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Business Tax Advocacy

 
Business Tax Advocacy
In-Depth Analysis, February 16, 2007
By Robert D. Dietz, PhD.
 

Do trade associations and other business interests advocate effectively on tax issues? This is a question raised by many in the tax policy community when discussing the positions adopted by business in tax debates. Essentially, these tax policy analysts are trying to determine why businesses would oppose proposals that the analysts believe would benefit business and the economy over the long-run. For these observers, an obvious potential answer is that the business community does not know what is good for them because tax law and the economics of tax policy are complicated. In this article, I argue that this conclusion is mistaken and that there are other, valid reasons why business interests in general, and home builders in particular, are wary of certain comprehensive tax reform proposals.

 

As a recent example, in November 2005, the President’s Advisory Panel on Federal Tax Reform released its report, which recommended significant changes to the nation’s tax system. [1] Among its proposals, the Panel recommended that the present-law mortgage interest deduction should be transformed. The Panel would repeal the existing deduction in its entirety, including the deductions for second homes and home equity loan interest, and replace the provision with a more limited 15% credit for certain amounts of mortgage interest paid on first home debt only. The National Association of Home Builders (NAHB) strongly opposed this proposal and other recommendations made by the Panel. NAHB argued that the proposal would overturn the established Federal policy commitment to homeownership by reducing the values of homes and hurting the wealth of homeowners, particularly recent homebuyers. NAHB was joined in its opposition by members of Congress and other housing-related organizations.

 

Is it possible that the home builders and other participants in the housing industry were wrong in their opposition to the Panel’s recommendations? Perhaps the proposal would simplify the tax system, thereby resulting in a more productive use of the economy’s resources and increased economic growth. And perhaps this increase in national income would produce net-benefits for home builders and homeowners in the long-run.

 

The preceding supposition is a common argument made by proponents of tax reform plans that are similar in scope to the Panel’s recommendations. For example, in a recent paper, Joel Slemrod, an economist at the University of Michigan, argued that businesses and business interests adopt tax advocacy positions that are short-sighted and therefore counterproductive. [2] In particular, Slemrod believes many businesses fail to consider all of the issues involved in a comprehensive tax reform package, concluding that “…the expressed positions of business representatives suggests that they evaluate tax changes, first and possibly foremost, by estimating whether their own companies’ tax payments will go up or down, holding pretax profits constant.” He further states, “…they ignore what economists would call the general equilibrium impacts of tax changes, and do not think much about the ultimate incidence of tax changes on prices and profits.”

 

Is this true? Are home builders opposing a set of recommendations that in fact would benefit them in the future? I argue in this article that this is not the case. Indeed, a simple argument against the notion that businesses do not consider the long-run general equilibrium effects of tax policy proposals is to note that such organization employ economists (including this author) to consider all the effects of tax proposals. Pro-tax reform advocates, including many academic economists and tax law professors, should consider other explanations as to why home builders or other business interests may oppose tax reform proposals that are favored in the ivory tower. It is these explanations and strategies that indicate that business interests are advocating effectively on tax issues. After all, who knows their own market and consumers better than the businesses who serve them?

 

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Business Tax Advocacy

 

To examine the general claim that businesses do not have an accurate sense of the full effects of a tax reform proposal, consider how such businesses adopt policy. Business interests are represented in many ways in the Federal policy arena. Businesses may employ advocates directly, or businesses in the same sector may band together and represent their issues through a trade association. Because these associations are typically arranged by common participation in a particular market, typically as competitors, it is often the case that these associations contain a wide variety of businesses with respect to size, function, location, and organization.

 

For example, the membership of NAHB includes high production national builders, such as Centex, Lennar and Pulte Homes, as well as local builders, who may only build one to four homes a year. As of 2006, NAHB had 235,000 members. One-third of these members are home builders and remodelers. The remaining members are associates working in the fields of housing finance and building products and services. The unifying philosophy of this group is a commitment to the importance of housing as a national priority.

