House Republicans say they want to balance the budget in a decade with only spending cuts and no tax hikes. In his state of the union address Tuesday, President Obama—perhaps channeling his new pal New Jersey Governor Chris Christie—had a response. In a word, fuhgedaboutit.
Obama’s priorities: Gun control and immigration reform, along with a dozen new government programs that he says will improve the lot of the middle-class and won’t add to the deficit–but surely won’t cut it.
The fiscal goal he described is the same one he’s had for months: By his count $1.5 trillion in new deficit reduction over 10 years that would stabilize the debt at slightly below current levels—a far cry from balance.
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The president would anchor that effort with a tax reform that he says will eliminate hundreds of billions of dollars in “tax loopholes and deductions for the well-off and the well-connected.” Of course, there are not hundreds of billions in loopholes in the Tax Code. There are, however, hundreds of billions of dollars in deductions and exclusions for mortgage interest, charitable gifts, employer-paid health insurance, and state and local taxes—none of which will be easily scaled back, even for the well off. ( Continue… )
In what will probably be the usual endless laundry list of State of the Union promises, President Obama is likely to include tax reform, by which he means a rewrite of the corporate revenue code. The White House seems ready to take a run at lowering corporate rates and scaling back targeted business subsidies. So is House Ways & Means Committee Chairman Dave Camp (R-MI), who is taking the lead in both individual and corporate reform.
But any corporate tax initiative will run into an odd coalition of resistance: liberal Democrats and big segments of the business community itself.
Progressives are fine with ending business subsidies, of course. But only if some of the new revenue the effort generates is used to either buy down some of the automatic spending cuts due to bite over the next decade or helps reduce the deficit. Obama, by contrast, seems ready to reform corporate taxes in a way that produces the same amount of tax revenue as today’s code.
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The tension between these two goals becomes transparent when, for instance, Obama talks about some of his favorite business tax targets—special tax breaks for corporate jets and oil production. Sometimes, Obama vows to kill these subsidies in the name of deficit reduction. Sometimes, he’d ditch them to finance lower corporate rates. But even presidents can’t use the same money twice. ( Continue… )
The Congressional Budget Office released its latest Budget and Economic Outlook earlier this week. As always, the Outlook provides insight into the fiscal status of the federal government. My three overarching reactions are:
First, because American Taxpayer Relief Act of 2012 (ATRA) instituted tax changes that had been widely expected, the official (“current law”) baseline is now much more reflective of plausible outcomes than it has been in the past. Hence, the baseline is now a more reliable guide to the fiscal outlook.
Second, unlike in long-term budget scenarios – where rising health care spending is the single most important factor – there is no “smoking gun” in the 10-year projections. Mainly, there is “just” an overall continuing imbalance between spending and taxes. Revenue is not projected to collapse, as it did in 2009-12, but rather to grow to higher-than-historical-average levels. Spending isn’t spiraling out of control—it is at the same share of GDP in 2023 as it was in 2012. Large projected cuts in discretionary spending are offset by net interest rising to historically high levels and increases in mandatory spending.
Third, while we do not face an imminent budget crisis, the data in the Outlook imply that we are not out of the woods. The 10-year budget outlook remains tenuous. Even if seemingly everything goes right – in economic terms and in political terms – we are still on the edge of dangerously high debt and deficit levels with little room to spare. For example, under the current law baseline, even if: ( Continue… )
After more than a decade of nearly constant change, the federal estate tax is finally permanent. It’s a bit more onerous than last year’s version but still only a shadow of its former self. New tables from the Tax Policy Centershow that in 2013, just 3,800 estates—fewer than one in 700—will owe the tax. And they’ll pay a total of just $14 billion—half the revenue collected five years ago.
With the passage of the American Taxpayer Relief Act of 2012 (ATRA), Congress set the effective exemption for combined bequests and gifts at $5 million, indexed that value for inflation, and allowed surviving spouses to claim any exemption not used by their deceased mates. It also raised the rate to 40 percent, 5 percentage points higher than in 2012.
