- January 2009
TAXES [updated January 2009]
It is almost certain that the tax polices that will be advanced from the new Congress and the Obama Administration will be dramatically different from those of the last several years.
President Obama campaigned on a promise to repeal the tax rate cuts of 2001 and 2003, impose new income taxes on upper income earners (the definition of which varied from $125,000 to $250,000), impose payroll taxes on incomes over $250,000, give the middle class a tax cut, and – in his own words to Joe the Plumber – “spread the wealth around.”
The downturn in the economy has caused the Administration to reconsider those campaign promises, given the accepted wisdom that raising taxes during a recession is bad policy, and as of this writing little can be predicted with any certainty about what to look for from Congress and the Administration in tax legislation, at least until the economy recovers.
Since President Obama and a number of Congressional leaders have advocated repeal of the 2001 and 2003 income tax rate reductions, an analysis of the current and proposed tax rates and the current distribution of the income tax burden are worth review.
Upper income earners already pay a disproportionate share of federal income taxes. According to IRS data (2006 data):
- the top 1 percent of income earners pay 39.89 percent of income taxes;
- the top 5 percent of earners pay more than 60 percent of income taxes,
- the top 10 percent of earners pay an incredible 70.70 percent; and
- the bottom half of all taxpayers pay only 2.9 percent of the income tax collected.
Given those tax distribution numbers, it is difficult to imagine how the upper income earners can pay a greater share of the tax burden; nonetheless, if the tax rate reductions set to expire at the end of 2010 are not extended – in other words, if Congress does not take any action – the income tax rates will go up as follows:
- the 10 percent rate will increase to 15 percent;
- the 15 percent rate will increase to 33 percent;
- the 28 percent rate will increase to 36 percent;
- the 35 percent rate will increase to 38.6 percent;
- the capital gains tax rate will increase from 15 to 20 percent;
- dividends will be taxed as ordinary income rather than at 15 percent; and
- the death tax rate will go from zero to 55 percent of estates over $1 million
OTHER TAX ISSUES:
Alternative Minimum Tax (AMT) [updated January 2009]
The AMT is an insidious tax originally enacted more than 35 years ago to reach 155 wealthy individuals who had successfully used tax deductions to avoid all taxation. But Congress failed to “index” the AMT to adjust for inflation, and the tax now reaches middle-class taxpayers who were never intended to be ensnared in the AMT parallel tax universe. Subsequent Congresses have failed to consider or defeated legislation that would have permanently corrected or repealed this flawed tax. Rather, each year they pass yet another AMT “patch” to protect additional taxpayers from its reach for one tax year.
“Mother of all Tax Reforms” [updated January 2009]
In late fall 2007 Ways and Means Committee Chairman Charlie Rangel (D-NY) introduced what he called the “mother of all tax reforms.” The Chairman’s measure would repeal the Alternative Minimum Tax (AMT), reduce the corporate tax rate to 30.5 percent, make permanent the increase in small business expensing, and expand some “refundable” tax credits and other tax deductions for middle- and lower-income earners. But the bill also assumed the expiration of all of the 2001 and 2003 tax rate reductions, resulting in a $1.3 trillion tax increase; full repeal of last-in, first-out (LIFO) inventory evaluation; and a 4.6 percent income tax surcharge on upper income earners that would have been applied not to taxable income, but to Adjusted Gross Income. In sum, the Chairman’s bill was a massive $3.5 trillion tax hike.
Congress did not debate or consider Chairman Rangel’s bill last year, and the legislation would have been vetoed by President Bush had Congress passed it, but Chairman Rangel has indicated he intends to propose a significant tax measure in this Congress. The “mother” tax bill is almost certain to be a factor in any new legislation the Chairman introduces.
LIFO (last-in, first-out) Repeal [Updated January 2009]
LIFO repeal was first considered in the Senate in 2006 when then-Majority Leader Bill Frist (R-TN) proposed repeal to raise new tax revenue to offset, or “pay for,” a one-time tax rebate of $100 to some taxpayers in response to the very high gas prices at the time.
Although the Senate Finance Committee held hearings on the issue in 2006, no action was taken on the legislation. However, the threat to LIFO was raised again in 2007 when House Ways and Means Committee Chairman Charlie Rangel (D-NY) included full repeal as one of the “offsets” – tax increases – in his “mother-of-all-tax-reform” legislation.
LIFO is also threatened from the regulatory front. Last November the Securities and Exchange Commission (SEC) published proposed regulations (their “roadmap”) to require all U.S. publicly-traded companies to file their financial statements using the International Financial Reporting Standards (IFRS) by 2014, and the international standards do not permit the use of LIFO. The Financial Accounting Standards Board (FASB) is expected to follow the SEC’s lead and apply the same rules to privately-held companies. Because of the federal “conformity” statute requiring companies to use LIFO for both “book and tax” if they use it at all, eliminating LIFO as an acceptable accounting standard de facto repeals its use for tax purposes as well.
Last year a small group of leaders of the NAW-led LIFO Coalition met with officials at the SEC, with the Assistant Secretary of the Treasury for Tax Policy, and finally with Treasury Secretary Henry Paulson, asking the Treasury Department to use its statutory authority to create an exception to the “book-tax” conformity requirement and permit companies to continue to use LIFO for tax purposes even if it is removed as an acceptable accounting standard. While we were cautiously optimistic that Treasury would at least consider acting, the collapse of the mortgage and financial markets last fall put all other issues on a back burner with the Administration so no action was taken.
While the Wall Street collapse eliminated our chances of getting the LIFO issue remedied by regulation, that collapse may ironically stall the SEC’s efforts to move U.S. companies onto IFRS. The international standards are “principles-based” rather than “rules-based” like the U.S. standards (Generally Accepted Accounting Principles – GAAP), and are therefore seen as much less strict and transparent than GAAP. Given the collapse of the U.S. financial markets and the billions of dollars of taxpayers’ money being spent to bail out failed companies, serious doubts are being expressed about the wisdom of moving to looser financial accounting standards.
If you are interested in more information on this subject, please see the following articles:
Death Tax [updated January 2009]
Gradual repeal of the Estate (or “Death”) tax was included in the tax relief bill enacted in 2001, but under the arcane filibuster-proof reconciliation rules of the Congress, the repeal will last for only one year – 2010 – after which the tax recurs at the original 55 percent tax rate. Because all tax provisions enacted in Reconciliation bills expire within ten years, permanent repeal of the death tax will have to be considered outside of Reconciliation and therefore supporters will have to garner the 60 votes in the Senate necessary to overcome a filibuster.
It is almost certain that permanent repeal of the death tax will not be enacted in this Congress. However, there is increasing belief that a permanent reform of the tax will be enacted this year. Opponents of repeal have indicated concern that if the tax is fully repealed, even for just the one year in 2010, it will be politically very difficult to reinstate the tax in 2011. The debate on permanent reform is likely to be focused on the necessary trade-off between the top death tax rate – most important to wealthy individuals – and the amount of estate to be exempt from tax – important to small business. .