Joint Hearings on Tax Code and Debt Break New Ground

Two powerful committees responsible for the federal tax code began a series of meetings today to examine ways in which the tax code incentivizes individuals and corporations to incur debt.

It is the first time in 70 years that the Senate Finance and House Ways and Means Committees have held joint hearings on tax reform. It was held in a new room in the Capital Visitor’s Center.

“It is a clear illustration of how serious the issue of tax reform is to both of these committees, and to the American economy,” said Ways and Means Chairman, Dave Camp (R-Mich.).

Debt versus equity—the first meeting’s topic—looked at how the tax code encourages consumption and debt, over savings.

The personal savings rate in the United States has traditionally been low when compared to other countries, said Finance Committee Ranking Member Orrin Hatch (R-Utah).

According to a study presented to the committees by Thomas Barthold, chief of staff with the Joint Committee on Taxation (JTC), household and government debt have increased by 50 percent in the last 25 years, while corporate debt has remained unchanged.

As of 2010 Americans’ debt totaled $13.4 trillion, according to the JCT. About three-quarters—$10 trillion—is home mortgage debt, which is favored under the code by an allowable deduction on mortgage interest.

Taxpayers are also allowed to exclude gains from the sale of their principle residences of up to $500,000. The JCT notes that no such exclusion exists for any other type of investment “further reinforcing the financial incentive to buy rather than rent a home.”

Deductions are available for interest on home equity loans, which encourages the use of loans to pay off other loans. “Some researchers believe restrictions on the tax-deductibility of non-mortgage interest payments have spurred home equity borrowing in the past,” according to the report.

“All taxes distort decisions to work, save, and invest,” said The Honorable Pamela Olson, former assistant secretary of the Treasury for Tax Policy, in testimony.

“A well-designed system should minimize disincentives to work and save and avoid skewing investment decisions,” she advised.

Corporate financing is particularly susceptible to tax code manipulation due to high-powered tax accountants and lawyers, who can devise creative ways to gain maximum advantage for their employers.

Under the current system, corporations are encouraged to take out new loans through tax breaks on interest payments, while discouraged from other ways of obtaining revenue, such as the issuance of new shares, since dividend paid out to investors are subject to tax.

Olson referred to this problem during testimony, calling it the “double taxation” of corporate income, caused by the decision to treat corporations and individuals as separate entities.

Sen. Hatch said multinational corporations are flush with cash, but are based overseas. They don’t bring it back to the United States to contribute to the economy because they will have to pay 35 percent in taxes, he said.

A significant problem for legislators is the challenge of defining and distinguishing between debt and equity. Barthold testified that in 1950 Congress tried to define it, regulate it, but abandoned the effort. Congress has that authority, Barthold reminded lawmakers.

“A business can make an infusion of cash look like either, and naturally, some businesses choose to cast their financing in a light that gets the best tax treatment. But this requires sophisticated tax planning, which not everyone can afford,” said Finance Committee Chairman Max Baucus, in opening remarks.

The issue of tax code reform has been put under the spotlight while the president and congressional leaders meet daily in search of a deficit reduction deal. All sides see restructuring the tax code’s many exemptions, deductions, and credits as an opportunity for compromise.

The president is in favor of reforming the individual tax code to eliminate some of the exemptions which largely benefit the wealthiest Americans, with a net result of increasing revenue for the government.