Washington Weekly: Hashing Out the Tax Increases

U.S. Office of Public Policy, 22 October 2021

This Week:

The Senate considered a comprehensive bill to change voting laws around the country, but the measure fell short of the 60 votes needed to advance. The House passed a bill to reauthorize funding for domestic violence prevention and a bill to expand protections for nursing mothers in the workplace. It also voted to hold Steve Bannon in contempt for not complying with a subpoena regarding the events of January 6th.

Next Week:

Senate and House Democrats will clear the schedule and focus on finalizing provisions to be included in the comprehensive budget reconciliation bill (see below).

The Leads

Democrats and Budget Reconciliation Bill.

House and Senate Democrats are operating under a self-imposed October 31 deadline to resolve their differences and finalize a comprehensive tax and spending plan. That deadline – a week from Sunday – is unlikely to be met. Nonetheless, Democrats made progress this week in crafting a final product. To get the support of Senators Joe Manchin (D-WV) and Kyrsten Sinema (D-AZ), the size of the bill has been reduced from $3.5 trillion to about $2 trillion. Although there’s been some scaling back of certain tax increases, many of the provisions in the tax bill introduced by House Democrats on September 13 remain in a draft bill. More difficult has been determining how to scale back or even eliminate some of the bill’s ambitious spending. The contentious intra-party debates over the final content of the bill will continue for days if not weeks. While disagreements on these details still could kill a final deal, we believe Democrats will close ranks and come to a final agreement at some point over the next two months.

December 3.

This is a significant red line date in Washington since it is the deadline for Congress to pass an extension of government funding and raise the debt ceiling. If Democrats don’t raise the debt ceiling through their budget reconciliation bill, there will be yet another partisan showdown with Democrats trying to pressure Republicans to provide sufficient bipartisan support for a debt ceiling increase. Democrats may once again try to pass a debt ceiling increase with the government funding bill, but we think these ultimately will need to be addressed separately. As of today, it’s still unclear what exact path Democrats will take to raise the debt ceiling. They could signal their intentions soon given that passing a debt ceiling increase through the reconciliation bill would first require them to amend the budget resolution passed over the summer. Like earlier this month, we will very likely enter December with a very uncertain and contentious path to extend the debt ceiling.

Other Issues

Hashing Out the Tax Increases.

As noted above, House and Senate Democrats have been negotiating the tax provisions in the House bill. We discuss below our current understanding based on conversations with lawmakers, but the situation is fluid. Democrats remain divided on many of these provisions and are still jockeying on the details. We discuss below a few issues on which we’ve received questions from our colleagues and clients.

  • Corporate Tax Rate. While the House bill increases the corporate tax rate from 21% to 26.5%, we believe the final bill will need to have a much smaller increase (perhaps even no increase) to gain the support of Senators Manchin and Sinema.
  • Bank Reporting to the IRS. There is a growing buzz around President Biden’s proposal to require financial institutions to report accounts with annual inflows and outflows over $600 to the IRS. No such proposal was included in the House draft bill. However, the Biden administration, Senate Finance Committee Chairman Ron Wyden (D-OR) and other Democrats are not giving up on the proposal. They have increased the threshold for reporting to $10,000 and are considering other changes (such as an exception for certain transactions like a home purchase) so that fewer middle-class Americans would be captured under the reporting provision. There also are concerns over privacy and general skepticism over how the IRS would use this information. While this provision ultimately may be abandoned, it still has the strong support of President Biden, House Speaker Nancy Pelosi (D-CA) and other important players.
  • Small Business. The House bill has a variety of tax provisions that would impact small businesses. It eliminates the 20% deduction for small business put into law in 2018. This change applies to income over $400,000 ($500,000 for joint filers). The bill’s broader tax proposals, including a 39.6% top individual tax rate and a surtax on income over $5 million, also affect small businesses. Finally, the bill would expand the 3.8% Net Investment Income Tax (NIIT) from Obamacare to cover “active” income, which includes wages, salary, and commissions. This provision, which would raise $252 billion, would capture more revenue from business owners. While Senator Sinema and a few other Democratic moderates are working to scale back some of these proposals, the provisions will remain in some form. Small business owners should be prepared for higher tax liabilities in 2022.
  • Like Kind Exchanges. President Biden proposed earlier this year the effective elimination of 1031 like kind exchanges, which allows for taxpayers to exchange property that is similar and defers the recognition of gain. The House proposal makes no changes to like kind exchanges. The proposed changes also don’t have sufficient support in the Senate. Despite the Biden administration’s push, we expect like kind exchanges to survive the reconciliation bill.

Climate Change Policies.

In little over a week, President Biden and other world leaders will meet in Glasgow for a major UN climate summit, “COP 26.” The Biden administration has set ambitious goals to reach 100 percent carbon pollution-free electricity by 2035 and have a net zero emissions economy by no later than 2050. However, these goals are bucking up against political realities. To begin, the administration has demurred from proposing a price on carbon. Additionally, Senator Manchin, who hails from a coal-producing state, has conditioned his support for Democrats’ big spending package on a rollback of various climate-related provisions, notably a $150 billion clean electricity program to incentivize utility companies to invest in renewables and punish those that don’t. The Biden administration does have regulatory levers on emissions standards and other issues, but these efforts have been moving unevenly and can be reversed by a future administration. In this context, the administration is very focused on directives for private finance, with the Treasury and other regulators issuing a joint report yesterday that sets the table for action on the financial risks of climate change. There will be a lot of focus on the climate change declarations made in Glasgow (in particular, whether the US can convince developing countries to increase their commitments), but the bigger question remains how all of the ambitious goals actually can be realized.

GameStop Report.

The SEC this week released its long-awaited staff report on the market volatility in GameStop and other meme stocks earlier this year. The report examines the trading dynamics in these stocks and the market structure and regulatory context for the events. It punts on the underlying causes of the meme stock phenomenon (including questions about whether there was market manipulation on social media platforms), indicating that this is a subject of speculation and out of scope. Another thing it does not do is provide a clear direction for policy action by the SEC. The report lists several market and regulatory issues – namely, shortening of the settlement cycle, gamification, payment for order flow practices, off-exchange trading and short-selling disclosure - that warrant further study. However, all these issues have been highlighted before by SEC Chair Gary Gensler in testimony before Congress and in other public appearances. While the SEC’s two Republican Commissioners point out that some of these issues had little obvious bearing on the GameStop events, they remain priorities for Chair Gensler.

The Last Word

President Colin Powell?

The death of former Secretary of State Colin Powell earlier this week was an occasion to think about his character and many accomplishments. One aspect of his life that will always remain a mystery is what would have happened if he had run for president in 1996. Given that the race was two and a half decades ago (and it remains unclear just how close to running Powell was), many forget what a formidable candidate he was expected to be. General Powell was widely viewed as one of the strongest Republican candidates to potentially run against President Clinton in 1996. Polling conducted in the fall of 1995 showed that Powell led Clinton by 15 points in a hypothetical matchup, while exit polling on election day had Powell up 50-38 over Clinton. While these polls don’t tell the whole story given that Powell never had to deal with the negative attacks that come with a campaign, they do demonstrate his popularity. And, despite having never run for political office, Powell managed to receive electoral college votes (three in 2016 from faithless electors) and votes for Speaker of the House (on multiple occasions). Secretary Powell played a significant role in American history over the past half a century, which leads many to continue to wonder what would have happened had he run for president.