The federal debt limit negotiations that preoccupied Washington for most of July did not result in immediate tax legislation. However, the general debate did succeed in helping to jumpstart a serious discussion over taxes that now has the momentum to continue. Tax increases, rate hikes, rate reductions and general tax reform are now all on the table.
Whether tax legislation will be recommended and passed at year-end 2011 as the result of an immediate directive to start trimming the deficit is but one possible outcome of the debt-limit debates. Another increasingly persuasive catalyst for tax legislation will result from the many Congressional hearings on tax reform now being held on Capitol Hill. Those hearings are using as springboards initial proposals that have been introduced recently by the White House Deficit Commission Report, the Republican Study Committee, and the so-called Gang of Six, a bi-partisan group of Senators suggesting ways to cut trillions from the deficit over the next 10 years. Finally, the need for Congress to act on the Bush-era tax cuts set to expire after December 31, 2012, will all but force Congress to deal with tax reform in an era in which careful budgeting is essential to economic growth.
At the center of President Obama’s plan to trim the deficit is an extension of the Bush-era tax cuts for lower and middle income taxpayers after 2012, but not for some higher income taxpayers now in the top two rate brackets. Under the president’s plan, taxes would increase for higher income individuals (which the White House defines as individuals with incomes above $200,000 and families with incomes above $250,000). The White House has also called for the elimination of certain oil and gas tax preferences, a permanent research tax credit and an extension of the 2011 payroll tax cut.
Gang of Six Tax Proposals
In early 2011, six members of the Senate (the Gang of Six) began negotiations on a comprehensive deficit reduction plan. On July 19, 2011, the senators released a bipartisan blueprint to reduce the budget deficit by $3.7 trillion over 10 years through a combination of spending cuts and revenue raisers.
Individual tax rates. The Gang of Six would replace the current individual marginal income tax rate schedule with three new tax brackets, ranging from: 8-12 percent; 14-22 percent; and 23-29 percent. The alternative minimum tax (AMT) would be repealed as well.
Tax expenditures. In return for lower tax rates and no AMT, the Gang of Six would reduce a yet unspecified number of “tax expenditures,” aka deductions and credits. Possible tax expenditures up for reform, but not repeal, could include the home mortgage interest deduction, the deduction for charitable contributions and the deduction for certain medical expenses.
Corporate tax. The Gang of Six would establish a single, lower corporate tax rate of somewhere between 23 percent and 29 percent while promising to raise as much revenue as under the current corporate tax system by eliminating many yet-to-be specified business deductions, credits and other preferences. The Gang of Six would also move to a territorial tax system under which profits would be taxed only by the country where the income is earned.
House Republican Study Committee
The Republican Study Committee (RSC) is made up of 175 conservative members of the House. The RSC drafted the deficit reduction proposal which passed the House on July 19, 2011 as the Cut, Cap and Balance Act. The Cut, Cap and Balance Act, ultimately rejected by the Senate, did not include any tax increases.
Tax reform. The RSC has called for a “smarter” Tax Code that would lower rates while broadening the tax base. The RSC to date has not offered any further specifics on how it would lower rates and broaden the tax base. The RSC has previously indicated its opposition to any scaling back of the Bush-era tax cuts.
White House Deficit Commission
The bipartisan National Commission on Fiscal Responsibility and Reform issued its final report, “The Moment of Truth,” in December 2010. The Commission developed a six-part plan designed to reduce the federal deficit by almost $4 trillion by 2020. The 18-member commission approved the report by a vote of 11-7, with Democrats and Republicans on both sides of the vote.
Tax reform. Tax reform as envisioned by the Deficit Commission would achieve at least 20 percent of the $4 trillion reduction. The Deficit Commission plan aims to reduce, if not eliminate, $1.1 trillion in tax expenditures in the current Tax Code for individuals and businesses. Under current law, the largest tax expenditure is the tax-free treatment of contributions to health care plans at approximately $144 billion per year.
Other substantial tax expenditures include:
- $79 billion by disallowing portions of the home mortgage interest deduction,
- $57 billion by curtailing accelerated depreciation,
- $53 billion by raising capital gains rates, and
- $49 billion by tightening the availability of the earned income credit.
At the same time, the plan would reduce tax rates, the amount depending on the amount of tax expenditures eliminated.
Individual income tax rates. Under one scenario, the Deficit Commission’s plan would provide three ordinary income tax rates as low as 8, 14, and 23 percent. The plan would treat capital gains and dividends as ordinary income, but, of course, ordinary income rates would be lower. The plan would eliminate the alternative minimum tax (AMT).
More “reforms.“ Other targeted reforms proposed by the Deficit Commission include:
- Limiting the charitable deduction for individuals to amounts over two percent of adjusted gross income;
- Repealing the state and local tax deduction for individuals;
- Repealing all miscellaneous itemized deductions for individuals;
- Capping the income tax exclusion for employer-provided health insurance; and
- Raising the federal gasoline tax by 15 cents per gallon.
Corporate tax. The Deficit Commission plan would provide a single corporate tax rate of 26 percent, compared to the current maximum rate of 35 percent. Additional business-related reforms include eliminating the Code Sec. 199 domestic manufacturing deduction, the LIFO (last-in, first-out) method of accounting, and oil and gas production incentives.
TAX WRITING COMMITTEES
In tandem with deficit reduction proposals, the tax writing committees in Congress are exploring possible reforms to the Tax Code. The Senate Finance Committee, controlled by Democrats, and the House Ways and Means Committee, controlled by Republicans, have looked at a variety of issues related to individual and business taxation.
The Senate Finance Committee (SFC), under the leadership of Sen. Max Baucus, D-Mont., has held a series of hearings in recent months on tax reform. The SFC has examined, among other issues, oil and gas tax preferences, the tax treatment of business and household debt, strategies to increase the voluntary compliance rate to 90 percent, and efforts to close the tax gap.
The House Ways and Means Committee has also held a series of hearings on tax reform in recent months. The Ways and Means Committee has examined, among other issues, the advantages and disadvantages of a value added tax (VAT), tax incentives to encourage foreign investment in the U.S., and the corporate tax rate.
Please contact this office if you have any questions over how momentum toward deficit reduction and tax reform may impact your bottom line tax liability in the future.