 

This diverse range of membership produces challenges with respect to establishing positions on tax policy or any other government affairs. Many of the large home builders are organized as C Corporations. However, some are privately-owned partnerships. According to the 2002 Economic Census, 65% of the businesses in the residential building construction sector were organized as corporate entities. Of the rest, 27% were organized as sole proprietorships, 7% as partnerships, and 1% as other entities. Different entities, even within the same commercial sector, are likely to have different tax policy priorities.

 

From NAHB’s membership, 2,800 members are selected to serve on the association’s board of directors. [3] The board of directors elects the association’s senior officers and helps set the association’s agenda through the consideration of specific policy resolutions. These resolutions originate from NAHB’s various committees and councils. Once a policy is approved by the board of directors, NAHB’s officers and professional staff in Washington provide analysis and action for these items in the media, on Capitol Hill, and within other government agencies.

 

While NAHB may be unusual with respect to the size of its board of directors, the point is that the consideration of policy is a deliberative one within a trade association. And in particular, the adoption of tax policy is not arrived at by examining last year’s tax return and then tallying whether various tax proposals increase or decrease final tax liability. Interaction between association membership and professional staff, as well as consultation with outside economic research parties, produces analysis of major proposed changes in Federal policy. A key aspect of this approach is to determine whether a given proposal will alter the market fundamentals of the business sector associated with the trade association.

 

For example, NAHB worked with economists from consulting firms and academic institutions to examine the impacts of the 2005 President’s Advisory Panel on Tax Reform proposals. This analysis was not limited to determining whether tax liability, holding profits constant, would increase or decrease. Indeed, the primary focus of the research was to determine what effects the Panel’s proposals would have on homeowners, residential investment, and housing prices; that is, the general equilibrium effects within the housing sector of the economy.

 

In particular, the analysis revealed that the Panel’s recommendations would cause prices for new and existing homes to fall by 10.9% over a five-year period. Within this category, new single family home prices would fall by 15.4% over a five-year period. In the first year after adopting the Panel’s recommendations, housing starts and sales would decline by more than 11%. Total housing wealth would decline by more than $2 trillion. The average homeowner would experience an increase in tax liability of $2000, representing a 20% increase, making the proposal the largest tax increase on homeowners in history. Home buyers of new homes, who tend to be high-income and carry larger mortgages than other homeowners, would experience an increase in tax liability of approximately 40%. This type of comprehensive analysis is also conducted for smaller tax policy proposals.

 

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Tax Policy Perspectives

 

If business interests consider what economists call the general equilibrium effects of tax reform, then what are the reasons for the business community’s hostile or silent response to the Panel’s tax reform proposals? Several more likely explanations are available.

 

Sector-Specific Impacts

 

One explanation is that tax reform may result in changes that are harmful to specific sectors of the economy. For example, NAHB opposes any tax reform proposal that places at risk the following present-law provisions:

  • Deductibility of mortgage interest payments
  • Deductibility of home equity loan interest payments
  • Deductibility of state and local property taxes paid
  • Low Income Housing Tax Credit

These tax policy positions reflect NAHB’s mission to promote homeownership and access to affordable housing. Indeed, President Bush instructed the 2005 Panel to craft tax policies that recognized the “importance of homeownership to society,” which is consistent with an extensive social science literature demonstrating the social and private benefits of homeownership. [4]

 

NAHB strongly opposed the Panel’s recommendations because the proposals significantly and negatively affected the tax policy commitment to homeownership and housing. Tax policy analysts may agree or disagree with both the purpose and methods of this policy, but it cannot be argued that the housing industry’s perception that the Panel’s recommendations represented a challenge to its interests was wrong. As noted earlier, the Panel’s recommendation would have reduced the value of the housing tax preferences in both the short-run and long-run for both home builders and homeowners. Other business sectors, such as the health care industry, had similar concerns with respect to other tax reform proposals produced by the Panel.

