Legislative Issue Update - July 2010
The tax system today is already too complicated for most to understand, and simply complying with the code – apart from paying the taxes owed – is a drain on the economy. According to the Tax Foundation, as of 2005 (the most recent data available), IRS regulations contained over 6,958,000 words—almost 9 times the total number of words in the King James Bible.
And according to the National Taxpayers Union (NTU), in Fiscal Year 2009, the IRS estimated that individual and business taxpayers spent 7.75 billion hours complying with the tax laws – the equivalent of 3.7 million employees working 40-hour weeks year-round without any vacation. And also according to NTU, the cost for federal tax compliance by corporations is $159.4 billion, which is 54 percent of the corporate income taxes collected in fiscal year 2008.
What is really needed, of course, is real comprehensive tax reform. There is some talk of the Fair Tax, Consumption tax, VAT tax, corporate tax reform, etc. A bipartisan tax bill was recently introduced by Oregon Democrat Senator Ron Wyden and New Hampshire Republican Judd Gregg. Their bill would reduce the corporate income tax rate to 24 percent and eliminate a lot of preferences and deductions, simplifying the code and broadening the tax base. We are unlikely to see this kind of comprehensive legislation enacted this year, but maybe Congress and the Administration will tackle this after the 2010 elections, if significant GOP gains force the Obama Administration to reach across party lines to get anything done.
But we have to get through 2009 first, and that is a serious challenge on the tax front.
It is becoming conventional wisdom in Washington that we have to raise taxes to deal with the debt and deficit because there is simply no way spending can be cut enough to stop the hemorrhaging. And if Congress does nothing at all this year on tax issues, we are facing daunting – and economically damaging – tax hikes in 2011. The tax cuts enacted in 2001and 2003 will all expire at the end of this year, leading to massive, automatic tax hikes starting next January. Specifically:
- the 35 percent bracket will increase to 39.6 percent;
- the 33 percent bracket will increase to 36 percent;
- the 28 percent bracket will increase to 31 percent;
- the 25 percent bracket will increase to 28 percent;
- the 10 percent and 15 percent brackets will condense to 15 percent;
- Dividends will no longer be taxed at the capital gains rate for individuals; and
- The capital gains tax will increase to 20 percent and 10 percent (from 15 and 10)
But Congress is not likely to do nothing. The President and Leaders in Congress have called for extension of the reduced tax rates for taxpayers in the middle-income brackets in response to the Obama campaign promise not to raise taxes on the middle class, but they oppose extension of the reduced rates on upper income earners or on capital gains and dividends, thus calling for a significant tax increase on those individual taxpayers and on businesses which file taxes as individuals.
Overall, the budget the President submitted to Congress in February specified about $2 trillion in tax hikes. In additional to the already-scheduled tax rate increases, the President’s budget called for phasing out itemized deductions and the personal exemption for upper income earners, limiting the value of itemized deductions to 28 percent while increasing the top margin rate to 39.6 percent, and full repeal of LIFO. And these proposed hikes – which would dramatically increase the top marginal tax rates – do not include the new taxes already enacted in the health care reform bill, which include an increase in the Medicare payroll tax on upper income earners and applying that payroll tax for the first time ever to unearned, non-payroll income.
Federal tax distribution tables:
The prevailing sentiment among Administration officials and leaders in Congress is that raising taxes on the wealthy is not just necessary, but fair; that the wealthy have benefitted inappropriately from previous tax cuts and should pay their “fair share” – that the tax code should be more progressive. That argument is both wrong and deceitful. The so-called rich already pay significantly more than their “fair share.” According to the most recent IRS data available:
- The top 1 percent of earners pay 40.42 percent of income taxes;
- The top 5 percent pay 60.63 percent;
- The top 10 percent pay 71.22 percent;
- The top 25 percent pay 86.59 percent; and
- The top half pay a full 97.11 percent of federal income taxes
Looked at the other way, the bottom half of income earners pay only 2.89 percent of federal income taxes. Even more significant, according to the IRS, 47 percent of all wage earners pay NO federal income taxes. The result is a tax system that exempts almost half the country from paying for programs that benefit everyone, including national defense, public safety, infrastructure and education. Not only does this place an unfair burden on the other 53 percent of wage earners, it also creates a significant block of voters who have no reason to oppose income tax increases since they would not be affected by them.
