Ten Questions About Tax Policy
for the Next Administration and Congress
October 2008
Ten Questions About Tax Policy
for the Next Administration and Congress
I. Introduction
II. Background
In 2009, the new Administration and new Congress will face what
many have called “a perfect storm for the tax code.” With the
2001 and 2003 tax cuts expiring,1 with congressional budget rules
effectively requiring additional tax revenues to offset the cost of new
initiatives, and with growing concerns about the overall health of the
economy, about the shift of jobs overseas, and about a host of other
issues with tax policy implications, taxpayers are likely to see the most
significant tax policy debate in decades.
The Political Setting. Although it is impossible to predict the outcome
of the upcoming elections, there will be a new Administration and
there is likely to be a Democratic Congress with larger majorities in
both the House and Senate than exist today.2 New presidents tend to
push major tax bills quickly to follow through on campaign promises
and to take advantage of the “honeymoon” period. The 1981
Reagan tax cuts and the 1993 Clinton tax bill were enacted by
August of the new Presidents’ first year in office. The conference report
for the Bush tax cuts was agreed to on May 26, 2001. If history is
any indication, there is a significant chance that major tax legislation
will be considered early in 2009, at a pace much faster than the
usual pace of tax legislation.
This upcoming tax debate raises many questions for individuals,
businesses, and nonprofit organizations. Will changes in the tax
rules for ordinary income, capital gains, and dividends significantly
alter the after-tax return on investments? How will Congress address
the financial crisis on Wall Street? What will happen to corporate
tax rates? Will certain tax benefits be on the chopping block
labeled by policy makers as “loopholes?” How will changes in the
foreign tax rules affect international operations? Is there a chance
that new tax incentives can be enacted notwithstanding the need for
additional revenues?
This paper is designed to assist in the consideration of these and other
questions. It provides general background, then discusses ten specific
questions about tax policy facing the new Administration and the next
Congress. These questions are:
1. What will happen to individual tax rates?
2. What will happen to the alternative minimum tax?
3. What is the outlook for the estate tax?
4. How will capital gains and dividends be taxed?
5. Will the corporate tax rate be reduced?
6. W
ill Congress change the tax treatment of income
earned abroad?
7. What is the future outlook for tax extenders?
8. H
ow will the new Administration and Congress address
the tax code and energy independence?
9. What is the outlook for taxes and health care reform?
10.Where will the new President and Congress look for
additional revenue?
The Impending Expiration of the 2001 and 2003 Tax Cuts. The
new Administration and Congress will immediately confront major
tax policy issues. The reasons are budgetary and structural. The
most recent Office of Management and Budget projections show
the projected 2009 federal budget deficit to be $483 billion
($611 billion if the deficit does not include the Social Security
surplus), and this was before Congress provided $700 billion
for the financial crisis. Although this deficit is projected to be cut
by 2/3 by 2012, this projection assumes the 2001 and 2003
tax cuts will be allowed to expire as scheduled in 2010.3 The
2010 expiration date structurally embedded in the tax code
now serves as a trigger that will force the new President and
Congress to quickly choose among competing priorities.
Thus far, the principal political debate, particularly in the presidential
campaign, has been whether to extend some or all of the 2001
and 2003 tax cuts. According to the Joint Committee on Taxation,
permanently extending the 2001 and 2003 tax cuts would cost
$2.3 trillion over ten years. In the presidential campaign, the debate
has been principally about whether to extend the tax cuts for upperincome individuals. But this is only part of the picture. The temporary
tax policies enacted in 2001 and 2003 include not only tax cuts that
primarily affect higher-income taxpayers, such as lower top marginal
rates and lower rates for capital gains and dividends, but also a wide
variety of tax relief that benefits middle-class taxpayers, such as the
new 10% tax bracket, relief from the marriage penalty, and doubling
the child tax credit from $500 to $1,000. Regardless of who controls
the White House, there will be overwhelming bipartisan support for
extending, at a minimum, portions of the 2001 and 2003 tax cuts
that benefit middle and lower-income taxpayers.
Ten Questions About Tax Policy for the Next Administration and Congress
2
Projected Deficits
Projected
With Tax Cuts
0
-3
-5
-50
-100
-126
-150
-135
-147
-148
-170
-200
Billions
-162
-174
-207
-250
-264
-300
-294
-304
-325
-350
-316
-328
-342
-356
-400
-407
-450
-438
-431
-500
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
Years
Source: Congressional Budget Office. The Budget and Economic Outlook: 2008 to 2018, at x and 20 (September 2008)
But extending even some of these tax cuts will be costly. For example,
making the $1,000 child credit permanent would cost $261 billion
over the next ten years. Extending relief from the marriage penalty
would cost $81 billion. On top of this, Congress wants to limit the
growing reach of the alternative minimum tax, which will cost nearly
$64 billion in 2008 alone to protect 25 million taxpayers from the
AMT. The tax code contains dozens of other temporary but worthy
policies, like the research and experimentation tax credit and the
deduction for college tuition, that expire year-to-year and whose
extensions will cost at least another $25 billion annually.
Cost of extending selected tax cuts
(10 years)
•
•
•
•
•
•
Lower Rates
Estate tax repeal
Child Credit
Dividends
Capital Gains
Marriage Penalty
$1.042 trillion
$670 billion
$261 billion
$217 billion
$102 billion
$81 billion
Source: Joint Committee on Taxation. Description of Revenue Provisions Contained in
the President’s Fiscal Year 2009 Budget Proposal. JCS-1-08, at 311 (March 2008).
The next Congress may not approve all of this tax relief. But it will
enact a substantial part. A conservative estimate of the cost is at least
$1 trillion (over ten years) – and it could be as much as $2 trillion.
On top of that, there are likely to be new initiatives to address health
care, education, energy independence, and retirement security that
will necessarily involve changes to the tax code.
The Pay-Go Constraint. Republicans have said that the cost of
extending tax cuts does not need to be offset by tax increases.
Republicans have argued that the 2001 and 2003 tax cuts were not
intended to be temporary and, moreover, the budgetary effects of
tax cuts would be counteracted by economic growth. Thus, President
Bush and Senator McCain have proposed to extend all of the 2001
and 2003 tax cuts without any offsetting tax increases.
Not so the Democrats. When they gained majorities in the House
and Senate, the Democrats reinstated and pledged to comply with
“pay-as-you-go” (pay-go) congressional budget rules, which require
that any tax cuts or spending increases be offset by tax revenues or
spending cuts, so that the overall effect does not increase the federal
deficit (as measured by conventional Congressional Budget Office
“scorekeeping”). Although congressional Democrats have made paygo budgeting a central tenet of their leadership, they have struggled
to keep the pledge in the 110th Congress.4 In the 111th Congress,
Democrats will try to continue to uphold their pay-go pledge. This has
Ten Questions About Tax Policy for the Next Administration and Congress
3
important policy implications. Under the pay-go rules, any future tax
cuts exceeding $10 billion, including any extension of the 2001 and
2003 tax cuts, must be offset by an equal amount of tax revenue or
spending reductions. Given that large spending cuts are unlikely, this
means that if Congress decides to abide by pay-go rules, it will have
to offset the cost of the large tax cuts with large tax increases.
