July 31, 2017 - Weekly Legislative Update
Budget Resolution Critical to Tax Reform
For the rest of the month until mid-September, Republicans in Congress must pass a budget for the coming fiscal year, issue reconciliation instructions to Ways and Means and Finance for a tax reform bill, and negotiate with the White House to fill a $1.5-$2.0 trillion revenue shortage in their tax reform drafts.
These actions won't address WOTC directly, but they'll definitely impact the odds for winning permanent WOTC when tax reform comes up. Realistically, there are only two possible outcomes:
1. WOTC is terminated by the tax reform bill;
2. WOTC is made permanent with or without expansions or cutbacks.
Right now, staffs in Treasury and Congress are pouring over every line of the tax code and evaluating effectiveness of programs like WOTC. We'll have to live with or challenge the results of those evaluations as they're produced, relying on Freedom of Information Act requests to obtain them.
But factors we have no control over, such as what the new tax rates will be, and the size of any gap between revenue lost from lower tax rates, versus revenue gained by curbing tax credits and deductions, can impact WOTC's odds of success going into the fight. The more revenue lost from lower rates, the more pressure for eliminating tax credits and deductions.
Tax reform based on reconciliation, which creates the best odds for passage, can't occur without first passing a joint budget resolution for Fiscal Year 2018. House and Senate must both agree on a budget, but so far there's no budget in either body. Nevertheless, due to good work by House Leaders and Budget Committee interacting with the Appropriations Committee, a partial budget exists with dollar ceilings, and subcommittees covering discretionary funding are already preparing FY 2018 appropriations bills for their agencies.
There are two holdups to finalizing the House budget resolution-first, the size of cuts to entitlement programs, and second, reconciliation instructions to the tax-writing committees.
Republican moderates are ready to accept $100 billion in cuts to entitlement spending, mostly in Medicare and Food Stamps (SNAP), but the Freedom Caucus demands $200 billion. Since no Democrat will vote for a GOP budget resolution, the support of thirty or so members of the Freedom Caucus is needed to pass the resolution.
Appropriations subcommittees are charged with funding entitlement programs authorized by Congress to assure they function to meet public needs, so when the hard work of making large cuts is passed to them, they can push back demanding lower cuts-that's what's happening now.
Time is running out for bringing a budget to the floor, we expect a breakthrough this week or next. The Senate Budget and Appropriations Committees are coordinating with the House, so the two bodies should be nearly on the same page when the House closes a deal.
Reconciliation instructions to Ways and Means and Finance Committees must be finalized and included in the budget resolution in order to speed passage of tax reform without a Senate filibuster. When Speaker Ryan and Ways and Means Chairman Brady wrote their tax reform bill last October, it was revenue-neutral and reconciliation instructions were easy to devise.
Since that time, White House negotiators have decided to drop the Speaker's border adjustment tax on imports, creating a $1.5 billion gap between revenue lost from lower taxes and revenue gained from cutting credits and deductions in the Ryan plan. Treasury Secretary Mnuchin then finds, after cutting all credits and deductions in view, that the bill he's drafting has a $2 trillion gap, which he proposes to fill by assuming tax reform will increase GDP resulting in more tax revenue.
Ryan continues to stick by his border tax as better than any alternative way of achieving a revenue-neutral tax plan while boosting global competitiveness of the US economy.
Obviously, the White House and Congress, now coordinating intensively to produce tax reform plans that are similar if not identical by mid-September, have decisions to make before reconciliation instructions can be finalized. McConnell and Ryan are negotiating with Mnuchin and National Economic Council Director Gary Cohn for the White House.
This is a tall order but Ryan and McConnell are proven leaders and they know their Party is anxious for victories. With the GOP facing major deadlines on their campaign promises, Ryan and McConnell will have the whip hand getting their caucuses in line to pass legislation because failure exposes inability to govern.
