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Budget

Democrats Go After Tax Loopholes for Yachts, Vacation Homes

Owners of luxury boats would pay more in taxes if Democrats have their way.(Valery Hache/AFP/GettyImages)

photo of Billy House
November 8, 2013

Democratic members of the conference committee trying to work out a budget agreement have drafted a memo listing "egregious tax loopholes" that they plan to raise publicly as early as next week if Republicans continue to balk at considering some new tax revenue to help soften sequester cuts.

The items contained on the list range from such well-tread suggestions as ending special deductions for corporate jet owners, to stopping subsidies for yachts or vacation homes, to "closing a loophole that lets hedge fund managers pay lower tax rates on their income than teachers and firefighters." The injection of such populism is sure to exacerbate the partisan tensions in the budget talks.

The memo, a copy of which was obtained Friday by National Journal, is already causing a stir on K Street. Most of that reflects worry that it represents a Democratic "hit list" that might be an early glimpse of some of what will be contained in a Senate version of a tax-code overhaul plan—rewrite work now being done in both chambers.

 

Adding to those perceptions is that, almost simultaneously to this memo's circulation, Senate Finance Committee Chairman Max Baucus, D-Mont., on Thursday night sent out a notice to committee members that they will have a "Senators Only" meeting next Thursday "to discuss tax reform."

But Democratic sources say the budget committee strategy and the Baucus meeting are unrelated, and this is purely a coincidence.

"This is in no way a draft of the upcoming tax-reform proposal—or a 'hit list'—completely false," insisted one Democratic aide, speaking of the memo. But the aide said Democratic budget conferees are prepared to raise these items as early as next week as examples of how sequester and other cuts could and should be replaced or softened by ending tax breaks for special interests.

The budget conference committee meets for a second public session on Wednesday. Its 29 members must make recommendations by Dec. 13 on how to keep government funded beyond Jan. 15, and perhaps soften or replace a new round of sequester spending cuts at the start of next year. Another $91 billion in automatic sequester cuts are set to go into effect in January.

Momentum is clearly starting to pick up: Congressional Budget Office Director Doug Elmendorf will join next week's budget-conference meeting. Before the conferees' discussion, Elmendorf will brief the conferees on CBO's budget and economic outlook, and answer questions.

The Democratic move on tax loopholes comes as a response to the quick warning from conference committee cochair and House Budget Committee Chairman Paul Ryan, R-Wis., last week in the panel's opening meeting that the conferees' work should not turn into an argument about raising taxes.

The indication from Ryan was that the bipartisan, bicameral panel should instead find non-tax revenue and user fees to go along with other spending cuts if the intention is to replace or soften the sequester.

As part of its work, however, the conference committee has been given the option of offering instructions to House Ways and Means Committee Chairman Dave Camp, R-Mich., and Baucus on how to proceed with their tax-code overhaul efforts, and could even provide directions to expedite that work. Some public unveiling of those efforts in either one or both chambers had been expected before Thanksgiving, but that appears now to be in doubt.

Democrats argue in their new tax-loophole memo that the budget conference committee's negotiation presents both parties with an opportunity and an immediate need to discuss and perhaps act on some tax issues now.

"The question is no longer whether we should replace sequestration, but how," the memo states. "Democrats believe that, in addition to responsible spending cuts, we should also replace sequestration by closing wasteful corporate loopholes and ending special-interest subsidies in our bloated tax system.

Here, according to the memo, are "just a few of the many egregious loopholes that Republicans should either bring to the negotiating table or explain to the American people why they can't find a single loophole to close to get a bipartisan deal." The 12 loopholes, quoted directly from the memo, are:

1. End Tax Deductions for Shipping Jobs Overseas—The last thing we need to do is give companies an incentive for shutting down business operations here in the U.S. and offshoring those jobs overseas. But right now, the tax code allows businesses to deduct their expenses when they move a plant overseas. Closing this loophole would save about $200 million over ten years.