“It shall not be in order in the Senate to consider any bill, joint
resolution, amendment, motion, or conference report … that would
cause a net increase in the deficit in excess of $10 billion in any
fiscal year provided for in the most recently adopted concurrent
resolution on the budget unless it is fully offset over the period
of all fiscal years provided for in the most recently adopted
concurrent resolution on the budget.”
—Section 315 of S. Con. Res. 70 (2008 Budget Resolution)
American people. And in between, the reach of the deeply flawed
alternative minimum tax … will threaten to hit tens of millions
of middle-class Americans unless Congress enacts major tax
legislation. Finally, the competitive pressures of a global economy
will force us to change our uncompetitive and inefficient methods
of business taxation, including one of the highest corporate
marginal rates in the world. “8
III. Questions
1. What will happen to individual tax rates?
If Senator McCain is elected president, there will likely still be tax
increases. Although Senator McCain has expressly rejected the need
to offset the cost of extending expiring tax cuts, he has previously
been known as something of a deficit hawk.5 If congressional
Democrats insist on offsetting some or all of the cost of tax cuts,
McCain, as President, may agree to do so at least to some extent.
Indeed, he has himself called for closing billions of dollars worth of
“corporate tax loopholes.”6
Background. Under the federal income tax system, taxpayers are
subject to tax on their worldwide taxable income. Taxable income
is total gross income less certain exclusions, exemptions, and
deductions. Income tax liability is determined by applying the regular
income tax rate schedule to the individual’s taxable income. This tax
liability is reduced by any applicable tax credits. The regular income
tax rate schedules are divided into several ranges of income called
“brackets,” and the marginal tax rate increases as the individual’s
income increases. The income bracket amounts are adjusted annually
for inflation according to the consumer price index (“CPI”).
Thus, whatever the outcome of the presidential election, there is
likely to be an intense search for politically palatable tax increases
next year. Even if the economy continues to sputter, the new
president could decide that economic stimulus proposals should be
considered first, and that major tax increases are inconsistent with
economic stimulus, but that will only delay tax increases, not prevent
them. Before too long into 2009-2010, the Administration and
Congress will have to confront the impending expiration of the tax
cuts, and will require significant offsetting tax increases in an effort
to reduce the deficit.
The Economic Growth and Tax Relief Reconciliation Act of 2001 (the
“2001 Act”) implemented a phased-in reduction in the tax rates that
began in 2001 and was accelerated by the Jobs and Growth Tax
Relief Reconciliation Act of 2003 (the “2003 Act”). The 2001 Act
also added a new 10 percent tax bracket for a portion of taxable
income that was currently taxed at 15 percent. Without further
congressional action, the 10 percent bracket will disappear and
pre-2001 rates will return in 2011 as follows:
Other Tax Issues. The new Administration will face other tax issues.
More than 20 years after comprehensive reform of the tax code in
1986, there have been calls to undertake another comprehensive
reform of the tax system, most notably in the 2005 report of the
President’s Advisory Panel on Federal Tax Reform, and Senators
McCain and Obama both have said that they want to reform the
tax code to eliminate inappropriate “loopholes.” In addition, as is
discussed below, tax issues will be implicated by efforts to address
health care reform and the shifting of jobs overseas.7
A Republican Senator, George Voinovich (OH), recently summarized
the situation that is likely to face the next Administration and Congress.
Introducing a tax reform bill in June, 2008 he said:
“A number of factors make the 111th Congress the occasion for
a perfect storm for the Tax Code. At the beginning of the next
Congress, a new President will take office and will be looking to
enact major tax changes. At the end, the 2001 and 2003 tax
relief will expire, resulting in an unprecedented tax increase on the
Pre-2001 Rate
Structure
2001 Rate
Structure
Post-2010
Rate Structure
-
10%
-
15%
15%
15%
28%
25%
28%
31%
28%
31%
36%
33%
36%
39.6%
35%
39.6%
The top tax rate on individual ordinary income has fluctuated
dramatically over the years. From 1971-81, it was 70%; the 1981
tax cuts reduced it to 50%, and the 1986 Tax Reform Act reduced it
to 28%. It was increased, thereafter, to 31% in the 1990 Bush budget
Ten Questions About Tax Policy for the Next Administration and Congress
4
agreement and to 39.6% in the 1993 Clinton budget bill.
The 2001 tax bill reduced tax rates, including the top individual
rates. Currently, the 33% rate applies to taxable income between
$164,550 and $357,700. The 35% bracket applies to taxable
income above $357,700 (joint return). According to the Joint
Committee on Taxation, to extend the reduction in all individual
income tax rates would cost over $1.04 trillion over ten years. Top Tax Rate
80
70
60
50
40
Top Tax Rate
30
20
10
0
1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010
Employees also pay federal payroll taxes of 1.45% for Medicare
and of 6.2%, up to $102,000, for Social Security (employers pay
matching amounts, and self-employed people pay both portions for a
total of 12.4%).
Proposals. The presidential candidates have taken dramatically
different positions on the appropriate top tax rates. Senator McCain
has proposed to retain the 2001 and 2003 tax cuts, including the
reductions to the top rates. Senator Obama, in contrast, proposes
to retain some of the 2001 tax cuts, but to allow the rate cuts to
expire for taxpayers earning more than $250,000 a year, thereby
increasing taxes on income in part of the 33% bracket and all of the
35% bracket. Senator Obama would also eliminate income taxes for
seniors making less than $50,000 a year.
In Congress, House Democrats have made two proposals recently
to increase top rates. First, Ways and Means Committee Chairman
Charles Rangel introduced tax reform legislation in 2007 that would
raise $832 billion/10 years by imposing a surtax of 4% on adjusted
gross income above $200,000 and 4.6% on adjusted gross
income above $500,000.9 Second, in 2008, the House passed a
war supplemental package that included as an offset for increased
veterans’ education benefits, a surtax of 0.47% on adjusted gross
income above $1 million.10 That provision would have raised roughly
$52 billion.11
With respect to payroll taxes, Senator Obama has proposed a
refundable income tax credit of up to $1,000 per family to offset the
payroll tax on the first $8,100 of earnings. Senator Obama is also
considering a plan that would impose additional employment taxes of
between 2% and 4% on those making over $250,000, although this
proposal would not start for at least a decade.
Assessment:
• Most taxpayers are unlikely to see an increase in their income
tax rates since both candidates propose extending existing rates
for those making under $250,000. The top individual tax rates
are likely to be higher than the 2001-2010 rate structure no
matter who wins the presidency, because a more Democratic
Congress will not approve legislation to permanently extend
the 2001 top marginal rate cuts. The top rates are likely to
be higher if Obama is elected president. Moreover, the tax
burden on those making over $250,000 will likely be greater
in the years ahead if Senator Obama’s proposed changes to
employment taxes are also adopted.