Leadership will be on display as McConnell takes a second crack at delivering on health care. By pumping billions into the insurance exchanges, Medicaid, and opioid addiction, his new bill satisfies moderates while preserving GOP goals goals to terminate the individual mandate, eliminate the income tax surcharge on the wealthy, and convert Medicaid from an entitlement to a block grant to the states. Don't be surprised if he wins on the vote to take up the bill. If he loses, setting aside the bill to next year will remove a hurdle to tax reform.
LIFO Coalition Call to Action
First, the LIFO Coalition has just submitted a comment letter to the Senate Finance Committee in response to Chairman Hatch's request for feedback on tax reform. Our letter has been posted on the Coalition website, and you can access it here: http://savelifo.org/wp-content/uploads/2017/07/Hatch-Letter-Comments-TaxReform.pdf
But far more important: the pace of tax reform is definitely picking up in Congress and the White House, with some saying that a full proposal could be released as early as mid-August. While that is still an ambitious schedule - and something less than a full, fleshed-out proposal is likely to be released first - the cancellation of part of the Congressional August recess makes it possible. What is clear is that the relevant tax teams from the House, Senate and White House are meeting regularly and making progress on a reform proposal.
And despite the previous intense focus on House Blueprint, it's also clear that the Senate is deeply involved in developing a tax reform plan and it appears that they are further along than previously understood.
What is also clear now is that LIFO repeal is part of the tax reform discussion.
While we do not believe that any decisions have been made, we do know that tax writers are actively looking for sources of revenue to pay for reduced tax rates and other reform proposals like expensing. The House "Blueprint" included a Border Adjustment Tax, or BAT, that would raise more than $2 trillion. That proposal proved to be very controversial and most tax observers believe it will not be included in a final tax reform proposal. Without the BAT, other revenue sources have to be found, and that search for other revenue puts LIFO in peril. Specifically -
-One House Ways and Means Committee member said recently that if the BAT did not survive, the Committee would "be looking under every rock" for alternative revenue sources.
-Two influential House members specifically mentioned LIFO repeal as a potential revenue source.
-It has been reliably reported that the tax reform proposal released by former House Ways and Means Chair Dave Camp in 2014 is being looked at as a source of ideas for revenue - and the Camp bill included LIFO repeal.
-House and Senate staff have said that "everything is on the table" and that stakeholders should be talking to Senate Finance members NOW if they have a tax issue of concern.
-And most recently, key Congressional staff have raised the possibility of LIFO repeal with a reduced tax rate on the recapture tax, similar to a repatriation tax.
In short, it is not an exaggeration to say that LIFO is at greater risk today than it has been for years.
Fact Sheet on Last-in, First-out Inventory Accounting Method
Purpose of LIFO and FIFO inventory accounting system:
1) To track product. A business always wants to have adequate inventory on hand to meet demand, whether manufacturing, distribution, or retail.
2) To track costs. A business must manage cash flow to maximize efficiencies. Since inventory items tend to be fungible, inventory conventions are a key part of tracking costs.
3) To determine income. The tax code requires taxpayers to use the best inventory accounting practice in the trade or business that most clearly reflects income. FIFO (First-in, First-out) is best suited to a business with falling prices. LIFO is best suited to a business with rising prices.
4) LIFO and FIFO achieve the same purpose: they most closely match the cost of goods sold with the cost of the replacement inventory the company must purchase in order to remain in business.