 

Risk Aversion

 

A second factor that could motivate resistance to tax reform is risk aversion. While any tax reform effort may begin with a blueprint or roadmap document, such as the 2005 Panel report or the 1986 Treasury II document, it cannot be known with certainty how the process will evolve within Congress. Moreover, with respect to the general equilibrium consequences of a proposed tax policy change, there may be no agreement among experts as to what those effects are. As an example within the housing context, Bruce and Holtz-Eakin (1999) find that adoption of a flat tax would have modest effects on housing prices, while Capozza, Green, and Hendershott (1996) report significant declines in housing prices. [5]

 

Risk aversion is a rational response to these uncertainties. Indeed, given the large number of moving parts that may lie within a comprehensive tax reform proposal, it may even be difficult for a business interest to determine the static tax liability effect, let alone the general equilibrium effect.

 

Tax Policymaking

 

If reluctance by business interests to embrace what some observers believe is a beneficial comprehensive tax reform proposal cannot be explained by sector specific factors or risk aversion, a final explanation may be at work. Business interests may have differing analytical beliefs about what constitutes “good” tax policy. It is probably fair to say that there is a rough majority of academics and analysts within the tax economics community (e.g. members of the National Tax Association) in favor of a certain set of positive analytical methods and normative policy preferences. To the extent that business interests’ tax preferences are at odds with the views of this majority, differing analytical approaches, rather than myopic tax calculations, may be the cause. An obvious example is whether to tax capital at all, which we can expect business interests (owners of capital) to oppose.

 

As another example, it is reasonable to expect that business interests, used to understanding gains from trade at the practical, everyday level, do not find the principles of dynamic scoring to be controversial. To the extent that tax reform is scored without macroeconomic effects, this methodology will certainly help shape the final set of policies, assuming that some budget constraint is used as a scoring target. It is fair to say that the support for dynamic scoring is stronger among business interests than it is among the tax economics community (although both support and recognition of its limits is certainly growing).

 

Similar to the issue of sector-specific impacts, business interests may also be more aware of regional or international business-related consequences of tax reform. While there are exceptions, many economists who study Federal tax issues are in general uninterested in such spatial effects of tax policy. Indeed, consider the fact that spatial price differences (for which there is no accounting in the Internal Revenue Code) overwhelm year to year temporal or inflation-related price differences (for which there are many indexation measures). A household with high income in a rural area may face relatively high income tax rates, yet a household with the same income in a large metropolitan faces the same rates but may be considered middling in income distribution terms given local prices. International and regional concerns such as these, which are respectively outside and within the Federal tax system, produce legitimate reasons for pause when considering tax policies that affect competitiveness and after-tax profit for firms.

 

Another area where business interests may diverge from the majority of tax economists is with respect to externalities, or economic activities that produce costs or benefits on third parties (parties who are not buyers or sellers in a market) or market failures. Economists have demonstrated that in certain cases, taxes (or tax subsidies or grants) are useful policy tools for correcting market failures due to externalities (e.g. taxing manufacturing that produces pollution). These taxes are known as Pigovian taxes, named after the English economist Arthur Pigou. The merits of Pigovian tax policies are experiencing renewed attention among some economists, yet many tax economists appear to be skeptical of such policies. [6]

 

From one perspective, this is understandable. With respect to the income tax, tax economists are wary of divergences in operative definitions of taxable income from comprehensive measures or real economic income (Haig-Simons). Nonetheless, tax policies may be an effective mechanism for producing efficient social outcomes in the presence of market failures, whether the externality is positive (e.g. technology diffusion, homeownership) or negative (e.g. pollution). Indeed, it was noted at a May 2006 National Tax Association conference panel on health tax preferences that from the health economist’s perspective, tax economists appear to be extremely reluctant to use tax policy to accomplish any other objective than to raise revenue for the government. [7]

 

Tax Reform and Simplification

 

A final reason for lack of business excitement for tax reform proposals is due to, perhaps, one of the constants of nature: tax complexity. Tax reform is often marketed as “tax simplification.”  Indeed, the President’s Panel entitled their report “Simple, Fair and Pro-Growth.” Who could oppose such a plan? As usual, the devil is in the details. What appears in a proposal to be simple inevitably becomes more complicated as anti-abuse provisions are added, as definitions are refined, as revenue consequences are considered and so forth. Moreover, in some cases, some proposals may actually make the tax code more complicated.