• T here may be a political “ceiling” at 39.6% for the top
individual income tax rate. Chairman Rangel’s proposal reflects
this reality, by maintaining an effective top rate of 39.6% in
his tax reform measure. The top rate might also be set short of
39.6% so that policy makers can provide all taxpayers with
rate relief as compared to the pre-2001 rate structure.
• M
any taxpayers could see higher effective rates, particularly
if Congress fails to extend provisions to repeal the overall
limitation on itemized deductions and repeal the personal
exemption phaseout, both measures included in the 2001
Act. Congress is likely to retain these limitations and phaseouts
in order to raise significant amounts of revenue from higher
income taxpayers.
• S
enator Obama’s proposal to modify the cap on income
subject to the Social Security tax could have the effect of
imposing a combined tax rate in excess of 40% on some of
the highest income taxpayers. However, that proposal is likely
to face criticism not only from conservatives, but also from
Democrats concerned that the proposal would undermine
the “social contract” aspect of Social Security (that is, the link
between taxes paid and the insurance benefits received).
• T he same concerns of undermining the “social contract” would
apply to Senator Obama’s proposal to rebate payroll taxes.
Republicans would attack this as transforming Social Security
from an earned entitlement into a welfare program.
• P roponents for making the 2001 and 2003 top rate cuts
permanent will argue that higher marginal rates will adversely
affect small business owners and stifle job creation. These
arguments are less likely to be persuasive with a Democraticcontrolled government. While it is true that most of those
earning over $250,000 do have small business income, very
few of them are traditional “small businessmen.” According to
the IRS, 32 million taxpayers filed small business tax returns in
2007. Only 576,000, or roughly 1.4% of these taxpayers,
paid the top individual rate.12
• W
hile the public debate might focus on the marginal rates,
taxpayers should pay particular attention to proposals to limit
or eliminate exclusions, exemptions, deductions and credits.
Such proposals might allow policy makers to keep all marginal
rates lower while increasing taxable income and tax revenue
Ten Questions About Tax Policy for the Next Administration and Congress
5
overall. Moreover, policy makers could raise revenue through
means that are less transparent. For example, there is research
to indicate the present consumer price index slightly overstates
inflation and that an alternative CPI would more accurately
reflect consumer behavior. Since the tax code contains a
number of features that are adjusted each year for inflation,
policy makers could adopt an alternative CPI that would
yield tens of billions of dollars in additional revenue annually
and would enable them to avoid tougher choices. However,
Democrats have opposed applying a CPI adjustment across all
government programs as it would lead to reduced spending
on many of their favored programs and entitlements. In short,
marginal rates are important but taxpayers should focus on their
overall tax burden.
2. What will happen to the alternative minimum tax?
Background. The individual alternative minimum tax (AMT) was
established as part of the first major tax reform law, the Tax Reform
Act of 1969. This was after Congress discovered that 155 taxpayers
with income above $200,000 had paid no taxes at all.13 The
purpose of the AMT, as described by the Senate Finance Committee
in 1982 (when the AMT was revised and expanded) was to assure
that “no taxpayer with substantial economic income should be able to
avoid all tax liability by using exclusions, deductions, and credits.”14
The Tax Reform Act of 1986 made a series of modifications to the
AMT, but retained it as a fundamental part of the tax system.
The individual AMT applies at rates of 26% or 28%, to “alternative
minimum taxable income” (AMTI) above an exemption amount
($62,250 for a couple filing a joint return in 2007). AMTI consists
of regular taxable income plus a series of preferences such as
deductions for state and local taxes, interest on tax-exempt bonds,
and accelerated depreciation.
Because the AMT exemption amount is not indexed, the number of
taxpayers that would be subject to the AMT has been scheduled to
rise dramatically, from 4 million in 2006 to 30 million in 2010, at
which point the amount of revenue raised from the AMT would have
risen from $24 billion to $119 billion. What was once a “class
tax” has slowly morphed to be a “mass tax.” To limit the reach of the
AMT, Congress has repeatedly enacted the so-called “AMT patch”
that temporarily increases the exemption. The most recent AMT patch
increased the exemption to $69,950 for 2008. The 2008 “patch”
expires on December 31, 2008, so it needs to be extended for
2009 (and each year thereafter), to prevent the number of taxpayers
subject to the AMT from spiking dramatically.
Like the individual AMT, the corporate alternative minimum tax
was established by the Tax Reform Act of 1969 and revised and
expanded by the Tax Reform Act of 1986. The corporate AMT
applies at a rate of 25% to AMTI above an exemption amount
($40,000, but phasing out for corporations with AMTI above
$150,000, and completely eliminated for corporations with AMTI
above $310,000). As for individuals, AMTI consists of regular
taxable income plus a series of preferences.
Unlike the individual AMT, the corporate AMT does not appear
to apply to a dramatically rising number of taxpayers or raise a
dramatically rising amount of revenue. Fewer than 1% of corporations
pay the corporate AMT.15
Proposals. Both Senators Obama and McCain have proposed to
fix the AMT, basically by pledging to prevent the number of AMT
taxpayers from growing. Although Senator McCain has publicly
stated that he would abolish the AMT, in reality, McCain is likely to
continue the annual AMT patch.
In recent years, Congress has repeatedly enacted a one-year
Projected Number of AMT Taxpayers
With and Without Effect of 2001-2006 Tax Cuts
60
Current Law/Tax Cuts Extended
50
Pre-2001 Law
MILLIONS
40
30
20
10
0
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
YEAR
Source: Len Burman, Julianna Koch, and Greg Leiserson. The Individual Alternative Minimum Tax (AMT): 11 Key Facts and Projections. Tax Policy Center, at 1 (December 1, 2006).
Ten Questions About Tax Policy for the Next Administration and Congress
6
“patch” to prevent the individual AMT from applying to more
taxpayers. Essentially, a patch temporarily increases the exemption
amount to reflect inflation. The latest patch covered 2008 at a cost
of $62 billion.
• A
lthough full repeal of the individual AMT would significantly
simplify the tax code, the associated cost makes repeal highly
unlikely unless undertaken as part of comprehensive tax reform.
Although full repeal may be a stretch, there is likely to be a
serious effort to revise the individual AMT on a more permanent
basis. The options might include changing the budget baseline
to assume an AMT fix or something like the Rangel proposal
wherein AMT would no longer be a concern for the vast
majority of taxpayers.
