesses disagreed about whether to extend all expiring tax extenders; however, all the panelists told the committee that fundamental tax reform is sorely needed.
Chairman Max Baucus (D-Mont.) said the stop-and-start nature of year-by-year extenders has been “disastrous” for many industries that rely on the tax code for business decisions.
“Each day that businesses do not know whether tax extenders will be in place this year means less American manufacturing, less production and fewer jobs,” Baucus said.
Baucus said that Congress needs time to work toward fundamental tax reform and that is “time that our recovering economy doesn’t have.”
“So as we work to pass tax extenders through this year, let us also continue the hard work of tax reform,” Baucus said. “Let us consider whether we should retain these provisions, or whether we should use the money to lower tax rates.”
Ranking Member Orrin Hatch (R-Utah) said the “explosion” of temporary tax provisions in recent years is “a very notable and problematic trend.” Hatch noted that number of temporary tax provisions has grown from 42 in 1998 to 154 in 2011 and even those tax extenders that are sound tax policy “lose much of their power due to their temporary character.”
Hatch said that Congress should provide certainty by making permanent provisions that are worthy of remaining in the law, and eliminating those that are not.
“Chairman Baucus and I agree, along with many of our colleagues, that the current tax code demands comprehensive reform,” he said. “In the meantime, before tax reform is accomplished, Congress needs to decide what to do about the tax extender provisions that have expired.”
Rosanne Altshuler, Professor and Chair of the Economics Department at Rutgers University, called on Congress to consider extenders within the context of fundamental tax reform.
“I recommend that instead of arguing about which provisions should be included in an extenders package, we should instead devote our energy to building a tax code that will allow us to face the daunting fiscal challenges ahead,” she said.
Altshuler said that first, Congress should isolate provisions that are fundamental policies of the current tax code and make them permanent.
“It does not make sense for provisions that are more properly considered structural features of our tax system, like the active finance exception, to be temporary in nature,” she said. “If the tax system provides deferral for active business income earned abroad of U.S. corporations in controlled foreign corporations (as it does), it should not single out certain types of active business income and subject it to current taxation.”
Second, Congress should admit that the remaining provisions, however well-intended, should be evaluated along with similar permanent provisions in the context of fundamental tax reform.
“While there are many fundamental reforms that could be considered, a reform that broadens the base would not only raise revenue but would simplify the system, increase transparency, make it less distortive by both allowing for a lower rate and reducing tax-induced biases towards certain activity, and improve the fairness of the system,” Altshuler said.
Jason Fichtner, Senior Research Fellow at George Mason University, said that while the basic goal of tax policy is to raise enough revenue to meet the government’s spending requirements with the least impact on behavior, the U.S. code has “long failed to meet this aim.” Fichtner argued that the code severely distorts market decisions and resource allocation, hampers job creation and impedes both potential economic growth and potential tax revenue.
Fichtner noted that most developed countries are reducing their corporate tax rates and restructuring them to be simpler.
“The very fact that we are here to discuss the dozens of tax provisions that expired last year alone is evidence of the tax code’s complex and temporary nature—two faults that increase both uncertainty and costs for American businesses,” he said. This drives competitive, profit-seeking corporations to minimize their tax exposure and defer income overseas to lower tax countries.
Additionally, Fichtner said that advocates for higher taxes on business should recognize that the United States’ corporate tax rate is among the highest in the industrialized world; “this increases business’ flight to lower tax countries, taking their jobs, money, and tax dollars with them.”
Fichtner argued that a tax on corporations is actually a tax on labor and for economic efficiency, it is important that income be taxed once.
“There is much concern that those who report significant earnings from capital gains or dividends pay a lower tax rate than those with ordinary income. But this fails to accurately reflect the incidence of the corporate income tax,” he said, adding that corporate profits are subject to double taxation through the corporate level and then again at the individual level.
“One of the reasons why we currently have a lower tax rate for individuals on capital gains is to account for the fact that capital gain income received by an individual was first taxed at the corporate level, up to 35 percent,” he said. “Hence, if a corporation first pays the maximum statutory tax rate of 35 percent on each $1 of profit, leaving $0.65 of retained profit to either be distributed as a dividend or realized as capital gain, then combining the individual’s 15 percent tax rate yields a combined tax rate of 44.75 percent.”
Caroline Harris, Chief Tax Counsel and Director of Tax Policy at the U.S. Chamber of Commerce, urged the Committee to extend all the provisions arguing that not doing so has “brought more instability and uncertainty into the economy and has created significant challenges for taxpayers planning for the future.”
Harris said the Chamber supports comprehensive, fundamental tax reform, the Chamber believes that true fundamental tax reform is “still a long way down the road.”
