The House voted Wednesday to extend $31 billion in popular tax breaks, including an income tax deduction for sales and property taxes, to be financed with a tax increase on investment fund managers and a crackdown on international tax cheats.
The 45 tax deductions and credits for businesses and individuals are scheduled to expire at year's end. The House voted 241-181 to extend them for a year, with only two Republicans voting in favor. The bill now goes to the Senate, which has rejected the tax increase on investment managers in the past.
The tax breaks include a sales tax deduction that mainly helps people in the nine states without local income taxes, a property tax deduction for people who don't itemize and lucrative credits that help businesses finance research and development. The nine states without a state income tax are Alaska, Florida, Nevada, New Hampshire, South Dakota, Texas, Tennessee, Washington and Wyoming.
The tax breaks are supported by Democrats and Republicans alike and are routinely extended each year, but there are big disagreements over the tax increases that would pay for them. The dispute, combined with the Senate's prolonged debate on health care, makes it unclear whether the tax package will be enacted this year.
Lawmakers could retroactively pass the package early next year, but that would make tax planning difficult.
The House bill would raise $24.6 billion over the next decade from the tax increase on investment fund managers. It would affect hedge fund and private equity managers, as well as the more than 1.2 million real estate investment partnerships, according to the Real Estate Roundtable.
The House bill would raise an additional $7.7 billion from a crackdown on international tax cheats, an issue the Internal Revenue Service and the Obama administration have embraced.
Investment managers typically get a fee to manage funds or assets. They also get a share of the profits earned for investors above a certain level. Under current law, the profit-sharing fees, called carried interest, are taxed as capital gains, with a top rate of 15 percent. The House bill would tax the fees as regular income, with a top tax rate of 35 percent, scheduled to rise to 39.6 percent in 2011.
President Barack Obama supports the tax package, including the tax increase on investment managers and the crackdown on international tax havens.
Democrats argued in favor of the tax increase, saying Wall Street financiers shouldn't be taxed at a lower rate than workers making less money.
"Those who invest their own money will continue to receive capital gains tax treatment," said Rep. Sander Levin, D-Mich. "Those who manage other people's money will have to pay ordinary income tax, like everybody else who performs services."
The two Republicans who voted in favor of the bill were Rep. Anh "Joseph" Cao of Louisiana and Rep. Walter Jones of North Carolina.
Most Republicans argued that the tax increase would reach far beyond Wall Street, hitting real estate investment funds across the country. Instead, Republicans said, the tax breaks should be financed by federal borrowing, increasing the budget deficit.
"It is nothing short of a new tax on the very investments needed to start a new business and create economic growth in this country," said Rep. Dave Camp of Michigan, the top Republican on the tax-writing House Ways and Means Committee.
Investment groups argued that the tax on fund managers would discourage investment.
"Raising taxes on growth investments by private equity, real estate and many other partnerships just doesn't make sense, particularly in this time of fragile economic recovery and continuing joblessness," said Douglas Lowenstein, president of the Private Equity Council.
A coalition of real estate organizations argued that the tax increase would hurt real estate partnerships, further eroding property values just as they are starting to rebound.
"Why would you want to put a $24.6 billion tax increase on this industry now, especially when it is having all these problems?" said David Pearce, vice president and counsel of the Real Estate Roundtable.
The crackdown on tax havens would impose new reporting requirements on foreign financial institutions doing business in the United States and on American advisers who help U.S. residents make investments overseas. Foreign firms that don't comply would be hit with a 30 percent withholding tax on income from their U.S. assets.
Lawmakers have been working for years on proposals to stop tax cheats from hiding assets overseas, and the Obama administration has pushed the issue as well.
Rep. Richard Neal, D-Mass., said tax cheats have a patriotic duty to come clean.
"I think that asking tax evaders to pay their fair share for the national defense is not an unreasonable request," said Neal, a top Democrat on the Ways and Means Committee.