The estate tax has endured nearly constant change over the past dozen years. The 2001 tax act (EGTRRA) reduced the tax in steps, raising the effective exemption from $675,000 in 2001 to $3.5 million in 2009 and cutting the top rate from 55 percent to 45 percent before repealing the tax entirely in 2010. Because EGTRRA expired entirely in 2011, the repeal lasted only one year. But rather than let the tax return to its pre-EGTRRA status, Congress set new parameters for 2011 and 2012: a $5 million exemption and a 35 percent tax rate. The tax reverted to 2001 law at the stroke of midnight last New Year’s Eve.
ATRA reversed that just a few hours later. For the first time in over a decade, we have a permanent estate and gift tax. The wealthy will no longer have to arrange their gifts and wills in the face of uncertain law as they did in the closing months of 2010 and 2012. ( Continue… )
In the realm of needless complexity, the work and family tax credits for low-income households rank near the top. The problem is especially challenging for immigrant families whose children’s legal status and residency determine eligibility for these credits.
A few weeks ago, the National Taxpayer Advocate in her Annual Report to Congress joined many others in calling for separating the work and family incentives in the tax code. This approach could make tax filing simpler and more efficient for low-income families.
Currently, the three largest child related provisions – the dependent exemption, the Child Tax Credit (CTC), and the Earned Income Tax Credit (EITC) – have three sets of rules governing eligibility. These inconsistencies in the law create confusion and prevent people from claiming deductions or credits for which they are eligible. Here are a few examples of how the rules differ: ( Continue… )
Can the income tax fund the government we seem to want? Probably not.
Will lawmakers create a revenue system that will? Not anytime soon.
That was the consensus of four tax policy experts at an Urban Institute panel I moderated Tuesday afternoon. The panelists–historian Joe Thorndike, Urban Institute economist and tax reform veteran Gene Steuerle, Tax Policy Center co-director Eric Toder, and IRS taxpayer advocate Nina Olson– agreed that the current Swiss cheese of a revenue code is not up to the task, at least not in the long-term.
And they agreed that someday, the federal government will turn to some form of a consumption tax to help make up the difference. It may be a broad-based levy such as a Value-Added Tax or an energy tax. It might replace the current income tax, or might be added on to the existing system. But given political gridlock, any form of major reform is years away.
As they were speaking, the Congressional Budget Office released its own fiscal update for the next decade. And, by CBO’s estimates, the panelists are self-evidently correct. While a growing economy will bring the annual deficit down to about 2.4 percent of Gross Domestic Product by 2015 (assuming, among other things, that discretionary spending remains capped in the way Congress and President Obama have agreed), the red ink will begin flowing faster again. By 2023, the deficit will be back to 3.8 percent of GDP and rising. ( Continue… )
With state finances gradually improving, some Republican governors are turning their attention to fundamental tax reform. Louisiana Governor Bobby Jindal has proposed replacing his state’s personal and corporate income taxes with higher sales taxes. Nebraska’s Dave Heineman and North Carolina’s Pat McCrory would do something similar, broadening the sales tax base and perhaps including some previously tax-exempt services.
With Washington apparently stuck in gear on taxes among other issues, it may be tempting to see the states as leading a way to reform. Unfortunately, some of the proposals currently circulating – and the idea of states as laboratories for a fundamental federal tax reform —are fundamentally flawed.
First, as my Tax Policy Center colleague Ben Harris has noted, income-sales tax swaps would be regressive – or hit low income household the hardest. This is because low income households must dedicate a greater share of their income to consumption to achieve a basic standard of living and more of their consumption tends to go toward goods (which are taxed) versus services (which are typically not). These households also often benefit from income tax rebates which presumably would be wiped out along with the tax.
