Build Back Better: A List of Wants, But at What Cost?

Articles From: Invesco US
Website: Invesco US

By: Andy Blocker Head of US Government Affairs, Invesco & Jennifer Flitton Vice President of Federal Government Affairs

Key takeaways

Tax reforms face a tough hurdle

Democrats have razor-thin margins in the House, a tied Senate, and no Republicans willing to support tax increases to pay for the reconciliation package.

We’re tracking several key tax proposals

Among them are provisions to increase the top marginal individual income tax rate and to increase the top capital gain and qualified dividend rate.

Two factors may determine the final package

How much revenue would need to be raised, and who would the tax proposals impact?

As Congress methodically moves forward to enact President Joe Biden’s Build Back Better agenda via the budget reconciliation process, it is grappling with several big issues, the biggest of which is how to pay for it.

There is broad consensus among the majority of congressional Democrats and the Biden administration on what they would like to deliver for the country, but there are substantial disagreements on how – and how not – to pay for it. As Mike Tyson famously quipped, “everyone has a plan until they get punched in the mouth.” Democrats on both ends of the ideological spectrum have entered the ring and the fight is heating up. The reality is tax reform is hard even when the majority has common goals and uses reconciliation to deliver on those campaign promises. 

Tax reforms face a tough hurdle

One doesn’t have to look too far to the past to understand the challenges of disrupting tax policy. The Tax Cuts and Jobs Act (TCJA) was passed via reconciliation in 2017 with the slimmest of margins and was the first robust tax reform since 1986. Tax cuts are a unifying war chant for Republicans, but TCJA had its ups and downs until the final moments before it was signed into law by President Donald Trump. The hard truth is that despite Biden and congressional Democrats’ wish list to expand the country’s social programs, roll back Republican tax cuts, and deliver on their climate agenda, finding ways to pay for them is not easy. With razor-thin margins in the US House, a tied US Senate, and no Republicans willing to support tax increases to pay for the reconciliation package, finding the right policies and enough Democrats to support the final package is not going to be easy sledding.  

Biden campaigned on an aggressive agenda to help Americans he felt had long been neglected by promising to invest in child care, education, health care, and climate solutions, but ambitious promises are often hard to deliver, especially when taxes need to be raised to pay for them. This is true even when many of those taxes poll well – at least those targeted at corporations and the wealthy. While congressional Democrats released reconciliation text on Friday, Sept. 24, there is no expectation that this version will reach Biden’s desk. Negotiations are ongoing and there will be many twists and turns before the end of this story. Most importantly, any text must pass the muster of all 50 Senate Democrats, including the magnifying glasses wielded by Senators Joe Manchin (Democrat-West Virginia) and Kyrsten Sinema (Democrat-Arizona), two powerful centrists.

Key tax policies to watch

Based on the Sept. 24 reconciliation text and the actions and statements of House Democrats, here are some of the key tax reform and pay-for policies: 

  • The proposal would increase the top marginal individual income tax rate from 37% to 39.6% for married individuals filing jointly with taxable income over $450,000, heads of households with taxable income over $425,000, unmarried individuals with taxable income over $400,000, and married individuals filing separately.
    • The new rates would be applicable to tax years beginning after Dec. 31, 2021.
  • The proposal would increase the top capital gain and qualified dividend rate from 20% to 25% for tax years ending after Sept. 13, 2021 (the date of introduction of the proposal), while the statutory rate of 20% would continue to apply to qualified dividends, gains, and losses for the portion of the tax year on or prior to the date of introduction. For 2021, the 25% tax rate for the period of Sept. 14 through Dec. 31, if enacted, would apply to taxpayers currently subject to the 20% rate; however, for 2022 and future years (if the separate proposal on the top marginal rate is enacted), the increased rate would apply to taxpayers subject to the highest ordinary income rate (39.6%).
  • The proposal creates a new 3% surcharge on a taxpayer’s modified adjusted gross income in excess of $5 million ($2.5 million for a married individual filing separately) or $100,000 for a trust or estate.
  • The Net Investment Income Tax (NIIT) imposes a 3.8% tax on individuals, estates, or trusts that have modified adjusted gross income (MAGI) above defined statutory thresholds.
  • The proposal would prohibit Individual Retirement Accounts (IRAs) contributions when balances reach $10 million and accelerate required minimum distributions for those accounts.
  • It would also extend the American Rescue Plan Act (ARPA) Child Tax Credit (CTC) expansion through 2025, and make the entire CTC fully refundable on a permanent basis.
  • In addition, it would make permanent ARPA’s temporary expansion of the Earned Income Tax Credit (EITC) eligibility and phase-in rates.
  • The proposal would make permanent ARPA’s modifications to the Child and Dependent Care Tax Credit (CDCTC).
  • It would also return to a progressive corporate income tax rate structure with a top rate of 26.5% applicable to corporate income above $5 million.
  • Finally, it would reduce the deduction for Global Intangible Low-Taxed Income (GILTI) to 37.5%, resulting in a tax rate of 16.5%; calculate GILTI on a country-by-country basis; reduce the deduction for Qualified Business Asset Investment (QBAI) to 5%; reduce the Foreign Tax Credit haircut to 5%; allow loss carryforwards for five years and disallow loss carrybacks.

