Executive summary: Tax policy and the prospect of divided government
Although U.S. congressional midterm elections took place several days ago, the potential implications for tax legislation both for the remainder of this calendar year, and over the next several years, remain uncertain.
As of early afternoon on Monday, Nov. 14, there had been no official determination as to majority leadership in the House of Representatives, with several key races still undecided. Republicans are inching toward control of the House, while the Democrats have retained control in the Senate.
Should expectations of a Republican victory in the House bear out, the likelihood of a year-end tax bill would seemingly be increased, as Republicans may be inclined to clear the decks of unresolved issues such as restoring immediate expensing of research and experimentation (R&E) costs under section 174, modifying the interest deduction limitation calculation under section 163(j) and reversing the scheduled phase-down of 100% bonus depreciation, to allow them more time to organize in the new Congress.
More broadly, the legislative landscape over the next several years will likely be devoid of significant tax legislative activity, although there remains a possibility for bipartisan agreement on certain issues, such as enhanced retirement savings proposals, to the extent they carry over into the new Congress.
Midterm elections results remain too close to call; control of House may not be known for days
Although U.S. congressional midterm elections took place several days ago, the potential implications on tax legislation for the remainder of this calendar year, and over the next several years, remain uncertain.
As things currently stand, Republicans are inching toward taking control of the House of Representatives, with just a handful of seats remaining to reach the 218-vote majority. In the Senate, Democrats have won a majority with 50 seats ahead of the Dec. 6 runoff in Georgia. Should the Republicans take the House, as is widely expected, Senate results arguably become somewhat mitigated, as the specter of divided government would be upon us.
Irrespective of final election results, a priority of the 117th Congress in its final months of legislating will be a year-end omnibus measure that would include several “must-pass” legislative provisions, such as government funding for the remainder of FY23.
An open question, however, both before and after the election, is whether certain tax provisions currently enacted into law will be part of such measure. This would include the requirement to capitalize and amortize R&E costs under section 174, and the requirement to use EBIT (earnings before interest and taxes)—as opposed to EBITA (earnings before interest, taxes, depreciation and amortization)—in the calculation of the interest expense deduction limitation under section 163(j). Similar questions arise as to provisions that are scheduled to take effect next year such as the commencement of a phase down in the percentage allowance for bonus depreciation. Interest in these provisions remains strong; however, the political calculus has shifted.
Should expectations of a Republican victory in the House bear out, the likelihood of a year-end tax bill would seemingly be increased, as Republicans may be inclined to clear the decks of such issues to allow them more time to organize in the new Congress. As part of this process, lawmakers must decide if they are willing to negotiate and seek compromise on these (and other) matters before a new Congress convenes next January. In this regard, the political will of either party remains uncertain.
More broadly, the political landscape that could unfold over the next several years will likely be one of political gridlock and discourse, with very limited tax legislative milestones. Bipartisan agreement will be required before any bills can be enacted into law. As Dave Kautter, former assistant secretary of the U.S. Treasury for tax policy and RSM’s senior tax policy advisor succinctly puts it: “In a divided government, there’s not much chance of any significant tax legislation happening at all.”
Should the Senate remain evenly split (with Vice President Kamala Harris able to cast the tiebreaking vote for Democrats), securing the agreement of the entire Democratic caucus, including Sens. Joe Manchin and Kyrsten Sinema, would continue to be necessary to move any bill out of the chamber. However, should the Democrats pick up an additional seat, then unanimous consent within the caucus would not be required, which could provide additional flexibility to tax leadership in advancing certain measures.
In the House, a change in leadership could see intra-party fractures emerge across the Republican caucus. The one constant would be the ability of Republicans to thwart President Joe Biden’s economic agenda.
There are also numerous implications for state and local tax policy heading into 2023 state legislative sessions. As of this writing, Democratic governors have fared well, flipping executives in both Maryland and Massachusetts, and securing trifectas in both states. However, an office was lost in Nevada and still could be gained in Arizona. Regardless, governors in split-controlled state governments will have to compromise to be successful.
Taxpayers should also be aware of tightening fiscal conditions in the second half of fiscal year 2023, potentially impacting both parties as they consider fiscal year 2024 state budgets. While the last two years have been flush with personal and corporate income tax cuts, inflation rebates, refunds and gas tax suspensions, tax collections in several states are running below projections and are likely to weigh heavily on state legislatures. RSM will release a comprehensive post-midterm analysis of state and local elections soon.
RSM’s tax policy team will host an hour-long webcast in the coming days to explain these implications in greater detail. Keep an eye on RSM’s events page for scheduling details.