TAXES

Financial Services, Manufacturers Keep Up Fight For Critical Tax Break

Mon. May 5, 2008


The battered financial services industry and manufacturers such as auto and heavy equipment-makers are lobbying hard to prevent what they regard as a critical tax break from falling victim to the budgetary and political environment on Capitol Hill.

The provision expires at the end of this year. It costs about $4 billion to extend it for one year and the lack of movement last year on a package of expiring tax breaks because of the pay/go rules has industry officials nervous.

Current law exempts from taxation "active financing" income from banking, insurance and financial transactions -- such as dividends, interest or gains from stock sales -- conducted by foreign subsidiaries of U.S. companies until it is returned to the United States. That is income defined differently from "passive" investment income simply parked in overseas accounts, which is taxable.

Without the exemption for active financing, backers argue, companies will be hit by "double-taxation" from foreign and U.S. taxes, putting them at a competitive disadvantage with firms headquartered in other countries that do not tax their firms similarly.

"This provision is essential to the ability to compete with foreign-based financial services companies," said Taylor Griffin, a spokesman for the Financial Services Forum, an industry trade group. "In addition, not extending this is an enormous tax increase that will cost American jobs."

Extending the provision has broad bipartisan support. Senate Finance Chairman Max Baucus has introduced legislation to make the active financing exemption permanent. He recently included a one-year extension in a massive $110 billion tax "extenders" bill he co-sponsored with Finance ranking member Charles Grassley, which includes a one-year fix for the alternative minimum tax.

On the House side, Ways and Means Select Revenue Measures Subcommittee Chairman Richard Neal, D-Mass., has introduced legislation making the provision permanent. CBO estimates the 10-year cost of making the provision permanent at roughly $50 billion. Neal acknowledged a short-term extension was more feasible.

"It's a complicated issue, it's large, it's looming and there are a lot of very important considerations here. My hunch is we get it done before the year is over," Neal said. "It's a priority, I've talked to [Ways and Means] Chairman [Charles] Rangel and we're working hard on it."

Neal is a longtime ally of the financial services industry. As chairman of the tax-writing subcommittee, Neal's view reaches beyond his district to the major financial centers of Boston, Hartford, Conn., and New York, he said.

"I represent a lot of big companies, and I think this is a critical component of being competitive around the world," he said. "If you live in the Northeast, you have literally tens of thousands of people who go to work for the financials. And [active financing] allows them to remain competitive internationally."

The measure is particularly important to companies like Citigroup Inc. and the financial services arm of General Electric Co., which have significant operations overseas, but also a host of other firms like American Express, Morgan Stanley, Prudential Financial, and Goldman Sachs.

Neal said work will soon begin on a bill to extend the active financing exemption and a host of other expiring tax breaks, as well as the AMT.

"It's not going to be easy, but at the same time I feel pretty confident we're going to get it done. There's some whispering now on the issue of getting all the extenders put into place, we're beginning to examine the pay-fors, and I think sometime in latter spring, at least there'll be discussions," Neal said.

Manufacturers such as Ford Motor Co., General Motors Corp. and Caterpillar benefit because they have leasing and other arrangements enabling them to finance the acquisition of big-ticket items by overseas customers, who are increasingly valuable.

"When we sell an off-highway dump truck to Canada for the tar sands up there or a bulldozer to Colombia, it's a package deal, combining the cost of both the machine and the financing," said Chris Myers, Washington manager of government affairs for Caterpillar.

"With the North American housing market down, our international sales and exports have become increasingly important to Caterpillar. If you're not buying houses, you're not buying the backhoe loaders to build the houses," Myers continued. "It's going to be a dramatic hit [if active financing is not extended]. We need to remain competitive internationally so we're going to have to squeeze someplace else" to pay the added taxes, which could result in lost jobs and higher prices for consumers.

The manufacturing argument resonates with lawmakers like Rep. Dave Camp, R-Mich., whose state is home to the Big Three automakers. Camp, who is angling to become ranking member -- or chairman in the event Republicans regain the majority next year -- on Ways and Means next year, co-sponsored Neal's bill to make the provision permanent. He said Congress must at least temporarily extend it.

"It imposes a tax that no other country imposes in a similar situation. If we don't extend it, American employers will lose their market share, their employees will lose their jobs, and the U.S. economy will suffer," Camp said. "So I think the fact that we're on the edge of an economic downturn, and certainly in Michigan we're past the edge, there's a growing sense that we need to pay attention to provisions like this."

While lawmakers and industry officials argue there is no dispute over the underlying policy, some have consistently cried foul, arguing the exemption is just an excuse for huge corporations to avoid paying taxes.

"It totally stinks. It's as bad as ethanol. And therefore you have general agreement that it should be done," said Robert McIntyre, director of Citizens for Tax Justice. "That's what it's about -- they're moving their U.S. profits offshore, so they don't have to pay taxes."

Active and passive income is inherently fungible, allowing companies to take advantage of the complexity of the tax code, he said.

McIntyre said the entire slew of expiring tax breaks essentially amounts to corporate welfare. "The members of Congress love them, I mean it's basically earmarks in the tax code, and one of the reasons to do them temporarily is you get to keep collecting the campaign contributions," he said.

Extending the active financing exemption from "Subpart F" of the tax code as it is called, has its roots in an overhaul proposed by President Kennedy in 1962. Sensing that multinationals were not paying their fair share of tax, Kennedy proposed to repeal the deferral rule altogether. Business lobbying went into overdrive and a compromise was struck to continue to allow deferral of active financing income.

Then as part of the 1986 tax reform, the provision was repealed, beginning an 11-year stretch where companies were being taxed by both the United States and their subsidiaries' host countries. In 1997, Congress restored the active financing exemption, although with more tightly drawn rules, and it has been extended temporarily four times, most recently at the end of 2006 for two years.

Last year after Congress reinstated pay/go for tax cuts, lawmakers could not overcome the 60-vote Senate hurdle and pass an offset AMT/extenders package. Last week, 41 Senate Republicans, enough to sustain a filibuster, wrote to Baucus to drop his plans to offset this year's version of the bill, which is much bigger than last year's House-passed, $76.5 billion version.

The active financing exemption was not even a part of that package, which focused mostly on provisions expiring at the end of last year. Since Congress could not pass an extenders bill last year, all of those will now have to be extended retroactively, including the popular research and development credit, bulking up the cost.

Adding to the uncertainty, opposition is building to an offset proposed by the Bush administration raising $13 billion over 10 years by requiring financial institutions to report reimbursements to merchants for credit-card and other electronic transactions. The National Federation of Independent Business wrote to the Finance panel last week opposing the plan, which Baucus has been considering to help offset the extenders package.

Grassley said only new tax laws should require offsets, not extensions of existing tax policies. He said he did not know how the negotiations would turn out, but that pressure to act would soon build. "I think the reality among Senate Democrats is they can't go into this election without doing something on AMT and that there's not enough offsets to take care of both AMT and extenders," he said.

Support for pay/go is strong among House Democrats, driven by members of the Blue Dog Coalition. A senior House Democratic aide said an early test of wills could come on the emerging supplemental appropriations bill, on which negotiators are considering adding a package of renewable energy tax breaks that expire at the end of the year. The question is whether, and how, to offset the provisions.

"I'm not sure when, but at some point the K Street crowd who have cast their lot with the Senate saying that the only way to get their provisions is to waive pay/go will have that come back to bite them," the aide said. "If those lobbyists spent 10 percent as much time trying to lobby Republicans to support offsets as they do beating on the House to forget about that silly pay/go rule, they'd have their tax credit by now."

by Peter Cohn

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