 

For example, in the 2005 Panel proposal, the mortgage interest deduction would be transformed into a limited credit based on mortgage principal amounts. However, the Panel recognized that implementing this plan would be unfair to homebuyers who obtained mortgages under the present-law system. Hence, the Panel included a slightly less unfair grandfathering mechanism that delayed full implementation of the proposal over a period of five years (an insubstantial length of time considering the length of the benchmark 30-year mortgage). Despite its good intentions, the proposal would increase administrative burden for homebuyers (by creating two classes of mortgage interest payments according to debt thresholds), in addition to creating horizontal inequity for new homebuyers. Further, the two classes of mortgage interest tax treatment would create a disincentive for existing mortgage debt holders to sell a residence.

 

Any comprehensive tax reform effort is likely to involve complicated transition rules, but it is important to note two other sources of complexity that would not be eliminated after a tax reform process. First, much of the complexity in the tax code is rightly associated with anti-abuse provisions. However, sometimes these provisions are too broad, thereby incurring significant administrative costs associated with compliance. In some instances, these costs may exceed the social costs associated with the targeted abuse [8] Another source of complexity in the tax code is the progressive nature of the present-law income tax. Rules that establish income phase-outs greatly increase complexity for taxpayers, and in particular, for sole proprietorships. Admittedly, tax preparation computer software offsets this burden, but unless the general national consensus for a progressive Federal tax system changes, such administrative burdens will be present with or without tax reform.

 

Finally, tax reforms proposals that are less than entirely specified do not help business interests adopt prudent policy positions. As an example, the 2005 Panel recommendations called for an end to most tax credits. However, there was no definitive list published by the Panel as to what credits were to be eliminated. Further, given that some credits are allocated and claimed over multiple years (such as the New Markets Tax Credit and the Low Income Housing Tax Credit), there was no discussion as to how such programs would be treated. Moreover, from the aggregate perspective, the Panel did not produce a set of revenue estimates associated with the proposals that constituted each tax reform plan. We know that such estimates exist because the Panel reported that the proposals were approximately revenue neutral. Despite this, the individual line items were not published. Certainly withholding this information interfered with the process of evaluating the merits of each proposal within the larger tax reform package.

 

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Is Pro-Business Tax Policy Good for America?

 

A related question concerning the tax policy position of business is whether the views advocated by business interests are good for the nation as a whole. To answer this question, it is worth considering the fact that because business interests must be sector-focused, they must take into account the general equilibrium consequences of tax proposals. Hence, businesses must be aware of the effects of tax proposals on the demand side of their particular markets.

 

So whether it be housing, education, transportation or any other commercial sector, businesses are to a certain degree advocates for the consumers of their products. As an example, NAHB supports the tax policy concerns of homeowners through its support of the mortgage interest deduction. This is due to the fact that home builders must be aware of the impacts of tax policy on homeowners and homebuyers. Consequently, NAHB represents these groups when it conducts tax policy advocacy.

 

This is not to suggest that the aggregation of business interests is a sufficient condition for determining welfare-maximizing tax policy, but it is certainly a necessary component to the larger public debate.

 

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Conclusion

 

So what can we conclude regarding business interests and the prospects for tax reform? Given the concerns detailed earlier, one conclusion is that the nature of any tax reform process matters as much as the substance of the ideas under consideration.