2. Close the Corporate Jet Loophole—Corporate jet owners can deduct their investments over five years, while commercial aircraft must be depreciated over a longer period. Closing this unfair loophole would save taxpayers almost $4 billion over ten years.

3. Close the Carried Interest Tax Break—With the "carried interest" loophole, hedge fund managers and private equity advisers face a 20 percent tax rate on their compensation, while all other taxpayers pay ordinary rates of up to 39.6 percent. Ending this loophole would save more than $17 billion over ten years.

4. End the John Edwards/Newt Gingrich Loophole—Some wealthy business owners knowingly mischaracterize their income as business profits instead of salary to avoid Medicare and Social Security payroll taxes. Ending this loophole would save about $12 billion over the next ten years.

5. Stop Tax Subsidies for Yachts and Vacation Homes—The wealthiest Americans often are able to deduct interest on loans that finance their vacation homes and yachts. Closing this loophole could save taxpayers as much as $15 billion over ten years.

6. Close the "Check-the-Box" Loophole—Many U.S. multinational corporations use this loophole in the tax code to make certain foreign subsidiaries disappear on paper, simply by checking a box on an IRS form. This allows these companies to avoid massive amounts of U.S. and even foreign taxes. Ending these so-called "Check the Box" schemes would save as much as $80 billion over ten years.

7. Treat Companies Managed and Controlled in the U.S. as U.S. Companies—Companies that are managed and controlled right here in the U.S. can avoid taxes by incorporating and setting up a P.O. Box in a tax haven overseas. In fact, 18,000 companies claim their headquarters is located inside a single five-story building in the Cayman Islands. Ending this loophole would save taxpayers almost $7 billion over ten years.

8. Tax Risky Derivative Contracts on a "Mark-to-Market" Basis—Excessive and risky bets on derivative contracts were a primary cause of the financial crisis. But the current tax system actually encourages these risky bets with complex and inconsistent rules, allowing Wall Street bankers to game the system. Streamlining the tax rules for speculative derivative contracts – by taxing them on a "mark-to-market" basis – would save at least $16 billion over ten years.

9. Limit Corporate Deductions for Excessive Executive Stock Options—Right now, big corporations claim enormous deductions by compensating their executives in stock options instead of regular paychecks, thereby skirting existing rules that limit deductible cash compensation to certain employees to $1 million per year. This loophole encourages the same type of reckless, short-term profit focus that contributed to the financial crisis. Closing this loophole would save as much as $50 billion over ten years.

10. Stop Wealthy Individuals from Playing Tax Games with their Retirement Accounts—Wealthy individuals should not be able to use their tax-deferred Individual Retirement Accounts (IRAs) as estate planning tools. But right now, that is exactly what is happening. Tightening these rules to prevent individuals from accumulating millions and millions of tax-deferred dollars in IRAs, as well as continuing to defer tax on these amounts until decades after they die, would save about $10 billion over ten years.

11. Defer Interest Deductions Related to Foreign Income—Current tax rules allow U.S. multinational corporations to finance expanded overseas operations with debt, and then deduct the interest on that debt before they report any foreign income to the IRS. This unfair tax break shifts tax burdens onto Americans and U.S. businesses without foreign operations. Ending this loophole would save more than $50 billion over ten years.

12. Close Estate Tax Loopholes for the Wealthiest Americans—Millionaires and their heirs can skirt the estate tax through a form-over-substance scheme that involves setting up a two-year grantor retained annuity trust (GRAT). If the grantor outlives the trust term of two years, the trust assets avoid estate taxation. Closing this loophole, by requiring a ten-year minimum term for grantor trusts, would save more than $3 billion over ten years.

Surprisingly, the memo makes no mention of repealing a host of tax breaks that the oil and natural gas industry has been receiving for almost a century. Congressional Democrats and President Obama have traditionally targeted these tax breaks as part of budget talks but have never succeeded in reducing or eliminating them.

In the past year, the American Petroleum Institute and other trade groups and companies in the oil and gas industry have made tax reform—and specifically preserving their current tax treatment—their top priority.

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