In the wake of the Democratic takeover of the U.S. Congress, many corporate tax counsel and corporate government relations officers are wondering what to expect over the next two years. Will the relatively business-friendly atmosphere of the past eight years be reversed? Will the tax breaks for the wealthy and upper middle class be rolled back? Will Congress turn to the business sector to fund tax breaks for middle income taxpayers by raising taxes on business income or by imposing new and onerous tax compliance burdens?
Before burnishing our crystal ball and attempting to answer these questions, it is critical to do what every sports fan does before heading to the ball park:
Get to Know the Players
Learn the Rules
Understand the Game Plan
Such an exercise should enable us to make some sense out of the many new tax priorities and proposals that are being readied for legislation in 2007 and beyond.
The New Tax Policy Players
Expect to see the biggest changes in the House of Representatives where Congresswoman Nancy Pelosi (D-CA) will be sworn in as Speaker of the House and Congressman Charles Rangel (D-NY) will serve as Chairman of the Ways and Means Committee. Although both have strong liberal credentials and constituencies, Pelosi and Rangel are by no means anti-business. Pelosi has cultivated ties with the hi-tech business community in Silicon Valley and beyond, while Rangel has solid relationships with New York's financial services industry and other business interests.
During the past eight years, Rangel and his Democratic colleagues on the tax-writing committee were largely shut out of the legislative process. Now that the control of the House has shifted, Rangel (together with Pelosi) will set the agenda and control the process. Rangel has pledged to work with his Republican colleagues, who have confirmed Jim McCrery as the Committee's ranking member. Thus, we should expect more bi-partisan action, as well as better bicameral (e.g., House-Senate) cooperation.
On the Senate side, the team of Senator Chuck Grassley (R-IA) and Senator Max Baucus (D-MT) will remain in place, but now incoming Chairman Baucus will take the lead on Finance Committee matters. Since a spirit of bi-partisan cooperation has traditionally prevailed in the Senate, this shift will not be a seismic one. Both senators have a good relationship with incoming Ways and Means Chairman Rangel.
The New Rules
Although the new rules have not been written yet, several are expected to be adopted. One anticipated change is the reinstatement of the "pay as you go" budget rule (PAYGO). In years past, a statutory PAYGO rule required all revenue and direct spending legislation to be deficit neutral, thereby requiring all tax cuts to be paid for through offsetting revenue increases (or mandatory reductions in spending would be triggered). Any new provision is expected to contain similar language. However, a mandatory PAYGO regime could make it difficult for Democratic tax-writers to pursue their agenda.
The Game Plan
Many of the details of the game plan are unknown, but it is clear that Congress is heading in a new direction. This new direction will include stronger focus on providing tax breaks for low-income and middle-class individuals. However, as noted above, PAYGO will require all tax reductions to be deficit neutral. Thus, there are indications that Congress will look to corporations (particularly those with multinational operations) to achieve revenue neutrality.
First 100 Hours Agenda. Speaker-elect Pelosi has set an aggressive course for the 110th Congress, placing particular emphasis on the first 100 hours of the new session. "In the first 100 legislative hours, Democrats will get to work immediately to restore civility, integrity, and fiscal responsibility to the House, while increasing prosperity, opportunity, and security for all Americans," said Pelosi. Her press release on November 21, 2006 listed various items that are expected to be taken up within the first 100 hours, including lobbying reform, minimum wage, and health care. At least two of the items, college affordability and ending Big Oil subsidies, are expected to involve tax law changes. Pelosi has also indicated that she will focus on taxing corporations that export jobs overseas.
College Affordability. College affordability is a hot topic in Washington. Speaker-elect Pelosi's plan is to make college more affordable by reducing the interest rate on subsidized loans. Senate Finance members, including Senator Baucus and Senate Schumer (D-NY), are also interested in making college tax incentives more effective. Schumer intends to introduce legislation combining the HOPE scholarship with the Lifetime Learning Credit for families paying more than $10,000 a year for tuition. He also expects the bill to contain a $4,000 tax "above the line" tax deduction to help defray educational costs. The estimated cost of the Schumer legislation is $49 billion through 2010.
The Energy Industry: A Mixed Bag. The end of Big Oil's tax subsidies could be near. In addition to being targeted by Speaker Pelosi's plan, legislation limiting or repealing may tax breaks currently enjoyed by Big Oil has been introduced in the last Congress by Senators Stabenow (D-MI), Cantwell (D-WA), and Salazar (D-CO), all incoming members of the Finance Committee. Tax breaks on the chopping block include: (1) the deduction for domestic production of oil, (2) expensing of exploration and development costs, and (3) the credit for enhanced oil recovery costs. Oil companies making payments overseas could also see a tax increase if the payments are directed toward countries without an applicable or equivalent income tax.
