The package, introduced in March by Senate Majority Leader Harry Reid, would have given small businesses a tax credit equivalent to 10% of the figure by which total 2012 salaries are more than total 2011 salaries, up to a maximum credit value of $500,000.
“These measures would increase the cash flow of businesses,” said Ed Marcum, partner at Nexia International member firm CliftonLarsenAllen. “How this cash flow is utilised is the real question.”
Bonus depreciation of 100% would also have been extended, enabling companies to deduct the entire cost of the purchase of new machinery or other equipment this year, rather than just half the cost under present rules.
President Obama included small business tax legislation on his Congress to-do list, but a Deloitte alert points out that “neither the House nor the Senate package appears destined to make it to his desk”.
Senator Reid has criticised the Republicans’ approach to tax reform, saying they “want to lavish huge across-the-board tax breaks on billionaire hedge fund managers”, while Senate Minority Leader Mitch McConnell attacked the President’s economic record, describing it as “nightmarish”.
Speaking before the Senate vote on the measure, and after another set of disappointing jobs figures, Senator Chuck Schumer, a Democrat, said: “This tax cut is by no means a cure-all, but it could be a difference-maker for small firms on the fence about adding payroll. After last month’s sluggish jobs numbers, we may be on the verge of a rare moment of agreement on how to help the economy”.
But Schumer was proved wrong by political posturing.
Bush era tax cuts
The House is also expected to vote this month on legislation that would extend the Bush era tax cuts for all taxpayers. Without action, on January 1 2013, the rate on long term capital gains will increase to 20% from 15%, while the top rate on qualified dividend income will go up to 39.6% from 15%.
House Majority Leader Eric Cantor has said extending the Bush tax cuts would prevent the “largest tax increase in history” and provide certainty to taxpayers while Congress tackles comprehensive tax reform.
Republicans want to extend the Bush cuts, while Democrats want the rates to continue for low and middle income taxpayers, but would allow them to expire for wealthier taxpayers. Republicans argue that excluding high earners from the cuts would harm job creation.
“If my friends on the other side of the aisle truly care about small businesses, as I know they do, then they should join us in stopping these tax hikes that will hit those very same people if the president has his way. If small businesses need help then the best thing we can do is stop all the tax increases,” said Republican Senator Orrin Hatch (pictured left), ranking member of the Senate Finance Committee.
Again though, political motivations in an election year are proving too much to overcome, and any developments on the Bush tax cuts also hinges on political factors, said Marcum.
“I believe the Bush cuts will be addressed only if the political climate becomes precarious for one party or the other. The decision to address the extensions is a political not economic issue now, so if one party feels vulnerable then a compromise might be reached,” said Marcum.
Wider reform
While he thinks the Bush cuts may be addressed, Marcum is less optimistic about comprehensive tax reform coming anytime soon.
“We might see movement to extend the Bush cuts before the election, but we will not see any movement on comprehensive tax reform. The last major tax reform occurred in 1986,” he said. “The bipartisanship was much higher in that time and it still took Congressional and Administrative leadership more than two years to reach the final result.”
The damage from neglecting reform for so long is already being done.
“Clearly the uncertainty is not helping businesses formulate long-term decisions,” said Marcum.
James McNerney Jr, Boeing chief executive officer and president of the Business Roundtable, agrees. He renewed his organisation’s calls for action on reform this week too, saying: “The current paralysis hindering principled compromise has fuelled needless economic uncertainty that impedes a more robust economic recovery. Without effective action soon, this uncertainty will spawn a dangerous crisis, threatening our economy, businesses and workers.”
The US tax system stands apart from most others in that it has a high corporate tax rate but no VAT or national consumption tax. The 1986 overhaul dramatically reduced corporate rates, with the reduction of the maximum rate from 46% to 35%, giving the US one of the lowest corporate tax rate structures in the world. Since then, other countries have acted, while the US tax code remained largely unchanged.
“Most countries matched this tax rate reduction and even lowered their own rates even further so now the US tax rate at 35% is one of the highest in the world. At the same time, many other countries became more dependent on the VAT/national consumption tax,” said Marcum. “To maintain a competitive environment, the US probably should reduce its corporate rate at least slightly.”
To achieve and accommodate a rate reduction, it is likely that a number of corporate tax breaks will have to be repealed, but Elaine Kamarck, chairwoman of the RATE Coalition of businesses advocating equitable reforms to the tax code, said it is imperative that negotiations surrounding which tax breaks to sacrifice must remain private.
“This is something that should not be engaged in public,” she said. “Because once it’s engaged in public, you cannot get a deal.”
Once more, Kamarck’s fear is that politics will interfere with, and overcome, tax policy negotiations.
“Engaging in a discussion about this expenditure versus that one is politically really counterproductive,” she said.
Worldwide approach
Marcum said the “more pressing issue” is the worldwide approach to taxation that the US employs, whereby the Internal Revenue Code treats any income earned anywhere by a US company as US income, though foreign revenues are not taxed until they are brought back to America.
“This creates a significant incentive for companies to plan their businesses to avoid US taxation on their worldwide income. This creates large reserves of cash and other liquid assets outside of the US,” he said.
There is much debate about whether bringing these cash reserves back to the US would create jobs but allowing repatriation at a lower rate would certainly mean there is more cash in the US, regardless of how it is used.
“This cash may not be used to invest in job creating activities, but it would allow companies to deploy the cash to clean up balance sheets, repurchase stock or increase dividends,” said Marcum.