This week the U.S. Senate is busy debating its tax reform plan. Republican leaders in the Senate plan to hold a vote on Thursday and hope to pass their tax reform bill. They would then have a conference committee with the U.S. House to work out the differences between the two chambers’ tax reform proposals. The goal of Republican leaders is to have a final bill passed and signed into law by President Trump by the end of the year.

Back in October, we detailed some proposed changes to the tax treatment of individual retirement plans that were being discussed as part of the tax reform legislation. Fortunately, those potential changes were not included in the actual legislation and appear to be off the table. Unfortunately, a minor provision is included in the House tax reform bill that could harm the investments of public pension plans.

The provision relates to what’s called the “Unrelated Business Income Tax (UBIT).” Public pension plans fall under the category of organizations exempt from federal income tax. The proposed tax provision would subject certain business that is not substantially related to the performance of the organization’s tax-exempt functions to UBIT, which is equal to the highest corporate rate. So while any of the normal investing activities of the pension fund are not subject to federal taxation, some very specific types of investments might become subject to taxation under UBIT. For example, an investment in a private equity fund that invests in a partnership that operates a business; an investment in a hedge fund that uses leverage; or debt-financed income, such as corporate securities or commercial or rental real estate purchased directly or indirectly with borrowed funds, could all be subject to UBIT under the new provision.

Even though the UBIT would only impact a small portion of a pension fund’s investments, it is still a cause for concern. By its very nature, a new tax means a loss of revenue for the pension fund, as it would have to pay a tax on investment activities that were previously exempt. Furthermore, the new provision is scheduled to take effect on January 1, 2018, meaning public pension plans would not have time to restructure investments to avoid being subject to the UBIT.

The UBIT provision in the House tax reform legislation may not be constitutional. Generally, under the 10th amendment, different levels of government cannot tax each other. Also, according to section 115 of the tax code, “any income derived from the exercise of any essential governmental function and accruing to a state or any political subdivision thereof” is tax-exempt. Republican tax-writers in the House claim that the UBIT provision is just to “clarify” existing law, but public pension plans have been expressly exempt from UBIT for decades. What, exactly, is there to clarify?

Pension supporters have to started to sound the alarm. The governor of Washington expressed concern about this provision in a letter to his state’s congressional delegation. Earlier this month, NCPERS, NASRA, and NIRS sent a letter to the House Ways & Means Committee and House leadership urging them to remove this harmful provision. Tax reform is moving quickly through Congress and Republican leaders are desperate for any pot of money to offset tax cuts that are increasingly favoring wealthy individuals and large corporations.