Tax News Update: October 21

EXTENDERS ENDGAME: TAX POLICY TREADING WATER AMID DC DYSFUNCTION

As Congress returns for week two of the session's closing stanza, a host of tax policy items remain up in the air. And while their resolution ultimately remains at the mercy of more than a few variables, a rapidly dwindling legislative calendar means the endgame is coming into focus. In the seven remaining weeks either chamber is scheduled to be in Washington, lawmakers must navigate impeachment, dispose of a high-profile trade deal, and manage to keep the government lights on, ideally in a way that can sustain unrelated policy riders. If they can manage all that, a year-end tax package is very likely—the question is what makes it in.

With all that in mind, here is what you need to know through the end of the year.

WHAT TO WATCH

Impeachment: The Elephant in the Room

It would be silly to try and analyze the prospects for any legislation without addressing the specter of presidential impeachment and, ultimately, the threat of removal. While its direct effects are difficult to quantify, and the path forward is far from clear, impeachment looms over everything that is happening in Washington. Even if Congress proves its ability to “walk and chew gum” (a la Gingrich-era Republicans during the Clinton impeachment process), the current inquiry makes an already stilted political environment that much more fraught. What’s more, every day spent litigating it on the House (or Senate) floor comes at the expense of these other prerequisites.

USMCA: Last Chance for a Win

The President’s NAFTA reboot remains the administration’s top legislative priority, and, realistically, the last best hope of a bipartisan achievement in the 116^th Congress before it is fully subsumed by the 2020 election. It also enjoys something of an odd symbiosis with impeachment. Democratic majority-makers, those “frontline” members who provided Speaker Pelosi with her gavel, have long been clamoring to leadership for USMCA as an accomplishment they can tout back home. The sudden acceleration of impeachment sentiment makes this need even more urgent; whatever their level of comfort in supporting the inquiry, those 31 Democratic members in Trump districts want to be able to show that they can work with the President to deliver for their constituents even as they vote to hold him to account. If the administration can work out a deal with Congressional Democrats on USMCA, the goodwill dividend alone could provide a jolt of momentum to the rest of the agenda; if the trade deal falls through, it’s easy to envision broader fallout. It should also be noted that free trade agreements fall into the jurisdiction of Ways and Means and Senate Finance, meaning that while no formal committee action is required under the fast-track process, attention of congress’ chief tax-writers will be divided until the deal is done.

Appropriations: Last Train Out of the Station

Realistically there will be only one opportunity to enact tax policy this year, and that will likely come on an end of year omnibus. The government is currently operating on a stop-gap continuing resolution that runs through November 21^st, but the odds of wrapping up the 12 spending bills in the interim are virtually nil. While the overall budget number has been set since August, lawmakers must still reach a deal on the funding allocations among the respective subcommittees, and negotiations are mired in a “prolonged slump,” per Senate Appropriations Chairman Richard Shelby (R-AL.). A final, short-term CR to buy more negotiating time would move us into December, where Congress is scheduled to adjourn by the 13^th. If an omnibus spending deal does not materialize, a longer term CR is possible, much to the chagrin of defense hawks on the right and domestic-spending advocates on the left. Whether aimed at getting beyond the impeachment process or closing out the fiscal year, a long-term continuing resolution would make it far more difficult to move tax policy.

While we are less than a year removed from a self-inflicted government shutdown, both sides appear to have calculated that such a move would hurt their electoral prospects heading into 2020. This calculus was most evident over the summer, when Speaker Pelosi and Treasury Secretary Steve Mnuchin hammered out an agreement to lift the debt ceiling along with the statutory budget caps. But budget numbers and handshake deals to avoid “poison pills” are one thing; adjudicating the power of the purse is another. Unresolved issues include potential landmines ranging from border funding to women’s health issues, any of which could send things sideways. And with a pugilistic President deep in the impeachment bunker, it wouldn’t take much to upend the entire process. Bottom line: the single most important element of moving a tax package this year will be keeping the appropriations process on the rails.

WHAT’S “IN PLAY”

Extenders—More than two dozen temporary tax breaks aimed at a range of industries lapsed at the end of 2017.  While retroactive extension has become customary, if not routine, an unprecedented 22 months have passed without congressional action. And although the 2015 PATH Act thinned out the extenders herd, including policies with some of the most formidable political constituencies, the 2017 batch still includes the biodiesel tax credit (BTC), dear to Senate Finance Chairman Chuck Grassley (R-IA) and his allies; and the track maintenance credit for short line rail, the footprint of which winds across the political map. Further complicating things, an additional array of temporary tax provisions expire at the end of the year, including the New Markets Tax Credit (NMTC), the Work Opportunity Tax Credit (WOTC), and the CFC look-through rule. And TCJA itself created two new extenders in reduced federal excise tax rates for alcoholic beverages, and an employer credit for paid family and medical leave.

Both chambers’ tax committee leadership have introduced legislation to restore the lapsed extenders. The House bill would extend all but two of the lapsed 2017 provisions through 2020, while tacking on an additional year for those expiring in 2019; the Senate bill is limited to the 2017 extenders and would renew all of them retroactively through the end of the year. The length of the extension does not figure to be a primary sticking point, although the additional cost of a third year is not insignificant at more than $12 billion. While the Senate launched a series of bipartisan task forces charged with examining temporary tax provisions on their individual merits, the process yielded little by way of consensus, making extenders once again a binary proposition—kick the can in its entirety with a simple date change, or leave them dormant until the next effort to revive them. Plans to mark up the Senate extenders bill to boost its negotiating position with the House have stalled out, but the opening bids of the respective chambers are clear.  A deal to pull out, say, biodiesel or short line rail does not seem likely at this point, but remains a possibility given their disproportionate clout.