In addition, there have been major proposals to make permanent
changes in the individual AMT. Finance Committee Chairman Baucus
and Ranking Member Grassley introduced legislation, S. 41, to
repeal the AMT. The Chairman of the House Ways and Means
Committee, Congressman Rangel, has proposed to repeal the
individual AMT but would deny the benefits of repeal to taxpayers
whose incomes are in the top 10%, by subjecting these taxpayers to
a replacement tax of 4% (4.6% of income exceeding $500,000).16
• F ixing the AMT problem suffers from several political
drawbacks. First, the vast majority of taxpayers are unaware
they would be subject to the AMT absent the patch.
Consequently, in addressing the problem, Congress would
be spending hundreds of billions of dollars to prevent a tax
increase that most taxpayers do not know exists. Second,
most politicians have already demonstrated a willingness to
approve the annual patch without offsets making it difficult to
spend real tax dollars in the future to address the AMT when
there are other competing priorities. Third, addressing the AMT
has become a political “gotcha.” Only when policy makers
come to terms with the true implications of the AMT will the true
problem be solved.
There also have been more specific proposals to address the
application of the AMT in particular circumstances. For example, in
2008 the House passed a provision that would abate interest and
penalties associated with the application of the individual AMT to the
exercise of incentive stock options.17
With respect to the corporate AMT, earlier in the decade there was
serious consideration of proposals to repeal it. This Congress, such
proposals have not been considered by either the House or Senate
tax committees.
3. What is the outlook for the estate tax?
Assessment:
• Congress will, at the very least, continue to provide a “patch”
indexed to inflation to prevent more taxpayers from becoming
subject to the individual AMT.
Background. The estate tax was established in 1916 and has remained
in effect ever since.18 In 2000, the exclusion amount was $1 million and
the top rate was 55%. As part of the 2001 tax cuts, Congress gradually
liberalized the estate tax rules, increasing the exclusion and reducing the
rates; in 2009, the exclusion will be $3.5 million and the top rate will
be 45%. In 2010, the estate tax is scheduled to be completely repealed,
but only for one year; in 2011, the changes to the estate tax, like other
provisions of the 2001 tax cuts, are scheduled to expire, and the estate
tax is scheduled to revert to its pre-2001 version, with an exclusion of $1
million and a top rate of 55%.
Estate Tax Rules
60
4,000,000
50
3,500,000
3,000,000
40
2,500,000
2,000,000
30
1,500,000
20
1,000,000
10
500,000
0
0
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Year
Rate
Exclusion
Ten Questions About Tax Policy for the Next Administration and Congress
7
This Congress, estate tax proposals have included updated versions
of the proposal that previously passed the House, a “2009 freeze”
that would make the $3.5 exclusion and 45% rate permanent, and
an alternative that would establish an exclusion of $2 million and a
top rate of 55%.21
Tax Rate for Capital Gains
30
25
20
Top Rate
Proposals. When Republicans controlled the House, they passed a
series of bills to permanently repeal or dramatically curtail the estate
tax, but the bills failed to pass the Senate.19 The most recent votes
occurred in 2006, when a bill to permanently eliminate the estate tax
received 57 of the 60 votes necessary to overcome a filibuster in the
Senate. Another option, to permanently establish an exclusion of $5
million and a top rate of 15%, received 56 votes.20
15
Capital Gains
10
5
0
1980
1985
1990
1995
2000
2005
2010
Year
Senator McCain, who originally opposed repeal of the estate tax,
supports a $5 million exclusion and 15% rate. Senator Obama
supports a 2009 freeze.
Assessment:
• W
ith the “yo-yo” years of 2010-11 fast approaching, when
the estate tax is scheduled to go from close to its current levels
to full repeal and then to the much lower exclusion and higher
rates of 2000, the new Congress will be under great pressure
to quickly establish a new set of rules to facilitate reasonable
estate planning.
• A
2009 freeze is likely to have considerable support, with
current supporters including Senator Obama and other
Democrats such as Senator Carper (D-DE) and Congressman
Pomeroy (D-ND).
• A
significant number of Senate Republicans including most
serving on the Senate Finance Committee support the complete
elimination of the estate tax. The cohesion of this group gives
them significant leverage in the outcome.
• A
more Democratic Congress next year may increasingly
support alternatives, such as the bill introduced by
Congressman McDermott (D-WA) to establish a $2 million
exclusion and a 55% top rate.22
• B
ecause the CBO baseline assumes a reversion to the 2000
system, even such seemingly moderate proposals as a 2009
freeze have substantial revenue costs.
• Look for Congress to include reforms to the gift and estate tax
rules to tighten perceived areas of abuse (i.e., family limited
partnerships, valuation discounts) and to help offset the cost of
higher exemption amounts and lower rates.
4. How will capital gains and dividends be taxed?
Background. Over the past few decades, the tax treatment of capital
gains has fluctuated. From 1921 to 1986, capital gains were taxed
at lower rates than ordinary income, generally through an exclusion of
50% or 60%. The Tax Reform Act of 1986 eliminated the differential
treatment of capital gains, subjecting both capital gains and ordinary
income to the same top rate of 28%. Thereafter, the differential
treatment of capital gains gradually returned for individuals (but not
corporations), as Congress raised the top rate for ordinary income but
not for individual capital gains.
After 1993, the top rate for individual capital gains remained 28%,
but the top rate for ordinary income had risen to 39.6%. In 1997,
Congress reduced the tax rate for individual capital gains to 20%
(10% for capital gains which otherwise would have been taxed at the
15% individual income tax rate). The 2003 Act reduced the 10% and
20% rates on capital gains to zero and 15%, respectively. The 2003
reductions are scheduled to expire at the end of 2010, when the tax
rate for individual capital gains is scheduled to revert to 20%.
In lowering the capital gains rate in 1997 and 2003, Congress
stated that economic growth cannot occur without saving,
investment and the willingness of individuals to take risks.
Congress believed that by reducing the effective tax rates on
capital gains, taxpayers would be encouraged to increase saving
and risk-taking. Moreover, Congress believed that a reduction
in the taxation of capital gains would improve the efficiency of
the capital markets because the taxation of capital gains upon
realization encourages investors who have accrued past gains to
keep their monies “locked in” to such investments even when better
investment opportunities present themselves. Until 2003, dividends received by an individual were included in
gross income and taxed as ordinary income. In 2003, the tax rate
for dividends was reduced to 15% (zero rate for dividends which
otherwise would have been taxed at the 15% individual income tax
rate). The 2003 reductions are scheduled to expire at the end of
2010, when the tax rate for dividends is scheduled to revert to the
same rate as that of ordinary income (top rate of 39.6%).
In lowering the dividend rate, Congress recognized that placing
Ten Questions About Tax Policy for the Next Administration and Congress
8
Some critics argue that the tax cuts enacted in 2001 and 2003
increased income inequality, reduced economic growth over the long
run, and contributed to the reemergence of the substantial budget
deficits. Warren Buffett frequently mentions that his secretary, who
earned $60,000 in 2006, paid a higher effective tax rate than he
did for that year. Mr. Buffett noted that he was taxed at a 17.7% rate
while his secretary was taxed at 30%. IRS data generally supports Mr.
