A Federal Budget That's Right for You?
Often cloaked in oh-so-promising titles, a number of preliminary budget proposals now confront the denizens of 1600 Pennsylvania Avenue and of Capitol Hill.
There's "The Path to Prosperity" from Wisconsin Republican Rep. Paul Ryan; the "Bipartisan Tax Fairness and Simplification Act of 2011" from Oregon Democratic Sen. Ron Wyden and Indiana Republican Sen. Dan Coats; "The Moment of Truth," as last year's proposal from the National Commission on Fiscal Responsibility and Reform is called. And, of course, there's this week's White House 2012 proposed budget, which doesn't yet have a fancy name.
But how would each of these affect large and small businesses? For many companies, the most significant and direct impacts concern two issues:
* Potential changes to the tax code and rates.
* The influence of the government's borrowing habits on the private sector's cost of capital.
Taxes are the top priority for most members of the National Association of Manufacturers, says Dorothy Coleman, vice president of tax and domestic policy. About a year ago, the organization laid out its strategy for boosting jobs and competitiveness, identifying four goals that are key to making that happen: a corporate tax rate of no more than 25%; a permanently strengthened R&D tax credit; a territorial, rather than a worldwide system for taxing profits earned outside the U.S.; and a permanently lowered rate for individual tax payers. (The stated U.S. corporate rate is now 35%, and overall corporate tax rates are among the highest in the world.)
NAM members are concerned about proposals, like that contained in the Deficit Commission's report, to eliminate tax credits. "Manufacturers are willing to get into a debate about eliminating some deductions and credits," Coleman says. "But, eliminating all tax expenditures is a big problem for us." On the other hand, the report advocates a territorial system of taxing corporate profits, in which the U.S. taxes only income earned within its borders. "That would go a long way to making U.S. companies more competitive," she adds.
The Deficit and Cost of Capital
A company's ability to access affordable capital also is critical, as CFOs and treasurers have learned over the past few years. That's led to growing concerns about the government's borrowing habits and the mounting Federal deficit.
"The U.S. Treasury is competing for funds from investors around the world. At some point, if its borrowing needs continue to grow, it will be able to compete for funding only with higher interest rates," says Tom Deas, vice president and treasurer of diversified chemical company FMC Corp., who also is president of the National Association of Treasurers. Since the cost of borrowing for most firms is tied to the rate paid by the U.S. Treasury, any jump there raises the costs for businesses, as well, Deas notes. "If funding isn't available or interest is too high, they'll defer projects."
As a result, Deas says many corporate treasurers will be watching the market's reaction to elected officials' ability -- or inability -- to reach agreement on a 2012 budget, as well as their willingness to change the debt limit when the U.S. hits its current borrowing capacity in mid-May, according to Treasury Secretary Timothy Geithner's estimate. What's key, Deas says, is that politicians commit to both lowering the deficit and raising the debt limit.
Individual Taxes and Small Business
The individual tax rate is a top priority for most small business owners, says Bill Rys, tax counsel with the National Federation of Independent Businesses. About 95% of all businesses are structured as flow-through entities, and pay taxes at the individual level, according to a recent Ernst & Young report prepared for the S-Corporation Association.
"Pursuing corporate-only reform that eliminates some or all business tax expenditures would increase the income taxes paid by individual owners of flow-through businesses, on average, by 8% or $27 billion annually from 2010 to 2014," the report says. The President's proposal to increase the individual tax rate "is a detriment to small businesses," Rys says.
What They Say
Judging from available information, all the major proposals contain provisions that most businesses view favorably --- mixed with provisions they don't:
* Sen. Wyden and Sen. Coats' "Bipartisan Tax Fairness" approach includes a single corporate tax rate of 24%, allows a one-time, low-tax repatriation of foreign earnings, and repeals the rule that allows companies to defer taxes on foreign income. It also allows businesses with gross receipts of up to $1 million to expense all equipment and inventory costs in one year.
* The National Commission on Fiscal Responsibility advocates a single corporate rate of between 23% and 29%, and eliminates business tax deductions. It also proposes a territorial tax system for active foreign-source income, and eventually phases out the exclusion for employer-provided health care. It also eliminates the LIFO method of accounting for inventory, with an appropriate transition.
* Rep. Ryan's "Path to Prosperity" recommends a top individual and corporate tax rate of 25%, while eliminating corporate loopholes and carve-outs. The proposal also would end taxpayer bailouts of financial institutions, and privatize Fannie Mae and Freddie Mac.
* The White House fiscal year 2012 budget would eliminate special interest loopholes and lower the corporate tax rate, although it doesn't specify by what amount. The budget also recommends expanding the current R&D tax credit by about 20%, and allowing the expiration of tax cuts for households with incomes of more than $250,000.
By the way, while the main title of the Obama budget is still generic, it does use positive-sounding subtitles, such as "Putting the Nation on a Sustainable Fiscal Path" and "Competing and Winning in a World Economy."
Study Your Tax Profile
The lack of currently available detail in many of the proposals doesn't worry Marc Gerson, a tax attorney with Miller & Chevalier in Washington, D.C. That's to be expected, he says, given that policymakers still need to come to agreement on several overarching principles. One such principle is whether tax reform should be a stand-alone effort, or done in conjunction with reducing the deficit. Another is whether corporate tax reform should proceed on its own, or as part of an overhaul of the broader tax system.
Not surprisingly, reaching consensus on these issues will take time. The discussions could extend over the next year and a half, or through the 2012 presidential election, Gerson estimates. "Tax reform," he says, "takes a lot of time, even in the best of times."
While it all gets hashed out in Washington, CFOs should be assessing their companies' tax profiles and identifying the deductions or credits that are most important, while estimating the change in the overall corporate rate needed to offset their elimination, Gerson says. In addition, they'll want to monitor the discussions taking place in Washington, and make their voices heard early on. "Any type of tax reform that lowers the rate and repeals tax expenditures, by definition, creates winners and losers," he says. "It's important for policy makers to understand the impact."