TCJA Technical Corrections—Certain errors in the tax law, such as the forgotten depreciation period for qualified improvement property (QIP), have been evident since the ink dried. Others have come to light more recently, such as fixes for Gold Star families and rural electical co-ops. Republicans have been eager to address these mistakes, deemed technical in nature by the Joint Committee on Taxation, even passing five top tier corrections along with extenders in a lame duck gambit that was promptly ignored by the upper chamber. In the interim, House GOP chief tax-writer Kevin Brady (R-TX) has released a discussion draft encompassing the broader universe of necessary fixes. For their part, Democrats have indicated that technicals are on the table, while stipulating that any fixes will come at a significant price. It's worth noting that the only TCJA tweak enacted to date, the so-called "grain glitch" for agricultural co-ops under Section 199A, however inadvertent its effects, was substantive rather than technical, underscoring the importance of having a politically powerful, geographically strategic constituency with bipartisan patrons.

Clean Energy Incentives—The Ways and Means committee continues to work on a package of clean energy tax incentives, elements of which could ride on an eventual tax deal. While the effort fits into the broader House Democratic agenda on climate, it also satisfies a key parochial priority within the committee. Indeed, the first indication of such a package came during the extenders mark-up via a colloquy between Chairman Richie Neal (D-MA) and Rep. Dan Kildee (D-MI). In the exchange, Neal committed to take up Kildee’s legislation to expand the electric vehicle (EV) tax credit in the context of a broader green energy package to be considered in the near future.

In addition to the Kildee EV bill, we expect core elements of the package to include significant changes to the energy investment tax credit (ITC). With the ITC scheduled to phase out beginning in 2020, Rep. Mike Thompson (D-CA) has introduced legislation to extend the credit at its current 30 percent level for an additional five years. And Rep. Mike Doyle (D-PA) once again has a bill to expand ITC eligibility to energy storage technologies. Look for some form of these bills to make it into an eventual chairman’s mark, along with other member priorities, such as energy efficiency incentives. The green energy package timeline has slipped considerably since the August recess, but as the committee adds the finishing touches, we expect to see a bill by November. A markup is possible later in the month, but a crowded calendar makes it difficult. This clean energy legislation won’t be considered as a whole, but elements of it (such as EVs) may be incorporated into year-end negotiations, and the balance will be in play going forward.

SECURE Act—House legislation to boost retirement and family savings was backed by all but three representatives when it came to the floor in May. The bill has languished in the Senate ever since thanks to anonymous holds, but as a bipartisan priority (the upper chamber has its own RESA proposal on the Finance Committee shelf), and the only obvious shell for the Senate to use for tax policy, some form of the SECURE Act is likely to be considered by the end of the year. The bill also includes the aforementioned fix for Gold Star families, a fact noted by GOP Senators in a letter to Majority Leader Mitch McConnell sent this week. McConnell attempted to bring the bill to the floor by unanimous consent (UC), but a path forward is murky until the holds are removed and a bipartisan agreement can be reached on terms of the floor consideration. Should appropriations fall apart, this is a long-shot vehicle to carry extenders and anything else that can make it in.

OBSTACLES TO A DEAL

Post-TCJA Angst—Nearly two years after its enactment, hard feelings over the GOP tax law still run deep. And while tax extenders have long been a bipartisan endeavor, House Democrats are now insisting on a progressive “win” in order to play ball. In that spirit, when the Ways and Means committee moved its extenders legislation, it was paired with a bill to expand the earned income tax credit (EITC) and the child tax credit (CTC). While there is recent precedent for such a deal—the aforementioned “grain glitch” fix was linked to an enhancement of the low-income housing tax credit (LIHTC)—Republicans have thus far balked at the cost, which the Joint Committee on Taxation pegs at $131 billion over ten years. The GOP could always counter with a scaled down the EITC/CTC increase, but it’s clear that some concessions will be necessary to move forward. And while Chairman Neal’s emphasis has remained on tax policy for working families, some elements of the committee’s clean energy package could suit a similar purpose.

While the parties find themselves at loggerheads in the wake of TCJA, the tail risk for stakeholders is that both sides generally think the business community got a sweet deal out of the tax law, and, outside of parochial interests, and a general acknowledgement that taxpayers have been conditioned to expect their renewal, the sense of urgency surrounding extenders on Capitol Hill is underwhelming.

Pay-fors—Congress typically renews tax extenders using a “current policy baseline,” meaning their revenue impact is ignored for budgeting purposes, but the past three years have turned the notion of business as usual on its head. The wave of Democrats that swept into power in the midterm elections are skeptical of deficit-funded tax policy, especially as it relates to businesses they see as having disproportionately benefited from TCJA. The House version of extenders legislation featured a rollback of TCJA estate tax treatment, a nod to these political concerns as well as the chamber’s “PAYGO” rules. Such changes will not fly in the Senate, let alone the White House, making its inclusion a placeholder at best, and a poison pill at worst. For their part, Senate Republicans have remained adamant that extenders should not be offset. One side will have to blink for this issue to be resolved.

THE UPSHOT

While top level negotiations are still in their earliest stages, the path to a significant package is clear and straightforward. Ultimately the biggest risk for tax-writers (and stakeholders) is that they don’t control their own destiny. They could hammer out the best tax deal in the world, and its fate will still come down to whether appropriators can get their act together, and whether a mercurial President, currently fighting for his political life, is willing to play ball.

We’ll keep you posted as we begin to solve for these variables. Until then, stay tuned.