Buffett’s claim. For years 2003 through 2005, the top 400 individual
income tax returns with the largest adjusted gross incomes reported
average income of $170 million and paid an average effective tax
rate of 18.6%. In comparison, the 2006 married filing jointly tax rate
for taxpayers making between $15,000 and $61,000 was 15%,
and the rate for those making between $15,000 and $124,000
was 25%. With regard to the top 400 taxpayers, capital gains
subject to the 15% preferential tax rate averaged 60% of AGI while
salaries averaged only 11%.
Proposals. Senator McCain has proposed to make the 2001-03 tax
cuts permanent, including the lower zero and 15 percent rates for
capital gains and dividends. Senator Obama has proposed to retain
the current capital gains and dividend rates for those making under
$250,000. For those in the top two income tax brackets, Senator
Obama would create a new top capital gains and dividends rate of
20 percent. Further, he would tax “carried interest” at ordinary income
rates. However, Senator Obama has proposed to create incentives
for small businesses and start-up businesses, in part by eliminating
capital gains taxes on income from investments in such businesses.
Assessment:
• Regardless of who wins the presidency, a Democratic Congress
is unlikely to extend the lower 15% tax rate for capital gains
and dividends. However, with Senator Obama’s announced
position, it is becoming more likely that tax rates for investment
income will not exceed 20%.
• T he upcoming expiration of the lower rates will force the
Congress to reconsider the appropriate tax treatment of capital
gains and dividends, including associated issues like “carried
interest” and a zero capital gain rate for small business startups.
• T he upcoming tax debate could lead policy makers to consider
alternative options for taxing capital gains and dividends as
they search for additional revenue. For example, the Joint
Committee on Taxation proposed in 2001 that the complicated
rate system for capital gains be replaced with a deduction
equal to a fixed percentage of the net capital gain. This
recommendation would simplify the computation of the tax on
capital gains and streamline associated tax forms. Another
alternative could involve an income exclusion for certain levels
of capital gain and/or dividend income for lower- and middleincome taxpayers.
5. Will the corporate tax rate be reduced?
Background. Presently, the top corporate tax rate is 35%. Although
this rate is low by historical standards and has not changed much
since enactment of the Tax Reform Act of 1986, there has been
a significant change elsewhere, with many other OECD countries
lowering their corporate marginal tax rates. The Treasury Department
recently concluded that Since 1980, the United States has gone from a high corporate
tax-rate country to a low-rate country (following the Tax Reform Act
of 1986) and, based on some measures, back again to a highrate country today because other countries recently have reduced
their corporate tax rates. Within the OECD, the United States
now has the second-highest statutory corporate tax rate (including
state corporate taxes) - 39% - compared with the average OECD
statutory tax rate of 31 percent.23
Tax Rate for
for Corporations
Capital Gains
United States
United Kingdom
Turkey
Switzerland
Top Rate
different tax burdens on different investments resulted in economic
distortions. Because interest payments on debt are deductible, the
tax code encouraged corporations to finance using debt rather than
equity and might put the economy at risk of more bankruptcies during
an economic downturn. Moreover, Congress was concerned that
prior law encouraged corporations to retain earnings rather than to
distribute them as taxable dividends to shareholders who might have
an alternative and better use for the funds, creating further inefficiency.
Sweden
Spain
Mexico
Korea
Japan
Italy
Ireland
0
10
Central Government
Corporate Tax Rate
20
30
40
Year
Others share this view. For example, Jason Furman of the Brookings
Institution (and now an advisor to Senator Obama’s presidential
campaign) recently criticized the U.S. business tax system because,
among other things, “[t]he United States has the second highest
corporate tax rate of the 30 countries in the [OECD].”24 Thus, there
seems to be an emerging consensus that serious consideration should
be given to broadening the base and reducing the corporate tax rate.
On the other hand, in July 2008, the Government Accountability
Office (“GAO”) issued a report reaffirming that most corporations,
including the vast majority of foreign companies doing business in
the U.S., pay no federal income taxes. During the eight-year period
reviewed by GAO, 72 percent of foreign-owned corporations went
at least one year without owing taxes and the same was true for 55
percent of domestic corporations. According to GAO, a possible
explanation involves the use of transfer pricing which can allow
companies to push their profits into lower-taxed jurisdictions. 25
Ten Questions About Tax Policy for the Next Administration and Congress
9
Proposals. The Treasury Department and the President’s Advisory
Panel on Tax Reform both recommended that the top corporate
tax rate be lowered to 28%26 and 31.5%, respectively.27 Senator
McCain has proposed to reduce the top corporate tax rate from 35%
to 25%.
On the Democratic side, House Ways and Means Committee
Chairman Rangel made a lower corporate tax rate a key element
of his tax reform plan, proposing to reduce the top corporate tax
rate from 35% to 30.5%, saying that this would “help American
companies stay competitive internationally.”28 Senator Obama has not
specifically addressed lowering the top corporate tax rate.
Many of the proposals stress that the corporate tax rate should not
be reduced in isolation, but rather as a broad trade-off, similar to
the trade-off at the heart of the Tax Reform Act of 1986, in which the
corporate rate is reduced but the corporate tax base is broadened
commensurately by eliminating or reducing tax preferences. Such a
trade-off is envisioned in the proposals by the Treasury Department
and the President’s Advisory Panel on Tax Reform, and is central to
Chairman Rangel’s proposal, which would fully offset the $363.8
billion cost of lower corporate rates by repealing or reducing
a number of corporate tax preferences. Specifically, Chairman
Rangel would achieve a 30.5% corporate tax rate by repealing
the LIFO method of accounting and the section 199 manufacturing
deduction; significantly limiting deferral; delaying the implementation
of worldwide interest allocation; and increasing from 15 years to 20
years the 197 amortization period for intangibles.
Assessment:
• Whatever the outcome of the election, an opportunity may exist
for lowering the corporate marginal tax rate in an effort to make
U.S. companies more competitive and to encourage innovation
and job creation. Many tax experts and lawmakers from both
parties have called for lowering the corporate tax rate.
• A
reduction of the corporate tax rate is likely to be part of
an overall proposal that offsets the cost of the reduction by
broadening the corporate tax base.
The current system has been repeatedly criticized, for different
reasons. On one hand, many Democrats, labor unions and others
have argued that the current system creates incentives for U.S.
companies to shift jobs overseas. For example, Senator Clinton was
asked during the Democratic primaries how she would prevent jobs
from being transferred overseas. She focused her answer on the tax
rules for international income, criticizing the current rules because “if
you create jobs overseas, you don’t have to pay taxes on them until
you bring the money back home.” Similarly, Senator Obama has
expressed concern about “large companies [that] have managed to
secure tax breaks or to hide their profits in overseas tax havens and
not pay any American corporate taxes at all.”
