December 26, 2010 Congress Addresses Uncertainty: Avoidance as Action

Volume 13 | Issue 4

For manufacturers to invest and hire, it’s time to end uncertainty about taxes. How did Congress address this critical issue? They left town

When Congress departed Washington in the waning days of September, it unfortunately left behind just one thing businesses could be certain about: uncertainty.

Federal spending and soaring debt, the new health care law, the flood of government regulations and even the rise of populist rhetoric – these have already contributed to an endemic uncertainty that has slowed recovery and job creation. But by failing to act on tax rates set to expire at the end of this year, the House and Senate only made it more difficult for manufacturers to plan, invest and compete in the global marketplace.

Most critically, Congress refused to extend the 2001 and 2003 tax cuts affecting individual income tax rates, dividends and capital gains. The fate of a key incentive for investing in innovation (the research and development [R&D] tax credit) remains unclear. Meanwhile, the estate tax, which fell to 0 percent this year, is set to jump back to a top rate of 55 percent in 2011.

DISTURBING SCENARIO
Consider what this means for owners of small but successful third-generation companies that made breakthroughs in manufacturing processes and plan to commercialize the invention, hire people and purchase equipment to apply the processes to an entire new product line. To raise capital, they intend to sell some investments.

“I need to plan for the R&D, all of the new people and equipment, so I guess there’s depreciation involved,” a business owner explains to the company’s accountant. “Capital gains, of course, from the stock sales. And, I really think this venture is going to take off, so I want to make sure we’re prepared to leave the company to the children. So what kind of tax liability should I anticipate?”

“Who knows,” the accountant responds.

This is hardly an environment conducive to investment, to say the least. The new level of uncertainty only adds to the competitive disadvantage posed by the United States’ second highest corporate tax rate among developed nations.

STEP NOT TAKEN
Extension of the 2001 and 2003 “Bush tax cuts” is the most important, immediate step that Congress should have taken before recessing for the campaign season. Full extension remains the critical first responsibility Congress faces when it returns in mid-November for a lame-duck session.

President Obama and leading Democrats in Congress want to extend the lower tax rates only for the bottom three tax brackets while allowing the top two rates to revert to 2001 levels. They characterize the strategy as preserving “middle class tax cuts” while renouncing “tax cuts for the wealthy.”

REALITY CHECK
Rhetoric ignores the reality of American business, especially small business. About 73 percent of all manufacturers are organized as S-corporations or other flow-through entities that pay income taxes at the individual rate, and they will be disproportionately affected by the tax increases. Since 2007, these companies have lost more than 850,000 jobs. If Congress fails to act and lets the tax rates return to the permanently higher rates, the National Association of Manufacturers estimates that manufacturers will lose an additional 238,000 jobs by 2019.

Individual income tax rates are not just the most prominent ones to increase at the beginning of 2011. Capital gains taxes will increase to 20 percent, and dividend tax rates will revert back to the top individual rate of 39.6 percent from the current 15 percent. The lower tax rates on capital gains and dividends help drive economic growth. Indeed, they were instrumental in pulling the economy out of the 2001-2002 recession.

EXASPERATING THE CONSTITUENTS
Inaction is especially frustrating because Congress saw the deadlines approaching. The 111th Congress convened in January 2009, knowing that the higher tax rates would return within two years. Thus, it undermined all the efforts to encourage hiring and economic growth.

In the past year – as the economy continued sputtering and unemployment remained well above nine percent – public pressure for the full extension of tax rates has grown. Further, campaigns highlighted the issue. Support is bipartisan. In mid-September, 31 House Democrats wrote to Speaker of the House Nancy Pelosi, calling for a full extension of the 2001-2003 rates. “We believe in times of economic recovery it makes good sense to maintain things as they are in the short term, to provide families and businesses the certainty required to plan and make sound budget decisions. Providing this certainty will give small businesses, the backbone of our economic recovery, confidence and stability,” the lawmakers wrote.

NO FOLLOW-UP
Here’s another serious case of omission by inaction: the congressional failure to renew the federal R&D tax credit. The United States pioneered the tax credit in 1981. This move proved such a successful impetus for innovation that other countries followed suit.

In 2009, 21 OECD countries offered R&D tax incentives – 16 of which offered stronger incentives than the United States – compared to just 12 OECD in 1996. This 75-percent increase over 15 years reflects a targeted effort by countries to jumpstart technological advancements and innovations by the private sector. Indeed, many of these companies actively recruit U.S. companies to move their research and development offshore.

Rather than respond by making the U.S. credit permanent and more flexible, Congress let this critical incentive lapse at the end of 2009 and failed to restore it this year. True, Congress has previously chosen this path of expiration and (often retroactive) renewal of the tax credit – but talk about uncertainty!

REALITY CHECK – PART 2
R&D fuels the innovation that drives new product development and increased productivity (two necessary factors for growth in manufacturing) but Congress has abdicated its role.

Finally, another deadline looms – and “deadline” is an apt term. In January, the estate tax, which was temporarily repealed for 2010, will rise to a job-killing 55 percent with a $1 million exemption. Small and medium-sized manufacturers spend an average of $94,000 a year to plan for the estate tax, and these costs have increased significantly since the legislation was passed in 2001. The tax affects these companies by discouraging savings and investments. The estate tax also reduces wages, stifles job creation and ranks as the leading cause of dissolution of thousands of family-run businesses.

LOOKING AHEAD
As the recession eases, smaller manufacturers will lead our national recovery by acting first to bring back laid-off workers and recruit new employees. Legislation enacted since 2001 to lower tax rates has been extremely helpful to smaller companies, but permanent, lower individual tax rates are needed to revitalize the U.S. economy.

Already, the economy, jobs and taxes dominate 2010 congressional campaigns. Indeed, high-stakes politics added to the drama of the House’s last day in Washington. Thirty-nine Democrats joined the Republicans to vote against a resolution to adjourn without acting on the tax rates.

“Vote no on this adjournment resolution. Give Congress a chance to vote on extending tax rates,” said House Republican Leader John Boehner of Ohio. The resolution passed by just a single vote.

But these issues are far more than just political, partisan disputes. The strength of the U.S. economy and the ability of manufacturers to grow and hire new employees are also at stake.

Congress still has a chance to extend the tax rates and improve U.S. tax competitiveness. It’s not just a chance; it’s a responsibility. About this national priority, manufacturers are very, very certain.

John Engler is president of the National Association of Manufacturers (NAM), whose mission is to enhance the competitiveness of U.S. manufacturers while helping to foster a stronger economy. Learn more about NAM, visit www.nam.org.

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