BEYOND THE NUMBERS
With the country facing high unemployment and a weak economy in the short term and severe budget problems in the long term, you’d think that senators negotiating a jobs bill would be trying to maximize both its short-term economic boost and its long-term budget savings. You’d be wrong.
In fact, senators trying to extract final concessions as the price of supporting the bill are pushing in the opposite direction.
They are trying to whittle down the measure’s temporary state fiscal assistance and help for unemployed workers, despite abundant evidence that these measures will save jobs, help the jobless, and boost the economy.
At the same time, they are trying to weaken or eliminate provisions designed to crack down on well-known tax loopholes, which would generate long-term budget savings in an efficient manner.
Specifically, they are caving in to (1) private equity managers who don’t want to pay taxes on their income (known as their “carried interest”) at the same rates everybody else faces on their income and (2) lobbyists seeking to convince Congress not to address a serious compliance problem with “S corporations” that government watchdogs have identified.
Regarding carried interest, which is the share of a private equity fund’s profits that a fund manager can receive without having to contribute a corresponding share of the fund’s capital:
- A bill the House passed in December would have raised $25 billion over ten years by taxing carried interest as ordinary income, rather than at the lower capital gains rate. This is entirely appropriate given that the income that fund managers derive is ordinary income — it is compensation for the work that they do and the services they provide, not a return on capital they have invested.
- House-Senate negotiators subsequently agreed on a compromise provision that would apply ordinary income tax rates to most but not all carried interest; this compromise would raise $18 billion. The House approved this provision as part of its jobs bill in May.
- When the jobs bill reached the Senate, a group of senators whittled down the provision further. The current Senate version would allow private equity fund managers to shelter up to half of their carried interest at preferential capital gains rates. It would raise $14 billion.
- Still, industry lobbyists have convinced some senators to push for more cuts in the provision.
The S corporation issue has received less attention but is just as problematic. Shareholder-employees of S corporations receive both wages from the firm and a share of the firm’s profits, but they pay payroll tax only on their wages. Not surprisingly, many small proprietors establish themselves as S corporations and then underpay themselves in salary (taking more of their compensation in profits), thereby avoiding payroll taxes that other taxpayers pay.
- The Treasury Department’s Inspector General for Tax Administration and the Government Accountability Office (GAO) have both explained that S corporations constitute a major tax compliance problem.
- The jobs bill the House passed in May partially addresses this problem by disqualifying some professional service providers (lawyers, accountants, etc.) from using S corporation status to save payroll taxes.
- Nevertheless, some key senators favor eliminating the provision entirely, which would allow what GAO has called a “multibillion dollar employment tax shelter” to continue indefinitely.
The nation’s short- and long-term challenges call for an aggressive policy response to encourage the nascent economic recovery without aggravating out-year deficits. By weakening the jobs bill’s measures to stimulate the economy and close egregious tax loopholes, the Senate has got it backwards.