On the other hand, many Republicans, business groups and others
have argued that the current U.S. tax rules make it harder for U.S.
companies to compete internationally, by subjecting U.S. companies
(and foreign subsidiaries of U.S. companies) to a complex set of rules
that have the effect of imposing higher taxes than are imposed on
their international competitors. For example, Pamela Olsen, the Bush
Administration’s Assistant Secretary of the Treasury for Tax Policy, has
said that “[t]he U.S. international tax rules can operate to impose
a burden on U.S.-based companies with foreign operations that is
disproportionate to the tax burden imposed by our trading partners on
the foreign operations of their companies.”29
“Some large companies have managed to secure tax breaks
or to hide their profits in overseas tax havens and not pay any
American corporate taxes at all. Barack Obama will level the
playing field for all businesses by eliminating special interest
loopholes and deductions … as well as by limiting the ability of
large multi-national corporations to use tax havens to hide income
overseas.”
-—Obama ’08 Tax Plan
“I don’t like obscene profits being made anywhere. I’d be glad to
look, not just at the windfall profits tax - that’s not what bothers me
- but we should look at any incentives that we are giving to people
or industries or corporations that are distorting the market.”
-—McCain Campaign Speech 05/05/08, Charlotte, NC
• T he impact on any particular industry or company is likely to
depend on the balance between the tax reduction resulting from
the lower rate and the tax increase resulting from broadening
the base by repealing or reducing business tax “loopholes”
and/or tax expenditures.
6. Will Congress change the tax treatment of income
earned abroad?
Background. The U.S. imposes a tax on the worldwide income of
taxpayers subject to U.S. taxing jurisdiction. The system has two
principal ameliorating features. First, U.S. companies receive a tax
credit for the taxes that they pay to foreign countries on the income
they earn abroad. Second, the foreign income of a controlled foreign
subsidiary of a U.S. corporation is deferred until the income is
repatriated to the U.S. in the form of a dividend payment, except for
income that is considered “subpart F” income (i.e., interest, royalties,
dividends, rents).
Proposals. The blockbuster issue in the upcoming tax debate is
deferral. Senator Obama has indicated he would move aggressively
to reform international tax laws, including deferral. During the
2004 presidential campaign, Senator Kerry proposed to eliminate
deferral altogether, and has introduced legislation to do so this
Congress.30 Senator Clinton supported this approach during her
presidential campaign.31 Ways and Means Committee Chairman
Rangel introduced legislation proposing that deductions associated
with foreign income be deferred until the associated income is
repatriated.32 The Joint Committee on Taxation estimates that the
Rangel proposal would raise $106 billion over ten years.
In addition, several bills have been introduced that would address
specific perceived abuses in the international tax rules, including
proposals to prevent “treaty shopping” under tax treaties,33 to tighten
up the subpart F rules,34 to curtail the use of “tax havens,”35 to
change the characterization of business entities (e.g., whether an
Ten Questions About Tax Policy for the Next Administration and Congress
10
entity is characterized as a U.S. corporation),36 and to change the
treatment of royalty and financial services income under the foreign
tax credit rules.37
Several other sources offer approaches that a new Congress may
consider in the international tax area, including a June 2008 Senate
Finance Committee hearing on the international tax system,38 a 2007
Treasury Department study of earnings stripping and transfer pricing,39
and a 2004 article written by Chairman Rangel, entitled “Current
International Tax Rules Provide Incentives for Moving Jobs Offshore.”40
The extender tail now is wagging the tax policy dog. The leaders of
the congressional tax-writing committees have expressed frustration
about this. In speaking on the floor of the House on a recent extenders
package, Chairman Rangel defined tax extenders as “when people
want bills passed, but they put expiration dates on them in order to
hide the real cost of the bill...we have so much garbage in this bill
that soon I hope someone would have the courage to take a look at
the tax bill that we have and strip it of the preferential treatment and
get down to making the bills that we want permanent, and those that
should not be permanent, just to kick them out.”43
Assessment:
• T he Congress will closely scrutinize federal tax rules affecting
international transactions but is unlikely to repeal deferral in
the near term. A proposal to outright repeal deferral would
be highly controversial, with most Republicans and some
Democrats opposing it.
• If a full repeal of deferral falls short, as expected, there are
likely to be alternative proposals to “tighten up” the international
rules. Indeed, that is what led to the enactment of subpart F in
the first place. In 1962, when President Kennedy proposed
to eliminate deferral, Congress rejected his proposal but
established subpart F in response. Specifically, Congress
retained deferral generally but established subpart F to
eliminate deferral for certain categories of income.
• T he limitation on expenses proposed by Chairman Rangel
may be seriously considered. Other possible areas of focus
include subpart F income; tax treaties, particularly to curb
behavior that may be characterized as “treaty shopping”; tax
havens; the operation of the transfer pricing rules; earnings
stripping; and reinsurance.41
7. What is the future outlook for tax extenders?
Background. Beginning in the 1980s, primarily for budget reasons,
Congress increasingly began to make some tax policies temporary.
Typically, these are tax incentives targeted to a specific industry or
activity. In recent years, as budget pressures have intensified, the
number of such temporary provisions that need to be periodically
extended has grown to the point that the most recent “extenders” bill
contains three dozen provisions extending expiring tax provisions,
whose total cost is $27 billion (the ten-year cost of a one-year
extension).42 Moreover, the process of considering tax extender bills has
become the dominant task of the congressional tax-writing committees.
This year, Congress waited until the last moment to address the
package of the tax extenders, many of which had already lapsed. Even
then, Congress had to attach the package to the emergency economic
stabilization legislation to secure the necessary votes.
Key Extender Provisions
Provision
Cost/10 yrs.
(in billions)
1-year AMT Patch
-64,108
R&E Tax Credit
-9,897
Leasehold, Restaurant, and Retail Improvements
-6,728
Subpart F Active Financing
-3,970
State & local Sales Tax Deduction
-1,742
New Markets Tax Credit
-1,315
Tuition Deduction
-1,223
Section 45 Energy Production Credit
-7,046
Section 48 Credit
-1,777
Advanced Coal Project Investment
-1,423
Coal Excise Tax
-1,287
Plug-in Vehicles
-1,056
Energy Conservation Bonds
-1,025
Energy Efficient Homes
-1,067
Other
-7,745
TOTAL
-108,592
Proposals. There have been a few efforts to separate particular
extenders and either make them permanent or extend them for long
periods of time. In 2006, Congress made permanent a number of
temporary pension-related provisions as part of the Pension Protection
Act of 2006. In 2007, Congress approved legislation, as part of
the bill to raise the federal minimum wage, extending the Work
Opportunity Tax Credit, which had until then been part of the various
extenders packages, for four and a half years.
A number of bills have been introduced this Congress to make
various extenders permanent. The bills that seem to have the
greatest support would make permanent the R&D tax credit, the
adoption credit, the rules relating to the subpart F treatment of
active financing, the deduction for donations of food inventory,
the exclusion for employer-provided group legal services, the
depreciation treatment of leasehold improvements, the deduction
for mortgage insurance premiums, and the rules for deducting film
production expenses.44 These bills seldom include specific proposals
to offset the cost of the permanent extensions.
