A Tale of Two Talks

Last week, economist Jared Bernstein interviewed Treasury Secretary Jack Lew at the Milken Institute in Beverly Hills, CA. During their discussion, Bernstein asked Secretary Lew, among other questions, “Why is there no tax reform?” Here’s what Lew had to say:

Why could we not get there?  We couldn’t get there because there were interests that presented themselves as small business interests that put a block in the way of it that became politically insurmountable and let me just say what that was, because I think it is going to come back in the future.

You had organizations like NFIB saying that unless you lower the individual rate, you’re hurting small businesses.  Ninety-five (95%) of small businesses would benefit from doing business tax reform as we proposed it.  Things like letting small businesses deduct a bigger amount of their investment in equipment in the year they made the investment would’ve affected all small businesses.

The kinds of “small businesses” that wouldn’t get the full benefit are the kind of businesses that reorganized out of the corporate tax code to become limited partnerships to avoid taxation.  Those are things like hedge funds and interstate pipeline companies.  They’re not mom and pop hardware stores.  They’re not 50-person small businesses that are the entrepreneurial startups.  And I think the larger firms that want to get the benefit of whichever system they can arbitrage actually put a stumbling block in the way of putting together a political consensus to do something that would be for the greater good.

And, I’m obviously speaking about it pretty directly and there are some will not like that I’m doing that but whether it is this year or next year or the year after, that’s a hurdle we’re going to have to get over.

There are a number of challenges with the Secretary’s response.  First, he simply ignores the tax hike on small business implicit in the Administration’s corporate tax reform plan.  Broadening the business tax base by repealing LIFO, accelerated depreciation and other business provisions means a broader base of taxable income for corporations and pass-through businesses alike.  But the Obama plan only cuts tax rates for corporations.  Pass throughs would still be paying top tax rates of almost 45 percent.

Second, Section 179 expensing helps numerous businesses – corporate and pass through alike – write off capital investments immediately.  But the reality is that very few companies have capital investments in Treasury’s proposed range.  Expensing helps, but there’s no way Treasury’s proposed 179 limits offset the full cost of their other base-broadening proposals.

Third, the Secretary trots out the old rhetoric about how only hedge funds and interstate pipeline companies are representative of the pass-through community.  Really?  Let see – there are several thousand hedge funds, over one hundred MLPs, and about 8 million S corporations, LLCs and partnerships.  Our first EY study makes clear who gets hit with higher taxes under the Administration’s plan.  Hint:  It’s not hedge funds and law firms.  It’s farms, manufacturers, retailers, etc.

Finally, the BIG whopper here is the Secretary’s notion that some sort of “consensus” existed on corporate tax reform.  When?  The Administration’s plan would have raised taxes on a broad swath of Main Street businesses, but it also called for an overall tax hike to fund new government spending.   A Congress led by Paul Ryan and Mitch McConnell would never have agreed to that.

Contrast Lew’s remarks with the message from Speaker Ryan’s op-ed published around the same time:

Ninety percent of Wisconsin businesses file their taxes as individuals. And the top effective marginal tax rate in America today for these small businesses is now 44.6 percent. Meanwhile, our friends on the other side of Lake Superior in Canada tax their businesses at 15 percent. A local manufacturer in Racine could be paying up to 44.6 percent in taxes. Add state and local fees and taxes, and these small businesses are paying over half of every dollar they earn in taxes.

If we tax our job creators and our businesses at much higher tax rates than our foreign competitors, they win and we lose. We’ve got to make America more competitive. That is why I am working to put out a tax reform plan to show how our businesses can stay in America. We are in a global economy, whether we like it or not. I want Wisconsinites that start small businesses to compete. Right now, the deck is stacked against our workers and small businesses. Let’s lower their tax rates, level the playing field, and watch our small businesses thrive.

As Ryan’s arguments make clear, it was this complete lack of common ground on tax policy and where it’s headed that doomed tax reform, not NFIB and the rest of the Main Street business lobby.

Oh, and the Speaker’s example of a small manufacturer paying nearly a 45 percent tax rate is not rhetorical – numerous manufacturers have testified before Congress that their effective tax rates (the amount of tax they actually pay) – went up dramatically after the Obama-led tax hikes in 2013 and for many of them, rates are now well above 40 percent.  The Obama corporate-only tax reform plan would have raised those rates even higher.  That’s the reason the Main Street business community is united in opposition to the Obama plan.