Senate Republicans are celebrating passage of their $1.4 trillion tax cut package but stark differences with the House version, including taxing public pension funds' investment income, will make it challenging to finalize tax reform by the end of the year.
When a conference committee of the two chambers meets in the coming weeks, one of the biggest stumbling blocks will be the $1 trillion the Senate package adds to the federal deficit, as calculated by the non-partisan Joint Committee on Taxation. The federal debt ceiling is projected to be reached Thursday, but another short-term extension is now likely, given the tax reform push.
The two versions also have plenty of differences when it comes to tax rates, with four individual brackets and a top rate of 39.6% in the House bill, compared to seven brackets and 38.5% in the Senate version. On corporate rates, the House bill would begin implementation in 2018, while the Senate is one year later.
Senate passage, by a vote of 51-49 early Saturday, was far from certain until the very end, with several senators holding out for assurances. One of them, Ron Johnson, R-Wis., a former small business owner, won a slight increase in the deduction for pass-through businesses to 23% from 20%. The House wants to lower the tax rate on pass-through income to 25% from current individual rates that top out at 39.4%, and Mr. Johnson pledged to aim for a higher rate in the final bill.
One of the last holdouts, Sen. Susan Collins, R-Maine, won adoption of her amendment to reverse what she called the "ill-advised" elimination of retirement account catch-up contributions by church, charity and public employees that the original Senate bill held.
Both chambers impose a new 1.4% tax on net investment income of large private university endowments with at least 500 students and endowments of more than $250,000 per student.
While private equity and other firms stand to gain with lower corporate rates for the companies they own, both the Senate and House bills limit interest deductibility to 30% of adjusted income, although real estate firms won several exceptions. Both bills also limit the ability of firm partners to pay a lower capital gains rate on carried interest to investments held for at least three years.
One of the biggest concerns for private equity firms and their limited partner investors is only in the House tax package: subjecting public pension funds to unrelated business income tax on earnings from direct investments, such as real estate and private equity.
Restructuring "tens of thousands" of existing private equity investments by the bill's target date of Jan. 1 would be impossible, Michael Mazzola, CEO of the Institutional Limited Partners Association in Washington, wrote to Senate negotiators, instead triggering a 39.6% tax bill that would hurt returns, and in turn, beneficiaries.
If the idea sticks in the final tax package, "the resulting decreased attractiveness of private equity investment by public pensions due to these factors may severely disrupt the U.S. private equity industry for both managers and investors, and impact the deployment of capital into U.S. businesses large and small," Mr. Mazzola said.
Chris Hayes, ILPA director of industry affairs, said the group's members, along with advocates for other institutional investors and public pension funds, will urge both chambers when they move to negotiations on a final bill "to be mindful of the harm such a structure would cause these important institutions."
The Save Our Savings Coalition, an alliance of retirement savings advocates and businesses, praised the Senate bill for not changing its tax treatment of retirement savings, but its members recognize the pressure to find more sources of tax revenue to get a final tax reform package approved is still very real.
There is also the political reality of selling what was initially billed as a middle-class tax cut but that the non-partisan Tax Policy Center in Washington estimates will result in 62% of the tax benefits in the Senate plan favoring the top 1% of households, with income of $730,000 or more. Democrats promise to not let their House or Senate counterparts forget that.
