The Fiscal Cliff Deal: A Missed Opportunity for Tax Reform
In the early hours of 2013, Congress and the White House were able to avert an immediate fiscal crisis. The last-minute deal delayed deep, automatic spending cuts and did not address the debt ceiling, setting the stage for upcoming battles over spending and the deficit. The American Taxpayer Relief Act of 2012 (ATRA) does, however, contain several tax provisions important to manufacturers. The package provides some much-needed certainty with respect to the individual rates, helping businesses taxed as flow-through entities, but it does not solve many of the deep, underlying problems with the tax code that undermine the United States’ economic growth and international competitiveness.
The manufacturing sector drives productivity growth in the U.S. economy, increasing at two and half times the rate of the service sector, and what manufacturers really need is a globally competitive tax code. Late last year, there was some hope for a budgetary grand bargain that would include a roadmap for tax reform in 2013, but that did not come to pass, and it’s possible that the fiscal cliff deal killed the prospects for tax reform in 2013.
The new law provides certainty for many taxpayers as well as temporary relief for many businesses. The ATRA was unexpected in some respects because it permanently addresses individual tax rates, the estate tax rate, and the alternative minimum tax (AMT) problem instead of simply passing a one- or two-year temporary solution as has been done so often in the past.
The ATRA permanently extends many of the 2001 and 2003 tax rate reductions and extends through 2013 many important business provisions. Among other things, it:
- Permanently extends the reduced individual tax rates for individuals with incomes under $400,000 ($450,000 for married taxpayers filing jointly);
- Permanently extends the reduced capital gains and dividends tax rates for individuals under the $400,000/$450,000 income threshold. For taxpayers with higher incomes, the rate on capital gains and dividend income increases to 20 percent;
- Provides a permanent fix to the AMT by indexing the exemption amounts for inflation;
- Establishes a maximum 40 percent tax rate on gift, estate, and generation-skipping transfers, with a $5 million exemption amount that is indexed for inflation;
- Extends for one year the 50 percent bonus depreciation rule, allowing for a faster recovery of costs for qualified assets;
- Retroactively renews through 2013 the research and experimentation tax credit, with a few tweaks;
- Seamlessly renews through 2013 the look-through rules applicable to payments made between related controlled foreign corporations;
- Renews through 2013 tax deferral for active financing income; and
- Extends the production tax credit for wind facilities and certain other renewable energy facilities if construction begins before January 1, 2014.
With the ATRA leaving the larger fiscal issues unaddressed, the calls for tax reform began before Congress even passed the legislation. The ATRA is a positive development in that it permanently extends several important provisions; however, a tremendous amount of uncertainty remains. Corporate taxpayers are left with income tax rates that are the highest amongst the OECD countries, several of the key provisions renewed this month will expire once again at the end of the year, the United States’ current tax treatment of foreign income places U.S. companies at a competitive disadvantage, and as Congress and the Administration look for revenue in the coming months, it is quite possible that changes to the corporate tax rules could be seen as potential sources of revenue. There is also the layer of uncertainty that the prospects of sequestration and the deficit bring to the table.
Toward the end of 2012, there had been encouraging discussions about providing manufacturers and other businesses with some certainty by permanently extending items such as the research and experimentation tax credit, which was first enacted in 1981 and has been temporary ever since. The provision has expired more than a dozen times, though it has almost always been seamlessly renewed. Last year, many in the business community were not confident about its renewal, and the constant cycle of uncertainty—with so many tax provisions being temporary—has an impact on the long-term planning decisions companies must make each day.
Tax Reform in 2013?
Just about everyone in Washington agrees that the tax code is too complex and uncompetitive; however, there are clear and fundamental differences on what tax reform even means. Republicans have been calling for revenue-neutral reform while the President and other key Democrats have stated their interest in using tax reform as a mechanism to generate additional revenue.
The fiscal cliff exercise, Part I, was likely a warm-up for what is coming in the next two months as lawmakers tackle the debt ceiling and sequestration. Relationships have been strained and the nomination of Jack Lew to serve as the next Treasury secretary has not helped the White House repair relationships with Republicans. The question becomes whether Congress and the Administration have the political will to make tax reform part of the upcoming negotiations or whether it moves separately (if it moves at all).
The growing sentiment on Capitol Hill is that tax reform is unlikely in 2013, as the recent deal has removed the immediate pressure to act. Key lawmakers, however, have stated their intent to pursue tax reform this year. House Ways and Means Committee Chairman Dave Camp (R-MI) and Senate Finance Committee Chairman Max Baucus (D-MT) have already stated their commitment to tax reform. In making a statement on the fiscal cliff deal, the President said, “Cutting spending has to go hand-in-hand with further reforms to our tax code so that the wealthiest corporations and individuals can’t take advantage of loopholes and deductions that aren’t available to most Americans.” In a recent op-ed, Senator Rob Portman (R-OH), one of the newest members of the Senate Finance Committee, wrote that tax reform is doable this year, as the now-permanent rates “end disputes over the baseline that have vexed past reform attempts.”
Over the past few years, significant work has been done to set the stage for tax reform. Hearings have been held, including one focused on the manufacturing sector, commissions have been created, and proposals have been released. New Members of Congress will need to be educated, but too much work has been done to be wasted as a result of “tax exhaustion.” Considering the nation’s antiquated worldwide taxation system and the corporate income tax rate’s status as the highest among the OECD countries, reforming the tax code is crucial to ensuring a vibrant manufacturing base.
During the upcoming spending debate and the search for new sources of revenue, Congress should resist proposals that would penalize companies and create further uncertainty for manufacturers. The goals of tax reform should be to simplify the tax code and make it more competitive by lowering the corporate rate, strengthening incentives that promote research and development, promoting investment, and adopting a more competitive international tax system.
As a new Congress gets to work and the President begins his second term, tax reform needs to be on the must-do list for 2013. A competitive tax code that fosters innovation, creates jobs, and incentivizes U.S. investment cannot wait.
 The Facts About Modern Manufacturing, http://manufacturingfacts.org.
 Table II.1, OECD Tax Database.
 Sen. Rob Portman, “Don’t give up on tax reform,” Politico, January 17, 2013, www.politico.com/story/2013/01/dont-give-up-on-tax-reform-86286.html.
 U.S. House of Representatives Committee on Ways and Means, July 19, 2012, http://waysandmeans.house.gov/calendar/eventsingle.aspx?EventID=303036.