The Business Tax Problem Causing Trouble for the GOP

The Senate tax plan encountered its first outright Republican opposition this week, from a senator whose concerns might foreshadow the biggest business challenge ahead for the proposal.

Senator Ron Johnson of Wisconsin called the plan -- which was approved by the Senate Finance Committee late Thursday -- “inadequate” because it would disadvantage many closely held businesses relative to major corporations, or so called C corps.

The plan would slash the corporate tax rate to 20 percent from 35 percent. But the rate for partnerships, sole proprietorships and other pass-through firms would be set by a formula -- with rates higher than 30 percent for some.

“I realize we have a problem here,” Johnson said in an interview. “I just don’t know yet the extent to the problem, how many dollars it’s going to take to fix it, where that’s going to come from.” Until it’s fixed, he said, he’s a “no” vote on the Senate measure.

GOP tax efforts seemed to gain momentum  as the House passed its tax bill and Republicans on the Senate Finance Committee voted later that night to amend and approve their plan.

But Johnson’s misgivings may throw a wrench into President Donald Trump’s top domestic priority. Senate Republicans -- who aren’t counting on Democrats to support their plan -- can spare the defections of no more than two members before the bill would collapse. Party leaders say they want to address Johnson’s concerns, but admit it will be difficult.

Currently, businesses organized as pass-throughs don’t pay income tax themselves, instead passing earnings to their owners, who pay at their individual rates.

The top rate is currently 39.6 %, but the Senate plan would cut it to 38.5%.

The plan that the Senate Finance panel approved Thursday night would allow all pass-through structures to deduct 17.4% from their business income -- up to $500,000 for married couples.

The income would then be taxed at the owners’ ordinary individual income tax rates.

Difficult Vote

Johnson was a difficult vote for GOP leaders to corral earlier this year as they tried and ultimately failed to repeal Obamacare.

His position zig-zagged as he threatened to vote against various iterations of the Senate plan due to policy and process concerns, and he even feuded with Majority Leader Mitch McConnell. Ultimately, he voted for the bill.

On the pass-through issue, “his concerns are valid,” said Senator John Thune, the chamber’s No. 3 Republican. “There is no easy way to deal with pass-through income. We’re trying in the bill to create rough parity between pass-throughs and C corps. And it’s easier said than done. You’re never going to get everybody totally happy with it.”

The Finance panel ultimately made no further changes to its pass-through provisions. Thune, a member of the committee, said Senate Republicans are more likely to deal with the issue when the bill comes before the full chamber.

GOP leaders have said they want to vote on their tax bill the week of Nov. 27.

Some observers question whether a pass-through solution is possible -- noting that Senate tax writers have already tried to trim the cost of their plan by setting their individual tax cuts to expire in 2026.

Not ‘Fixable’

“I don’t think it’s fixable, because you just run into a numbers problem,” said Seth Hanlon, a tax expert at the Center for American Progress, a liberal research and advocacy group.

“They’ve already stuffed what’s in essence more than $2 trillion in deficit-increasing tax cuts into a $1.5 trillion box with these sunsets. Anything that Johnson is talking about is going to be hugely expensive. So something has to give."

“The original sin here is promising enormous corporate tax cuts and then thinking you need to create parity with pass-through businesses,” he said.

One way to address Johnson’s issue may be to raise the 17.4 percent pass-through deduction to 20 percent, Thune said, but “you have to figure out a way to offset it someplace else.”

“It’s a challenge to find revenues,” he said.

The revised pass-through proposal is estimated to reduce revenue by $362 billion over a decade; providing more generous terms would increase that cost.

The Senate proposal would cost $1.41 trillion over a decade. Under budget rules that GOP leaders plan to use to fast-track their bill past Democrats’ objections, the revenue cost must stay under $1.5 trillion and it can’t add to the long-term deficit.

‘Everybody’s Vote’

Deeper tax breaks to pass-through entities could be paid for by raising the corporate tax rate above 20 percent, but that would upset larger corporations, a critical constituency of support for the tax overhaul. Trump and his advisers have said going above 20 percent is non-negotiable.

Adding to leaders’ tough task, various GOP senators have outlined other concerns: the deficit impact, the effect that repealing the Obamacare individual mandate repeal would have on the individual insurance market and the need to prevent any middle-class tax increases.

On Thursday, Congress’s official tax scorekeeper reported that the Senate measure would lead to a 13% tax hike on Americans making between $20,000 and $30,000 a year by 2021.

In that year, those earning from $500,000 to $1 million would see the biggest tax cut -- 8.5% -- according to the Joint Committee on Taxation.

Senate Finance Chairman Orrin Hatch said that it’s “probably more likely” that more pass-through relief would be addressed on the Senate floor, but he kept mum about how he might go about winning Johnson.

“We’ll look at it and do what we need to do,” he said. “I want everybody’s vote.”

‘Greater Scrutiny’

Senator Mike Rounds, a South Dakota Republican, said he can support the tax plan as written, but he said Johnson “correctly points out the discrepancy” between corporations and closely-held businesses.

Bridging the gap “would mean either finding additional revenue to provide additional reductions for the pass-throughs, or trade some of the difference between the two,” he said, suggesting that could mean “perhaps a 21%” corporate tax rate. “I just intend to see that we get this tax bill through to the president.”

Rounds, who previously ran a real estate and investment firm that operated as a pass-through, said that under the Senate bill, his old firm would have considered restructuring as a C corp to get the 20 percent rate.

He said the pass-throughs that would have the most difficulty under the existing proposal would be “individuals that are trying to grow and invest -- so people that are trying to purchase equipment in competition with C corps, individuals who are trying to hire talent in competition with C corps.”

“Those would be the two that I would think would be most impacted,” Rounds said. “Individuals who deal in intellectual properties, where you’re looking at trying to expand and develop an intellectual property.”

Johnson -- who before his 2010 Senate election made millions of dollars running a pass-through manufacturing business -- said he’s still working to identify which types of companies would need more relief, how much help they’d need and how much it would cost. He said he’s meeting with the White House and House Speaker Paul Ryan to discuss solutions.

Johnson also complained that the process is moving too quickly.

“All this stuff moves pretty fast, which I’m not wild about,” he said. “I would rather take a little bit more time, be a little more thoughtful, subject whether it’s the health-care bill or this one to far greater scrutiny, so every member understands exactly what the intended and unintended consequences of these policies are.”

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