Ten Questions About Tax Policy for the Next Administration and Congress
11
Assessment:
• There is likely to be an intensified effort to break out of the
extenders box, by making some of the extenders permanent,
lengthening the duration of others, and letting some expire.
Although this has been tried before and generally has
failed, the level of congressional frustration, with the need to
repeatedly pass extender bills, seems to be growing.
• If the new Administration and Congress begin to address
issues such as education, health care, energy independence,
and competitiveness, many of these temporary tax extenders
could find homes on larger policy initiatives. For example, the
temporary deduction for qualified tuition and expenses, QZABs,
deduction for teacher classroom supplies and enhanced
deduction for school book donations could be incorporated
into comprehensive education tax legislation and dealt with on
a long-term or permanent basis. The same could hold true for
energy-related or business tax provisions.
• T he cost of making various extender provisions permanent is
high. For example, the ten-year cost of making the R&D credit,
active financing rule, and sales tax deduction for non-itemizers
permanent is $115 billion, $56 billion, and $37 billion,
respectively. Consequently, many extenders are likely to remain
temporary until the deficit situation is addressed.
• P ulling this together, there is likely to be a continuation of the
current situation, in which very few of the extenders are made
permanent or extended for long periods of time, while the rest
remain part of annual period extender legislation.
• A
compromise in Congress is possible by either making some
of the extenders permanent with offsets permanently closing
loopholes or conversely, temporarily extending some tax cuts
with the offsets coming from temporarily closing loopholes.
• T o the extent that the Congressional Budget Act’s
“reconciliation” process is used to pass a tax bill, the use
of extenders is likely to increase, because revenue-losing
provisions in that bill will be required under the operation of
congressional budget rules.45
8. How will the new Administration and Congress address the tax
code and energy independence?
Background. Over the years, Congress has established a series
of tax incentives for energy production. Originally, these incentives
primarily were for the production of fossil fuels (e.g., the oil depletion
allowance). More recently, Congress has established tax incentives
for energy conservation and for the production of energy from
renewable sources, such as solar, wind, and biomass. For example,
in the Energy Policy Act of 2005, Congress established new tax
incentives for energy efficient homes and commercial buildings,
residential and business use of solar power, and vehicles that use
alternative technology.46 However, many of those tax credits have
already expired or are near expiration, and a thick stack of new
proposals for incentives for energy conservation and renewable
energy production and infrastructure has been introduced.
Proposals. During the current Congress, there has been intense work
on a package of tax provisions that would extend and expand energy
tax incentives. Generally, the package has included extension (and,
in some cases, expansion) of production tax incentives for electricity
produced from renewable resources (including biodiesel),47 investment
tax credits for advanced clean coal technologies (particularly those
that demonstrate high levels of carbon sequestration), production
incentives for biodiesel and other renewable fuels, as well as a range
of other incentives.48 Some of these include:
• b
onus depreciation for placement of “smart” electric meters and
grid systems;
• investment tax credits for solar, fuel cell technologies, and
certain “green” properties;
• expansion of tax-free bonds for certain clean renewable fuels;
• credits against the coal excise tax for certain sales of coal; and
• a new credit for “plug-in” hybrid vehicles.
The House Ways and Means Committee and the Senate Finance
Committee each reported versions of an energy tax package, and,
after the package reported by the Ways and Means Committee
passed the House, congressional leaders agreed on a compromise
version of the bill, which passed the House but fell one vote short
in the Senate. The bill was not enacted earlier this year, primarily
because of a dispute between Democrats and President Bush and
Senate Republicans about whether the cost of the bill should be offset.
The fully offset energy package was eventually enacted as part of
the Emergency Economic Stabilization Act of 2008. Many of the
provisions are of only short duration. The next Congress is likely to
consider further energy tax incentives through a number of legislative
proposals, possibly including a substantial energy policy bill and
reauthorization of the surface transportation bill.
Beyond the general debate over offsets, the energy extenders
package and other energy proposals have been complicated by a
debate about whether oil and gas production should be the target
of offsets (e.g., the section 199 domestic production incentive), and
the fact that opening new territory for oil and gas exploration has
been excluded from the legislation. As a side note, the Democratic
leadership in the Congress has proposed legislation that would tax
the “windfall” profits of oil and gas companies. Although this issue
should be watched because of its political relevance, it is not a
provision that appears ripe for approval at this point.
One recent legislative effort that hints at issues that could be debated
next year is a bipartisan proposal recently released by Senators
Conrad and Chambliss. The proposal includes robust extensions of
production tax credits for renewables, new consumer tax credits for
purchase of vehicles that run on non-petroleum based fuels, credits for
capture and sequestration of carbon dioxide in industrial processes,
and new credits for infrastructure related to renewable fuels and the
production of liquid fuels from coal. The details of this “New Era”
energy bill are being worked out now and could likely form the basis
for limited proposals at the end of this Congress and a much larger
package in the next Congress.
Ten Questions About Tax Policy for the Next Administration and Congress
12
McCain
Climate Change
Obama
Supports a 60% reduction in greenhouse gas (GHG)
Supports an 80% reduction in greenhouse gases (GHG) by
emissions by 2050 through a cap and trade mechanism. The
2050 through a cap and trade mechanism. The plan also calls
plan also calls for the U.S. to reduce GHG emissions to 1990
for the U.S. to reduce GHG emissions to 1990 levels by 2020.
levels by 2020.
Biofuels
Opposes ethanol subsidies and wants to lift the tariff on
Supportive of the existing ethanol mandate.
foreign ethanol.
Oil & Gas
Wants to open more of the outer continental shelf to drilling;
Supports imposing a windfall profits penalty on oil selling at or
however, opposes opening the Arctic National Wildlife Refuge
over $80 per barrel.
(ANWR) to drilling.
Wants to rescind existing tax incentives, including the domestic
Has spoken against subsidies for the oil and gas sector,
production exemption (Sec. 199).
including the domestic production exemption (Sec. 199),
expensing of exploration and development costs, the 15%
credit for enhanced oil recovery costs for tertiary wells, and
the special depreciable lifetimes for select oil company assets,
among others.
Alternative (Wind/Solar)
Utilities
Does not advocate targeted subsidies for wind and solar.
Supports extension of existing tax credits in support of alternative
Generally opposed to technology specific subsidies.
energy such as wind and solar.
Has advocated for stronger clean air protections.
Wants major investment in power grid to increase
renewable generation and accommodate smart metering
Wants large investments in the power grid.
and distributed storage.
Supports smart metering.
Coal
Supports development of clean coal technologies.
Supports development of clean coal technologies.
Willing to ban new traditional coal facilities and to ensure
rapid commercialization and deployment of low carbon
coal technology.
