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Tax Relief Proposals May Hurt Your Bottom Line

Tax relief and reform remain popular pursuits on Capitol Hill. The dilemma lies in how to “pay for” various initiatives. Increasingly, the proposed trade-offs include inventive tax increases, which have set off a scramble in the business community and with taxpayer advocates.

As long as Congress continues to use static analysis as its basis for scoring tax cuts – that is, the precept that such cuts cost the U.S. Treasury rather than help grow federal revenues due to the dynamic boost such freed resources bring to the economy — the search will be on for offsets to the budget.

Spending cuts are clearly off the table. In general, Congress has demonstrated no collective will to pare back — even on wasteful spending. As noted by the Cato Institute, even self-proclaimed budget hawks have a dismal record in voting against pork projects. Rep. Jeff Flake, R-Ariz., for example, introduced “dozens of amendments that would defund ridiculous pork projects such as swimming pools, retail markets and aquariums” according to Cato. On good day he may have been joined by a tenth of his House colleagues in support of the amendments.

LIFO: Case in Point

The Gas Price and Relief Act of 2006, with its featured $100 rebate, was mocked by the public and subsequently dropped by Senate Republicans. It also served as a wake-up call to businesses that use the last-in, first-out (LIFO) method of accounting. LIFO repeal was offered up as way to pay for the rebate.

According to the Tax Executives Institute (TEI), the purpose of the LIFO method “is to permit taxpayers to properly match their current sales revenues with the current replacement costs and thereby compute – and pay taxes on – a meaningful gross profit amount.” During inflationary periods, LIFO “tempers the distortive effect of the inflation on the taxpayer’s reported profits.”

Ensconced in the tax code since the late 1930s and widely used by small and large companies alike, the TEI asserts that LIFO repeal would increase the tax bills of many U.S. companies. In a letter to Senate Finance Committee Chairman Chuck Grassley, R-Iowa, and ranking member Max Baucus, D-Mont., TEI wrote that “outside the context of fundamental tax reform” LIFO repeal would have “anticompetitive effects” that “may produce unintended consequences that are far greater than the immediate tax revenues obtained.”

“LIFO accounting is the best system available to match the true cost of providing a product for sale against the revenue received for that product. It directly and accurately reflects the current market as defined by a willing seller and a willing buyer,” said Michael Fredrich, President of Manitowoc Custom Moldings, a small manufacturer in Wisconsin.

As a LIFO user, Fredrich says that repeal would require a major change in accounting systems, which would be expensive for his company. Its impact on the economy would be far reaching as well.

“It would disrupt financial markets as earnings would no longer reflect an accurate representation of revenue and expenses,” Fredrich added.

At Senate Finance Committee hearings in mid June, pro-repeal witnesses exasperated business community representatives with what they viewed as inaccurate testimony regarding LIFO’s utility, purpose and widespread use. The LIFO Coalition, an ad hoc group of more than fifty trade associations in support of maintaining the method, provided Senators Grassley and Baucus with a detailed memorandum offering a different perspective than “seriously inaccurate” testimony provided at the hearing.

Tax expert Leslie J. Schneider wrote (to the Coalition and then provided to the Committee) that a more balanced evaluation of LIFO would show its “efficacy…in detecting book and taxable income” as well as its “central importance to capital formation, and the drastic adverse impact” that would result from repeal.

Will business taxpayers bear the brunt of “offsets”?

With the LIFO method being the predominant accounting method in industries that carry inventories of goods – particularly for those in manufacturing, mining, wholesaling, retailing, distribution and energy production — its repeal represents one additional uncertainty to the bottom line of these businesses and U.S. competitiveness.

While the momentum to repeal LIFO has slowed due to the educational efforts of tax experts and business advocates, Sen. Grassley has not taken repeal off the table as an offset to future tax reform proposals. Additional hearings are planned for September.

Other proposals that cost the U.S. Treasury have also targeted offsets to generate revenue. For example, Republican legislation to expand Health Saving Accounts (HSAs) includes a new death and disability tax on accounts, a tripling of the non-medical withdrawal provision, and a “senior tax.” In the context of entitlement reform, the administration and Congress are looking at yet another commission to develop proposals that would remedy the financial crisis that these programs face – the current buzz is that tax increases may be on the table in constructing recommendations.

As a business owner toiling in the trenches, Fredrich is not surprised by these “classic government solution” approaches. He wishes our political leaders would wake up.

“They need to understand that you do not fix a problem by creating [more],” he concludes.

Karen Kerrigan is president & CEO of the Small Business & Entrepreneurship Council, a research and advocacy group based in Washington, D.C. that works to protect small business and promote entrepreneurship. She is also founder of Women Entrepreneurs, Inc., an association helping women business owners succeed through education, networking and advocacy. Kerrigan can be reached at kkerrigan@sbecouncil.org.

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