United States: Tax Policy Update - December 1, 2014

EXTENDERS IN DEPTH

White House Veto Threat Sinks Hope for a Multiyear Deal

A one-year deal on a tax extenders package is now more likely, after House and Senate leaders, along with leaders of the tax-writing committees, spent much of the past few weeks negotiating a multiyear tax extenders deal, only to have it crumble under a veto threat from the White House on Tuesday.

The deal included provisions favored by both the Ways and Means Committee and the Finance Committee. The compromise would have extended most of the provisions that the Ways & Means Committee had made permanent, and the remainder of the extenders would have been extended for two years, consistent with the Finance Committee's EXPIRE Act of 2014. Under the proposed deal, the following provisions would be made permanent:

1. The research and experimentation credit, as simplified under the House-passed bill, H.R. 4438;
2. Section 179 expensing;
3. State and local sales tax deduction;
4. American Opportunity Tax Credit;
5. Employer-provided mass transit and parking benefits exclusion;
6. Reduced recognition period for built-in gains of S corporations;
7. Rules regarding basis adjustment of S corporation stock for charitable contributions;
8. Tax-free distributions from IRAs for charitable purposes;
9. Deduction for charitable contribution for conservation purposes; and
10. Deduction for charitable contribution of food inventory.

The deal also phased down the wind production tax credit and modified the bonus depreciation provisions.

Important for Democrats, the developing deal included two of these permanent provisions championed by progressive senators: (i) the American Opportunity Tax Credit for higher education, and (ii) permanent exclusion for transit benefits on parity with the exclusion for parking.

The deal headed south when the White House, which previously had not fully engaged in the negotiations, issued a veto threat stating that the proposed deal did not go far enough with respect to individual tax cuts vis-à-vis business tax cuts. White House aides hinted that additional provisions, such as permanency of the expanded earned income tax credit (EITC) and the child tax credit (CTC), would be necessary to balance the package.

Republicans responded by halting the negotiations and were befuddled as to why they might have to negotiate twice to reach an agreement.

Why The Veto Threat Is Likely To Tank A Multiyear Deal

The veto threat jeopardizes any multiyear agreement because the deal that congressional leaders negotiated is only worth it to each side if the bill actually becomes law. For Democrats, swallowing a bill north of $300 billion without offsets is worth it only if they get multiple years of clean energy provisions and significant tax cuts for middle- and low-income Americans. For Republicans, a deal that extends those low-income provisions and energy credits is only palatable if significant provisions, such as the R&D credit, are made permanent.

Two paths remain for trying to get a multiyear package approved. Neither is likely.

First, Republicans could try to address President Obama's concerns as part of the negotiations. However, including the EITC and the CTC raises significant issues in the Republican caucus. The U.S. government inspector general's office and outside watchdog groups have identified significant errors in these refundable credits. Republicans might agree to make them permanent, but only if significant reforms were made to reduce the errors and fraud. Democrats and President Obama are unlikely to agree to the reforms Republicans would propose. Consequently, Republicans are unlikely to agree to the provisions that President Obama has hinted are necessary to withdraw his veto threat.

The second path is to ignore the president's threat and try to pass the multiyear deal that was within striking distance. While this is possible in the Senate, it is unlikely in the House. In the Senate, if some combination of Democratic leadership (Sen. Reid, Sen. Durbin, Sen. Schumer and Sen. Wyden) announced support of the package omitting the EITC and CTC provisions, then the Senate Democratic caucus would split. Democrats supporting the package in combination with most Senate Republicans could possibly garner the 67 votes necessary to override the veto. The package of provisions being negotiated is more inclusive than the bill that all finance committee Democrats voted for earlier this year. Pressed to a vote, a majority of Senate Democrats would want to vote in the affirmative. Senate Republicans might relish overriding a veto — something many of them hope to do in the upcoming Republican-majority Congress. A split in the Democratic caucus, however, would be problematic for Democrats, and some will advise not breaking with Obama.

But this second path breaks down in the House of Representatives. Obtaining a majority in the House of Representatives would not be too difficult; however, obtaining the required two-thirds vote to override a presidential veto is highly unlikely. President Obama's position is more closely aligned with that of most House Democrats, who opposed the individual permanency bills that came to the House floor this summer. If the president does not soften his position, many House Republicans will tell their leadership that they will not vote for a bill that contains permanent EITC and CTC increases but lacks reforms to prevent error and fraud. That in turn enhances the power of House Democrats, most of whom would sustain an Obama veto.

These developments could be overcome if: (i) Members had sufficient trust in one another to sit down and think things through, and (ii) there were more than two weeks left in this Congress. Neither is the case, however.

Accordingly, it appears that a one-year extension of all of the EXPIRE Act provisions is the only way forward for this year, setting up another debate over extenders in the new year.