 

Tax reform proposals in the future, from whatever source, must not read like reader-friendly versions of tax form instructions. This type of document is not surprising given the background of most tax analysts, who are accountants, lawyers and economists with tax research and policy backgrounds. Such analysts are used to thinking within the interactive sphere of tax rules. However, it would be useful for economists in particular to encourage the inclusion of more discussion of the economic context and effects of tax policy in future reform proposals.

 

Thus, if a tax reform plan includes a proposal to end the deduction for employer provided health insurance, the proposal should discuss the economics of such a plan. What effect would this have on large and small businesses and their employees?

 

As another example, the Panel reported in its recommendations that less than 30 percent of taxpayers (including taxpayers residing in the same residence) benefited from the mortgage interest deduction during tax year 2002. While this may be a relevant statistic for taxpayer profile purposes, it is a misleading estimate for describing the economics associated with the tax benefit of the mortgage interest deduction. The economics of the demand for mortgage debt reveal it is a lifecycle-related event, whereby young households move from renting to owning (thereby acquiring a mortgage) and pay the principal of the debt over a period of years. [9] The Panel’s limited benefit claim is similar to concluding that government programs for higher education are only of value to 6.7% of the US population (those currently attending college), rather than for all beneficiaries of higher education over many years. [10] A more meaningful statistic concerning the mortgage interest deduction is provided by a recent study from economists at the Congressional Budget Office who estimate that 94% of mortgage interest payments were deducted for tax year 2002. [11]

 

Certainly, discussions pertaining to the actual economics of these and other issues would help shape the debate surrounding any tax reform effort. In other words, if the question is on the merits of a tax reform proposal from the business and social welfare perspectives, the advocates of such reforms must also consider the general equilibrium effects.

 

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Footnotes:

[1] Simple, Fair & Pro-Growth: Proposals to Fix America’s Tax System. 2005. The President’s Panel on Federal Tax Reform. 
[2] Slemrod, Joel. 2006. “Is Tax Reform Good for Business? Is Pro-Business Tax Policy Good for America,” presented at the conference “Is It Time for Fundamental Tax Reform,” April 2006, Rice University.
[3] In practice, there are approximately 1,700 voting members with the remaining members serving as alternates. The board meets three times a year. At a given meeting, there are usually approximately 1,000 voting members in attendance.
[4] Dietz, Robert D. and Donald Haurin (2003). “The Social and Private Micro-Level Consequences of Homeownership.”  Journal of Urban Economics 54(8), 401-50.
[5] Bruce, Donald J. and Douglas Holtz-Eakin (1999). “Fundamental Tax Reform and Residential Housing.”  Journal of Housing Economics 8, 249-271. Capozza, Dennis R., Richard K. Green, and Patric H. Hendershott (1996). “Taxes, Mortgage Borrowing, and Residential Land Prices.”  In Henry J. Aaron and William G. Gale (eds.), Economic Effects of Fundamental Tax Reform. Washington, DC: Brookings Institution.
[6] For example, consider Greg Mankiw’s Pigou club, which supports higher taxes on carbon emissions and gas purchases.
[7] Hence, the unfortunate use of terminology that a tax reduction “costs” money, when in fact the tax cut may reduce deadweight welfare loss.
[8] For example, the new Section 4965 was drafted broadly and may affect unintended parties. Without regulatory correction, the provision, which was intended to prevent the use of certain tax shelters, may negatively affect business arrangements established to comply with other aspects of the income tax code.
[9] According to the 2005 American Community Survey, 32% of all owner-occupiers own their homes with no mortgage debt (including home equity loans). These homeowners tend to be older and higher-income than owner-occupiers with mortgage debt. 
[10] Source: 2005 U.S. Census and 2005 Digest of Education Statistics.
[11] Congressional Budget Office (2005).  “Taxing Capital Income: Effective Rates and Approaches to Reform.”  Washington, DC: Congressional Budget Office.

For more information about this item, please contact Robert Dietz at 800-368-5242 x8285 or via email at rdietz@nahb.org.


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