Three Potential Dark Horse Offsets in the Budget Reconciliation Package

Congress is primed for a dicey debate as lawmakers consider how to extend the Trump tax cuts. Key provisions of the landmark 2017 law are set to expire at the end of this year, and as Congressional Republicans prepare to preserve them, they are also looking to add more cuts. But they want to offset the costs of any new breaks. 

That means to save money for new tax cuts, such as no tax on tips, some older ones might have to go. Lawmakers have already compiled which cuts could be on the chopping block: House Budget Committee Chairman Jodey Arrington (R-Texas) released an initial list in January. And just the other day, the White House sent Republicans specifics on additional tax cuts. This may ultimately force members to look for more offsets. The painful work of prioritizing them is underway. 

That menu has plenty of big-ticket usual suspects, such as enhancing work requirements for food stamps and capping funding for the Consumer Financial Protection Bureau (CFPB). But three offsets that appear further down the list and so far, haven’t gathered much attention could play an important role as Congress deliberates over the budget reconciliation package that will move the tax changes forward. Specifically, the stock buyback tax, the municipal bond tax exemption, and the treatment of qualified small business stock are drawing new interest from Congressional tax writers. Below, we take a closer look at each.  

Stock Buyback Tax 

The Inflation Reduction Act imposed a one percent excise tax on stock buybacks. In a stock buyback, or share repurchase, a company purchases its stock back from investors, reducing the number of outstanding shares.  

Republican lawmakers are divided on whether to raise taxes on corporations at all. “House conservative proposals to raise corporate taxes to offset the cost of [President] Trump’s tax package are going over like lead balloons in the Senate, where Republicans are warning their House counterparts to back off,” The Hill reported. Yet according to The Wall Street Journal, “Congressional Republicans may consider capping corporations’ ability to deduct state and local taxes from federal taxable income.” 

If more Republicans back raising revenue from corporations, hiking the tax on buybacks could get serious consideration, even if it has not been explicitly pitched to date.  

Democrats previously floated raising the buyback tax to four percent. Of course, raising the tax on buybacks would reduce cash flows to investors that usually can be reinvested in “young, high-growth firms,” according to the Harvard Business Review. 

 Municipal Bond Tax Exemption  

Municipal bonds are debt securities issued by cities, counties, or states to fund public projects such as schools, hospitals, and airports. Under our current system, investors in these bonds do not pay federal income taxes on interest they earn from them. That allows state and local government entities to issue debt at a lower cost.  

Some influential economic advisers are suggesting limits to this preferential treatment. According to Stephen Moore, an informal adviser to President Trump, the policy might be “a ‘cap’ on the exclusion on newly issued bonds rather than a broad repeal for debt that is currently outstanding.” 

Applying the federal income tax to municipal bonds would significantly impact investors since there are over $4.2 trillion of outstanding U.S. municipal bonds — a significant sum.  

Qualified Small Business Stock 

Congress originally enacted a capital gains tax exemption for “qualified small business stock” back in 1993 to encourage a nascent U.S. startup scene. The policy has been a huge success, spurring a boom in venture capital funding that has made the U.S. globally dominant in launching new companies.   

The policy’s performance inspired Rep. David Kustoff (R-Tenn.) to propose a significant expansion that would apply the break to convertible debt instruments and S-corporation issuers, as well as introduce a tiered capital gains exemption so investors could benefit earlier from their stakes.  

Yet Arnold Ventures is circulating a plan to water down or eliminate the tax incentives altogether. Some legal experts object, noting that the change would reduce the incentive to invest in small start-up firms that rely on VC funding.  

Finalizing the legislative text to extend the Tax Cuts and Jobs Act via the budget reconciliation process will likely take more time than expected. The permutations of tax cuts and potential revenue offsets will take a long stretch to develop; unifying the Republican Party around specific provisions will take even longer. Although the corporate tax rate is permanent at 21 percent (and may even be reduced), businesses still face many uncertainties over tax provisions they rely on. Be on the lookout for these three dark horse offsets that could be defining moments for corporate America and institutional and individual investors.