5) Myth-buster: Tracking the flow of physical inventory and tracking costs are two different things. Both FIFO and LIFO track costs, not the flow of physical inventory
LIFO is not a tax expenditure:
LIFO is a 76-year-old GAAP-approved inventory accounting system which does not meet the statutory definition of a tax expenditure. From its adoption in 1939 through 2008, LIFO was not included in the Joint Tax Committee list of tax expenditures, and is still not included on the Department of Treasury list of expenditures today. http://savelifo.org/wp-content/uploads/2017/06/LIFO-is-not-a-tax-expenditure.pdf
LIFO repeal would slow the economy, cost jobs, and reduce revenue prospectively
The economic dislocation that repeal of LIFO would cause would more than offset any new Federal revenue. A Tax Foundation study released in February, 2016, found that repeal of LIFO would reduceGDP by $116 billion per year, reduce federal revenue by $518 million annually, and cause the loss of as many as 50,300 jobs. Click here for a Tax Foundation study on the impact of LIFO repeal: http://savelifo.org/wp-content/uploads/2016/02/TaxFoundation-FF501.pdf
LIFO repeal would be uniquely and punitively retroactive:
LIFO repeal would require the retroactive recapture all LIFO-related deductions that have been taken by LIFO taxpayers, sometimes over many decades. Under current law this recapture tax is paid only when the company reduces its inventory levels, experiences deflation, or goes out of business. To impose that tax in the absence of any of those triggering events would retroactively change the rules for LIFO taxpayers. For more on this click here: http://savelifo.org/pdf-2012/LIFO-Coalition-White-Paper-re-Retroactivity-Updated.pdf and here: http://savelifo.org/lifo-repeal-retroactivity-patrick-driessen-article-published-by-tax-analysts/
LIFO works the way it was intended to work:
LIFO is designed to react to price fluctuations. LIFO has a built in "toggle switch" that triggers tax when prices go down. For example: Crude oil has dropped in price in recent years, significantly reducing the LIFO reserves of oil and gas companies and bringing millions of dollars into current taxable income. Under current statute, the benefit from LIFO is recaptured when the taxpayer's inventory levels decline, prices fall, or the taxpayer goes out of business, in which case the taxpayer no longer needs tax treatment under LIFO.
LIFO is used by a wide cross-section of industries and not exclusively by large energy companies:
LIFO is used by more than a third of all U.S. companies, including hundreds of thousands of pass-through small and mid-sized businesses, including manufacturers, distributors and retailers of a wide variety of products. Click here for a list of LIFO Coalition members: http://savelifo.org/about-lifo-coalition/ and here for a Georgia Tech study on LIFO usage: http://savelifo.org/pdf-2011/GA%20Tech%20Study%20Consequences%20of%20the%20Elimination%20of%20LIFO.pdf
Small businesses would be disproportionately harmed by LIFO repeal:
Small businesses that operate on tighter margins particularly rely on LIFO to ensure their ability to maintain inventory levels. Repeal could force many of them into debt not only to pay the recapture tax, but to replenish inventory - a backward spiral that will put them in a position of always trying to play catch up. Some may be forced out of business. Click here for a Small Business Administration Office of Advocacy letter: http://savelifo.org/pdf-2011/SmallBusAdministrationLetter.pdf
LIFO should not be repealed on a prospective-only basis:
LIFO was added to the U.S. tax code as an approved inventory accounting method in 1939 to address the corrosive impact of inflation on the ability of U.S. companies to maintain adequate levels of replacement inventory. The need for LIFO has not changed. If a company which sells a product that rises in price does not have sufficient after-tax profit to buy replacement inventory that company cannot remain in business.
LIFO repeal should not be repealed in the context of tax reform or to offset tax rate reductions:
A reduction in income tax rates would not compensate LIFO users for repeal. Many companies have built up their LIFO reserves over many decades and their LIFO reserve is a multiple of one year's taxable income. A simple deferred payment scheme for the repayment of tax from LIFO repeal would not be sufficient to mitigate the harm that LIFO repeal would cause. Repeal would force some smaller companies out of business.
No factually accurate substantive arguments have been made to justify LIFO repeal:
While LIFO repeal has been discussed for nearly a decade, no factually accurate substantive argument for repeal has been made; rather, LIFO repeal has been proposed to generate revenue to fund other programs or tax cuts. Click here for a letter on LIFO legislative history and purposes: http://savelifo.org/wp-content/uploads/2017/01/Camp-Letter-re-Comments-Draft-Tax-Reform-Act-03-31-14.pdf