Senator Byron Dorgan (D-ND) and others plan to push renewable energy legislation. Dorgan believes that Congress should be providing incentives for alternative energy to help wean Americans off oil. In its final hours, the 109th Congress extended some of these tax incentives through December 31, 2008. In addition, Dorgan will likely push for extension of the alternative motor vehicle tax credit. This tax credit provided tax savings of up to $3,400 to purchasers of fuel-efficient vehicles.
AMT: Fix Or Repeal? Congressman Rangel has indicated that fixing the Alternative Minimum Tax (AMT) is one of his highest priorities. The AMT claws back certain tax preferences and credits that Congress has enacted. Since the AMT generates substantial revenue, any fix or repeal of the AMT would need to be offset under the anticipated PAYGO rules.
Fixing the AMT would come at a steep price. The estimated revenue cost of a partial AMT fix (generally referred to as the "AMT patch") is $45 billion a year, and the total cost of fixing or repealing AMT could reach as high as $520 to $750 billion. Congressman Rangel has acknowledged that fixing the AMT would be difficult. Still, he has made it clear that it is a top priority.
Retirement Savings: Another Look. Congress is expected to consider retirement savings measures again in 2007 and beyond. Two new proposals - AmeriSave and Lifetime PAY - are popular among Democrats. AmeriSave is a program that allows for low-income and middle-class workers to increase their retirement savings through matching contributions. The U.S. Government, through AmeriSave, would match up to the first $1,000 invested into a new or existing retirement account. This plan would most likely be funded by reducing current tax credits. Congressman Earl Pomeroy (D-ND) has sponsored retirement legislation named Lifetime PAY (short for "Pension Annuity for You"). The Lifetime PAY legislation would provide an incentive to those converting part of their retirement savings into a lifetime annuity. Under the Pomeroy plan, up to 25 percent of the monthly annuity distributions would be exempt from income taxes each year.
Corporate Taxes: Going Up? Many Democratic priorities would reduce individual taxes, but if they have to be "paid for" under PAYGO, corporate tax increases and business tax compliance measures may be attractive means of achieving revenue neutrality. Key members of Congress have indicated that they will push for the codification of the "economic substance" doctrine and increased compliance with the "earnings stripping" provisions. Congress is likely to give both a serious look when searching for revenue raisers.
Legislation codifying the economic substance doctrine is likely, but not certain. The economic substance doctrine analyzes transactions to make sure there is a business purpose as well as tax benefits. Legislation to codify the economic substance doctrine has already been passed by the Senate several times in the past. Such legislation was also contained in a tax bill sponsored by Ways and Means member Rahm Emmanuel (D-IL) and could be embraced by Chairman Rangel in a PAYGO environment. Codification should increase tax revenues, but just how much is the question. Early estimates peg the increased revenue at only $8 million to $16 million over the next 10 years.
Congress will also take another look at enforcing the earnings stripping provisions. Current law limits the deductibility of interest involving earnings stripping payments. The deduction limitations apply to interest payments made to related parties. However, compliance among multi-national entities is an issue. Thus, a pending proposal would require additional reporting to the IRS on applicable transactions. The additional reporting requirements would presumably increase compliance and raise additional tax revenue.
In the tax world, 2007 is going to be a whole new ballgame. Individual income taxes, college education, and alternative energy are the new favorites. Big Oil will be targeted, while the economic substance doctrine and other corporate tax compliance provisions may be used to make up revenue shortfalls. Knowing the players, understanding the rules, and analyzing the game plan will allow you to make sense of the new tax agenda of the 110th Congress.
Kathleen M. Nilles is a partner in the Washington, DC office of Holland & Knight. She was former tax counsel to the Committee on Ways & Means in the House of Representatives under then-chairman Dan Rostenkowski and Select Revenue Measures Subcommittee chairman Charles Rangel. She has worked on a wide variety of legislative tax issues, including federal excise taxes, energy tax incentives, insurance tax issues, pension and employee benefits issues and international tax issues and the alternative minimum tax. She can be reached at (202) 457-1815. Telly J. Meier is an associate in the Washington, DC office of Holland & Knight, where he practices tax law within the firm's Government Section. He can be reached at (202) 419-2549.