Harris argued that many of the extender provisions encompass deductions and credits that have been in the Code for many years and have been extended multiple times and despite their expiration dates, such provisions in reality are longstanding deductions and credits that taxpayers have come to rely on when making business decisions.
The uncertainty of expired deductions and credits can have a material impact on a business’ bottom line in certain cases, requiring certain disclosures such as in financial statements filings, which can adversely affect the business more broadly, she said.
Harris pointed to the active financing exception, which she noted mitigates the double taxation of such income, thereby bringing the tax treatment of American worldwide financial service providers into parity with their international competitors.
“This provision was in the Code for 77 years and was repealed by the 1986 Act. The historical treatment was reinstated in 1997 and has been in the Code since then,” she said. “A provision that has been in the Code for 91 of the 102 years it has existed can hardly be considered temporary.”
Harris also argued that newer provisions are also “reasonable and necessary” policy, pointing to controlled foreign corporation (CFC) look-through rules, which are “essential” to mitigating double taxation and allows the U.S. to compete with foreign competitors.
“Inaction on these provisions has real consequences,” Harris said.
Calvin Johnson, Law Professor at the University of Texas School of Law, was scheduled to testify but encountered travel difficulties and did not participate in the hearing. His written testimony can be viewed here. In his testimony, Johnson argued that certain extenders, including active financing, should be allowed to expire.
Question and Answer
Baucus said that there are too many temporary tax extenders and that perhaps Congress should eliminate them, which would allow for a base broadening of the tax code.
Altshuler said that Congress should take two steps to do so: identify certain provisions that should be structural provisions of the code, such as active financing.
She said the rest that are not structural features, in theory, should be considered through cost-benefit analysis to see whether they are necessary or beneficial. “I’m very skeptical that we’re actually going to do that,” she said. Baucus asked why she believed that and Altshuler said she does not think there are resources to do so.
Hatch asked whether it makes sense to extend some or all of the provisions ahead of comprehensive tax reform.
Altshuler reiterated that some should be a part of the structural tax code. Others that have expired, she said, should remain expired as an incentive to undertake fundamental reform.
Fichtner said the bottom line is that the U.S. needs fundamental tax reform. Some provisions, he pointed to CFC look through and other business provisions, are needed, but Congress needs to make clear that it will go forward with fundamental reform.
Harris again argued that all provisions should be extended because businesses are relying on them. However, Congress should “absolutely” have a conversation about fundamental reform.
Fichtner said that whatever extenders Congress does intend to pass should be done sooner than later because businesses might make a decision to not invest in the U.S. because of uncertainty over whether a provision would be extended.
Altshuler added that having a temporary provision already greatly reduces the incentives of that provision because of the added uncertainty of its possible expiration.
Harris added that the global economy is going forward with business decisions and that the U.S. needs to be a part of the global economy.
Sen. Ben Cardin (D-Md.) said that the U.S. pays a price for the uncertainty of tax extenders.
He said he believes there is growing consensus that “we should either make these provisions permanent or that we shouldn’t have an extenders list.”
“I strongly support tax reform, but I want to point out the urgency for us to act on many of these provisions … the consequences of not acting on extenders is well known,” Cardin said.
Sen. Richard Burr (R-N.C.) asked if Congress did fundamental tax reform, would there even be a need for tax extenders.
Altshuler argued that aside from occasional stimulus or disaster reactionary measures, no, there would be no need for extenders.
Sen. Charles Schumer (D-N.Y.) said he wants to include the expired transit benefit to set aside $230 before taxes, currently capped at $125 a month since the provision expired at the end of the year. Cardin also argued for the benefit to be increased.
Sen. Maria Cantwell (D-Wash.) said that while she supports comprehensive tax reform, she does not at the cost of certain extenders, such as the sales tax deduction. Cantwell said the sales tax deduction is about equity for states like Washington, Florida and South Dakota, which do not have income taxes.
“I’m offended when someone thinks that the sales tax deduction is somehow special; it’s not special,” she said, adding it was once in the Code, taken out and has now been an extender for seven years. “And yet every year we have to play this game we about whether or not we are going to have the equity that other states have.”
Cantwell said that extenders are being held hostage by the possibility of fundamental tax reform.
Harris said it is absolutely essential to bring parity for states that rely on sales taxes instead of income taxes, adding that it may deter businesses from doing business in states that do not rely on income tax.
Sen. John Thune (R-S.D.) said that the short-term nature of tax extenders is problematic because of the uncertainty they cause for businesses, but also that they hide the true budget deficit since they are not factored into budget analysis.
Thune asked whether longevity should be a primary criteria for whether a provision should stay in the code.
Harris agreed that longevity could be a factor in that determination. Harris said that active financing is an answer to a changing global landscape. Because the U.S. has a worldwide system of tax and most other countries have moved to a territorial system, active financing was put in place to fix the possibility of double taxation.
For more information about this hearing, please click here.