Wall Street silent as GOP eyes derivatives

Wall Street is feeling new pressure from an unlikely source — the top Republican tax writer in the House.

Rep. Dave Camp (R-Mich.), the chairman of the Ways and Means Committee, released a draft plan last week that he says would modernize the treatment of derivatives and other complex financial instruments that often have similar economic effects but very different tax rules.

{mosads}The draft is part of Camp’s long-running goal of overhauling and simplifying the tax code. But in releasing it, the Ways and Means chairman signaled support from the right side of the aisle for tackling the risky and complicated trading of derivatives that many blame for the 2008 financial meltdown.

Camp’s plan would force derivatives to be valued on the market for tax purposes each year, scrapping a number of tax breaks in the process.

The proposal comes more than two years after the Dodd-Frank financial overhaul increased regulatory oversight of derivatives and other complex trading swaps. Republicans oppose Dodd-Frank, and pledged during the 2012 campaign to repeal it if Mitt Romney won the White House.

Now that Obama’s reelection has cemented Dodd-Frank as the law of the land, Republicans are moving to address the taxing of derivatives, an issue where Dodd-Frank left gaps. 

The financial industry, which is no fan of Dodd-Frank, is treading cautiously around Camp’s outline. Numerous industry groups declined to comment on the proposal, with several saying they were still evaluating it.

But some experts say there is reason to think banking centers might have concerns.

“You might think that the losers would be the financial centers,” said Steve Rosenthal, a tax lawyer and visiting fellow at the Urban-Brookings Tax Policy Center. “Derivatives are by and large traded in Chicago and New York, and historically there have been some strong Ways and Means members from those financial centers.”

Camp’s plan, for instance, would scrap a provision that lets some investors treat 60 percent of earnings as long-term capital gains.

It would instead force gains from a derivative marked to market to be treated as ordinary income, which is taxed at a higher rate. President Obama has put forward similar proposals in past budgets.

Many investors, especially those on derivatives exchanges in Chicago, prize the 60/40 set-up, a preferential treatment that has been in place since the late Rep. Dan Rostenkowski (D-Ill.) was chairman of Ways and Means.

Aides to the Ways and Means panel stressed that their proposal on financial instruments should not be looked at in isolation, but as just one part of the committee’s broader efforts to revamp the tax code from top to bottom.

Tax practitioners and the American Bar Association helped the panel sketch out a plan to more uniformly tax derivatives, and a committee aide noted that the efforts on that front started long before Dodd-Frank. Any work the Camp proposal does to build on that legislation, the aide said, would be at best coincidental. 

Staffers have also said that, even as Camp wants a final tax overhaul to neither add to nor reduce the deficit, it would not be possible for every change to the code to be revenue-neutral. The congressman wants reform to reduce the income tax rates that investors could face under his draft plan on financial instruments. 

“It has long been suggested that steps needed to be taken to provide greater uniformity in the tax treatment of financial products, including moving toward a more unified approach to mark-to-market,” said Michelle Dimarob, Camp’s spokeswoman. 

“The draft proposal seeks to ensure that tax treatment is applied evenly, and it envisions that occurring in conjunction with comprehensive tax reform that significantly lowers rates.”

The Ways and Means chairman is also seeking input on the proposal from stakeholders and the business community, as he did when he released a 2011 draft on how to tax offshore profits of multinational corporations.

With that in mind, industry players have not rushed to criticize Camp’s proposal, instead saying they recognize that it is just one piece of a broader attempt to overhaul the tax code.

Those efforts, industry officials say, might trim tax provisions preferred by some sectors, but would result in a simpler code and lower rates across the board.

This latest proposal would advance another Dodd-Frank effort.

A key piece of Dodd-Frank is the so-called Volcker Rule, aimed at preventing banks from engaging in “proprietary trading” — when banks trade with their own funds in search of profit, rather than at the direction of clients. Profit-seeking trades are banned under the rule, but those made to keep markets flowing would be exempt.

Striking that balance has proven a major chore for regulators, who have missed deadline after deadline for crafting the rules, leading Republicans to openly question whether the idea is even workable.

Camp’s proposal would also set sights on risky, speculative trading.

Under his plan, only taxpayers engaged in speculative derivatives trading would have to employ mark-to-market accounting at the end of each year to identify any gains or losses for tax purposes. Any gains or losses would then be treated as ordinary income for tax purposes.

Businesses using derivatives to hedge against a business risk — for example, an airline using derivatives to guard against fluctuations in fuel price — would be exempted from the new requirement.

Under the Ways and Means proposal, some industry-preferred provisions could be scrapped, but in a way that simplifies the code — providing relief to businesses not looking to gain an edge by taking advantage of the complexity.

“This discussion draft provides a much more favorable regime for corporations,” said Viva Hammer, a former Treasury Department official handling financial products tax policy, now at Brandeis University. “The current regime is just completely chaotic.”