Even more significant, the bottom 40 percent, on average, make a profit from the federal income tax, meaning they get more money in tax credits than they would otherwise owe in taxes. For those people, the government sends them a payment.
Outlook for tax legislation in 2010:
There are clearly many significant tax policy issues on the table this year: the scheduled tax increases that will take effect on January 1, 2011 if Congress fails to act; the President’s promise not to raise taxes on the middle class; the expiration this year of the death tax and its recurrence next year at the pre-2001 rate of 55 percent on all estates over a million dollars; the expiration last December of a number of tax provisions (see separate section on tax extenders below); the 2010 AMT “patch” to prevent that tax from reaching millions of additional middle-class taxpayers; and the array of new taxes proposed by the President in his budget in February.
With that much tax policy pending, business in particular has been looking for some indication from Capitol Hill as to how and when they plan to begin dealing with these issues. But Senate Finance Committee staff report that Committee Chairman Max Baucus (D-MT) has not decided what he plans to do, or when he plans to begin deliberations. Moreover, President Obama’s promise not to raise taxes on the middle class has been a focal point of tax policy debate since his election, but late last month several Democratic members of the House and Senate, including House Majority Leader Steny Hoyer (D-MD), said they are not committed to keeping that presidential campaign promise and that tax hikes on earners at much lower income levels than those the president promised to protect may well be in the cards.
No major action on tax bills is expected before Congress returns in September from its August break, and there is no indication that they have even begun thinking about what tax matters to take up when they begin their last few weeks of work before adjourning for the November elections.
Death tax [updated July 2010]:
One issue on which the failure of Congress to act could have serious consequences is the “death tax.” As we have reported before, gradual repeal of the Federal estate tax, 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 could last for only one year – 2010 – after which the tax is set to recur at the pre-2001 level of 55 percent on all estates over one million dollars. We have been reporting this for eight years, and for eight years repeal advocates in Congress have been unable to garner sufficient votes to either permanently repeal or permanently reduce this hated tax.
We assumed from the beginning of 2009 that although Congress would not permanently repeal the death tax, the position long advocated by NAW and several business and tax coalitions, some action would be taken to prevent full repeal from taking effect this year. Our crystal balls told us that opponents of death tax repeal would NEVER allow full repeal to take effect in 2010, since it would then be politically very difficult to reinstate the tax in 2011.
But as Congress adjourned sine die in December, that is exactly what happened, and as of January 1st this year, there is no Federal death tax for 2010.
Leaders in both houses of Congress pledged to act quickly in 2010 to reinstate a Federal estate tax, and some said they plan to make it retroactive. However, serious questions were raised about the viability or constitutionality of retroactively imposing a tax triggered by a death; many doubt the tax could realistically be assessed against an estate which had already settled.
And despite the promise of speedy action – and the need for it – Congress has yet to move on this issue. Senators Jon Kyl (R-AZ) and Blanche Lincoln (D-AR) have introduced and pushed for consideration of legislation to enact a permanent death tax law with a 35 percent rate on all estates in excess of $5 million (per spouse) with stepped-up basis for capital assets, but they do not yet have the votes for enactment of their proposal.
And last month, Senator Bernie Sanders (I (Socialist) - VT) and a few other liberal Democratic Senators introduced a competing version of estate tax reform calling for a graduated tax on high value estates. Under the Sanders bill, estates under $3.5 million would be exempt from the death tax, estates between $3.5 million and $10 million would pay a 45 percent tax, estates between $10 and $50 million would be taxed at 50 percent, estates over $50 million would get hit with a 55 percent tax, and a 10 percent surtax would apply to estates valued at more than $500 million.
Senators Lincoln and Kyl received 51 votes in support of their proposal on a non-binding resolution last year, but they will need 60 votes to overcome a certain Democrat filibuster of their bill. It is not clear how much support the just-introduced Sanders proposal has among his colleagues, but it, too, would require 60 votes to succeed. At this point there is no clear path to a resolution of this issue this year, and imposition in 2011 of the pre-2001 death tax law is very much a possibility.
LIFO (last-in, first-out) Repeal [updated July 2010]:
After three years with no legislative activity, LIFO repeal moved back to the front burner a year ago when President Obama included repeal in the budget he submitted to Congress. His repeal proposal was “scored” as a $61 billion revenue increase. The proposal was later re-scored by the Joint Tax Committee with a price tag $18 billion higher, for a revenue increase of $79 billion.