While reconciliation is being processed through the House, it’s important to note that behind-the-scenes House staff are diligently working with Senate staff to pre-negotiate much of the legislation. As part of that process, Senate Finance Chairman Ron Wyden (Democrat-Oregon) and other Senate Democrats continue to float alternative revenue raisers such as tax changes to partnership arrangements, stock buybacks, executive compensation, etc. Included in the Senate Democrats’ proposal to tighten up partnership tax arrangements is a new tax on Exchange Traded Funds (ETFs), and a requirement for financial institutions to report account flows to the IRS. While the partnership provisions seem to fit into Hill Democrats’ long-desired objective to ensure the wealthy and the largest corporations pay their fair share, the ETF provision seems misaligned with that goal given that over 90% of ETF investors make less than $400,000 and 50% make less than $125,000, per data from the Investment Company Institute (ICI).

While discussions between the House and Senate are ongoing, it is clear that Chairman Wyden and Senate Democratic leadership see the advantage of circulating multiple alternative tax proposals should there be a final hour funding need during negotiations within their caucus.

Other tax proposals in the works

Beyond these changes to tax policy and efforts to generate revenue, there will be additional attempts to modify the tax code, particularly in the energy arena. Democrats are interested in reorganizing the code so that it provides more policy support for energy sources like wind, solar, geothermal, and energy storage. There are also expected to be changes so that electric vehicle credits — both the Investment Tax Credit and the Production Tax Credit — incentivize domestic clean energy supply chain manufacturing with a focus on union-made goods.

Additionally, the reporting requirements for financial institutions were not included in House Ways & Means Chairman Richard Neal’s (Democrat-Massachusetts) bill, however he and Senator Wyden are negotiating a higher threshold making its inclusion in the final bill more likely. Another tricky issue that remains undetermined is whether Democratic lawmakers will attempt to bring back the State and Local Tax (SALT) exemption—a big objective of Democratic Members in high tax states.

Two factors may determine the final package

Overall, we expect that two overarching factors will determine which tax provisions make it into the final package:

  1. The final size of the reconciliation bill will determine how much revenue needs to be raised to pay for it. A $1 trillion package is much easier to pay for than a $3.5 trillion package.
  2. Who does the tax provision impact? If a provision predominantly impacts corporations or individuals making more than Biden’s $400,000 red line, it has a much greater chance of making it into the final package.

The Build Back Better agenda feels like it has been moving at a snail’s pace and has been a frustrating process for the majority party. Unfortunately for those involved, the only guarantee is more twists and turns as these possible tax changes for the country are deliberated and debated.

Originally Posted on October 1, 2021

Build Back Better: A List of Wants, But at What Cost? by Invesco US

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The opinions expressed are those of Andy Blocker and Jennifer Flitton as of Sept. 29, 2021, and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

All information is sourced from Invesco, unless otherwise stated. All data as of Sept. 29, 2021 unless otherwise stated.

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