Another key issue is whether states would go after currently untaxed services. Most states have already picked off easy targets like tuxedo rentals and tattoo parlors. As pointed out by the Tax Foundation’s Joe Henchman, it’s a much heavier lift politically to tax professional services of lawyers, accountants, and real estate agents. Just ask lawmakers in Maryland, Michigan, and Florida who enacted new sales taxes on some services but were forced to repeal the levies in the face of industry backlash. ( Continue… )
For years, the battle over carried interest has focused on how to tax the compensation of private equity managers. But a careful reading of the law suggests that all the business profits of these investment firms, not just the pay of their managers, are ordinary income, and should be taxed that way.
Until now, the analysis of this issue has simply accepted the funds’ profits as capital gains. But when researching a newly-published article, “Taxing Private Equity Funds as Corporate Developers,” I discovered that Congress intended capital gains to be defined narrowly so that ordinary profits—those that arise from the everyday operation of a business—would be taxed at regular rates.
Private equity funds earn sizable profits, largely from acquiring companies, improving them, and reselling them (and they now manage much greater amounts of money: $2.5 trillion in 2010, up from $100 billion in 1994). The funds report these profits as capital gains, and allocate a large share to their managers as reward for their services (which is how Mitt Romney achieved 14% effective tax rates). But what if these profits are not capital gains at all? And what if our tax rules have been incorrectly subsidizing the growth of these funds for the last two decades?
Our tax laws generally treat the profits of taxpayers that develop and sell property in the course of a trade or business as ordinary income. For example, real estate developers often take many years to buy, develop and resell property, and they report their profits as ordinary income. So, why should private equity funds that buy, develop and resell companies (or their stock) treat their profits as capital gains? ( Continue… )
In one of the more dangerous fiscal developments of recent months, some on the left are defining successful deficit reduction as merely stabilizing the federal debt at about 70 percent of Gross Domestic Product by 2022. While there is no magic target, this one is far too modest and threatens to leave future fiscal policy perilously constrained.
Under current assumptions this goal can be achieved with combined reductions in spending growth and/or increases in taxes of $1.4 trillion over the 2014-2022 period, far less than the total deficit reduction provided by the 2011 Budget Control Act (BCA), which resolved the 2011 debt ceiling debate, and the American Taxpayer Relief Act of 2013 (ATRA), which recently avoided the fiscal cliff.
Richard Kogan of the Center on Budget and Policy Priorities, supported by Martin Wolf of the Financial Times makes the case for more modest deficit reduction. The editorial page of the Washington Post shares my concern that their goals are dangerously modest.
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Imagine facing the next recession with a debt-GDP ratio already above 70 percent. It is almost certain that we shall have another slump before 2022. If not, it will be the longest period without a decline in the recorded history of U. S. business cycles. Add a modest stimulus to the recession-driven reduction in tax revenues and increases in social spending and the debt-GDP ratio would top 100 percent in the blink of an eye. But it is harder to argue for a stimulus with the debt already soaring, and without one, a future recession would be more severe than necessary. ( Continue… )
House Ways and Means Committee Chairman Dave Camp (R-MI) has proposed requiring most derivatives investors to pay tax on their annual returns even if they don’t realize their gains by selling their securities. This proposal, which requires investors to mark-to-market the value of financial derivatives, has ramifications far beyond the heady world of high-tech finance. It implicitly challenges our most basic and firmly held beliefs about why we tax investment gains the way we do.
Camp’s plan raises two key questions: First, should mark-to-market be required for all investment assets, not just derivatives? Second, does his proposal fracture one of the main justifications for taxing long term capital gains at roughly half the rate on ordinary income?
Ask most tax experts why, in a nutshell, rates should be lower for capital gains, and you’re liable to get a mini-lesson on the “lock-in effect.” There’ll be other reasons too. But the lock-in effect is going to be pulling some serious weight.
What the lock-in effect is and how it relates to mark-to-market—and why Camp’s proposal calls it into serious question—is best explained by way of analogy. ( Continue… )