Fortunately, the budget that was subsequently adopted by Congress last year did not include LIFO repeal, and no repeal legislation was introduced in 2009. LIFO repeal was also included in 2009 in a list prepared by the Senate Finance Committee of possible “pay-fors” for their health care reform proposal, but after an aggressive lobbying campaign waged by the NAW-led LIFO Coalition, repeal was not included in the legislation the committee finally produced.
Repeal is again included this year in the President’s budget, and members of the LIFO Coalition are again meeting with key members of the House and Senate to urge their opposition. The meetings have been productive, with Coalition members continuing to report that the most of the members of Congress and staff with whom they have met oppose repeal. Late last month a group of Coalition members met with three key Republicans on the House Ways and Means Committee, again affirming their opposition to repeal and the Coalition commitment to wage an ongoing lobbying effort.
We also continue to monitor the activity at the Securities and Exchange Commission (SEC) as they move toward a decision on convergence of U.S.GAAP with the International Financial Reporting Standards (IFRS). Coalition leaders met in June with the Chief Accountant and several Deputy Accountants at the SEC to discuss possible actions, and with several staff members at the U.S. Treasury Department’s Office of Tax Policy. While a decision by the SEC on whether to proceed with convergence is not expected until 2011, and adoption of IFRS several years beyond that if they make the decision to adopt IFRS, we are continuing to pursue possible regulatory actions that would remove the “book-tax” conformity requirement as a de facto repeal of LIFO.
Tax Extenders Bill [added July 2010]:
As previously mentioned, the Congress annually passes legislation to extend expiring tax provisions including the R&D tax credit, expanded small business expensing, the teacher tax credit, state sales tax deductibility for residents who pay no state income tax, and many others.
This year that extenders package was seen as a likely vehicle to carry not just the annual tax provisions, but a host of spending initiatives as well. The primary spending programs were extension of unemployment insurance benefits for the long-term unemployed and additional COBRA subsidies for laid-off workers. But also proposed were Federal aid to states to cover Medicaid expenses, the so-called “Doc Fix” postponing a scheduled cut in Medicare reimbursements to physicians, Federal funds to the states to prevent teacher lay-offs, and much more.
The House passed its version of this bill just before Memorial Day, but not without a very contentious debate. Their bill would extend the expiring tax provisions, prevent the scheduled reduction in Medicare reimbursements to physicians, extend unemployment benefits, and raise billions of dollars in new taxes on business, primarily from changes to foreign tax credit law and to the taxation of “carried interest.” The “cost” of their bill in new spending is $113 billion, and it would increase the deficit by $54 billion. But that number doesn’t tell the whole story: the original bill would have cost $200 billion and increased the deficit by $100 billion. The reduction in the size of the bill – through the elimination of billions in dollars in spending programs – was forced on the House leadership by moderate Democrats concerned about the mounting debt who threatened to vote against the bigger bill – and who would have had enough votes to kill it.
The Senate spent much of June attempting to pass its version of the extenders bill, with an even more contentious debate. Senate Democrats objected to the removal of the spending provisions from the House bill, and insisted on restoring that spending in the Senate version of the bill, raising both the cost of the bill and the amount of deficit it would have incurred.
But Republicans and at least one moderate Democrat objected to the increased spending and deficit in a protracted debate that lasted several weeks. Spending proposals were removed from the legislation over the objections of many liberal Democrats to address the deficit concerns of moderates from both political parties.
In addition to objections to the spending, moderate Republican Senator Olympia Snowe (R-ME) objected to a proposal in the bill to impose payroll taxes on income generated by some Sub S professional firms, a provision that would raise $9 billion and, according to Senator Snowe (who is ranking Republican on the Small Business Committee) impose an unfair hardship on some small Sub S companies.
Majority Leader Harry Reid (D-NV) made several attempts to pass the Senate version of the bill, but on June 24th failed again to garner the 60 votes necessary for passage, and pulled the bill from the floor.
The Democrats are accusing the Republicans of denying extended unemployment insurance to millions of unemployed workers; the Republicans argue that other spending should be cut so that the UI benefits are “paid for” and don’t add to the federal deficit.
Is it not clear whether the Senate will attempt to resurrect this legislation, or when; it is very clear that both sides believe that their position will win popular support that helps them in the November elections.