Adapted from Joe Lieber, Election Update: McCain and Obama on the Issues. Washington Analysis (Aug. 13, 2008).
Senators McCain and Obama have both made general proposals to
significantly invest in alternative energy and conservation to stimulate
the economy, but there is not yet sufficient detail in these plans to
prognosticate on critical differences and possible legislative outcomes.
Both plan to invest in renewables, including extensions of credits like
those now in place for solar, biomass and other renewables. They
also both have proposed incentives for clean coal technologies and
transportation that uses non-petroleum based fuel. Thus, their plans
generally recognize many of the issues contained in recent and
proposed legislation. Senator McCain appears to be more committed
to development of domestic fossil fuel resources than Senator Obama.
Assessment:
• Although energy tax incentives were recently enacted, the
next Administration and Congress will seriously consider
additional energy tax incentives, which have been very
popular in recent years.
• T he House and Senate are likely to continue to take
somewhat different approaches, with the House proposing a
smaller package that emphasizes renewable resources and
technologies as well as conservation and the Senate a larger
package that includes those incentives plus more incentives for
clean coal and other conventional fuels.
• T here is likely to be a continuing debate about whether the
cost of the energy incentives should be offset exclusively by
limiting tax benefits available to the oil and gas industries or
instead should be offset, at least in part, by other revenueraising proposals.
9. What is the outlook for taxes and health care reform?
Background. The federal income tax system affects health policy in
several ways, most significantly through the exclusion of employerprovided health insurance from taxable income. Since 2001, the
Bush Administration has proposed changes in the tax treatment
of health benefits as a means of shifting the responsibility and
incentive for providing health care coverage from the employer to
the individual. However, the tax deductions that are available to
individuals who purchase their own health insurance are currently not
comparable to the tax deductions available for employer provided
coverage. While a number of conservatives have consistently
criticized the health insurance tax exclusion for encouraging people
to participate in “gold plated” employer-provided plans rather than
Ten Questions About Tax Policy for the Next Administration and Congress
13
purchase individual policies, liberal groups such as the Progressive
Policy Institute are also joining the call for health insurance reform.
Regardless of the outcome of the 2008 elections, changes to the tax
treatment of employer-sponsored health benefits are likely to play a
key role in health reform proposals in 2009.
Top Federal Tax Expenditures (FY ‘07 - ‘11)
(in billions)
Reduced Rate (Capital Gains & Dividends)
631.9
Healthcare: Exclusion of Employer Contributions
628.5
Pension Contribution Exclusion
607.3
Mortgage Interest Deduction
430.2
Exclusion of Capital Gains at Death
279.9
Earned Income Tax Credit (EITC)
234.9
Tax Credit for Children Under Age 17
201.3
Deduction for Charitable Contributions
187.0
Exclusion of Benefits Provided Under Cafeteria Plans
185.5
Deduction of State and Local Income Taxes
175.1
Presidential Candidate Proposals. Little is surprising about either
Senator Barack Obama or Senator John McCain’s approach to health
care issues. Senator McCain is taking a traditionally Republican
approach to health reform by adopting a platform that focuses on the
themes of individual choice, competition, and tax rebates. Senator
Obama has focused on the traditionally Democratic themes of
universal and comprehensive coverage.
Senator McCain’s health reform plan focuses on encouraging the
individual insurance market by reforming the tax code to eliminate
the bias that favors employer-provided coverage. Senator McCain
has proposed a refundable health insurance tax credit of $5,000
per family and $2,500 per individual. McCain’s proposed tax
credit would be available for either employer-provided or individual
coverage, and would consequently limit the tax preference for
employer-sponsored health insurance. Senator McCain’s proposal is
similar to President Bush’s 2007 proposal—a proposal based on the
Advisory Panel on Tax Reform’s recommendation—that would have
limited the exclusion for employer-provided health insurance benefits
to $15,000 per family and would have allowed individuals who
purchase their own health insurance to take an equivalent deduction
of up to $15,000.
Senator Obama, on the other hand, supports reforming the health
care system by building on the existing employer-based system.
Senator Obama has proposed a series of non-tax reforms of health
care that include income-based federal subsidies and direct spending
programs to increase health coverage. Senator Obama’s current
plan does not explicitly rely on major changes to the tax code (e.g.,
limits on the exclusion for employer-provided coverage and individual
savings incentives) to expand health insurance coverage. The Obama
plan would, however, provide small businesses that pay a share of
employee health costs with a refundable tax credit equivalent to 50
percent of premiums paid on behalf of their employees.
Polls have shown that voters are evenly split in their support for
Democratic and Republican approaches to health care reform.
Although Senators Obama and McCain have a very different
approach to health reform, neither plan is likely to enjoy any kind
of mandate.
Current Legislation. One of the major legislative proposals to watch
during the health reform debate this year, S.334, The Healthy
Americans Act, includes components that appeal to both Democrats
and Republicans. The plan pleases Democrats by assuring that every
individual will have access to coverage and includes the financing to
ensure nearly universal coverage in the short term. Republicans like
the plan because it moves away from the third-party employer-based
payment system to one of individual responsibility and the promise of
a more competitive market.
Senator Wyden (D-OR) introduced S. 334, The Healthy Americans
Act, along with 15 Senate co-sponsors, who range in political
ideology from Bennett (R-UT), the bill’s cosponsor, to Cantwell
(D-WA), Lieberman (I-CT), Grassley (R-IA), Crapo (R-ID) and Gregg
(R-NH). The Wyden bill aims to achieve universal coverage by
shifting away from the employer-based system of health care
coverage. Instead of companies helping to buy insurance for their
workers, Wyden proposes that private insurers offer coverage
directly to consumers. Individuals would receive a flat personal tax
deduction. Employers could continue to offer employees health care
coverage, but would be required to pay a tax based upon a sliding
scale of 3% to 26% of the cost of basic health insurance—tied to
their size and revenue per employee. Employers that currently offer
coverage would transfer the money they now spend on employee
health insurance to workers’ wages.
The Congressional Budget Office and the Joint Committee on Taxation
reports that the Wyden plan would be budget neutral by 2014, and
could be implemented as early as 2012.
While the Wyden Bill has bipartisan appeal in Congress, some
companies are concerned about the Bill’s effect on their bottom
lines. In exchange for all of the new business, the Bill would subject
insurers to more regulation including minimum loss ratios and a
complex bid process that would likely result in narrow premium
margins. Some large insurance companies like Aetna and Cigna
have made moves to target the individual, or non-group market in
order to prepare for the potential of a health care overhaul. Most
insurers, however, remain hesitant to move into individual markets,
and remain committed to expanding coverage through the employerbased system.
Similarly, a number of labor unions and employers are hesitant to
change the employer-based system. The Wyden Bill would require
employers who currently provide employee health benefits to
convert their existing health support into higher wages. In addition,
employers would have to make “fair share” contributions to help fund
the state insurance pools that the Bill establishes. The Bill’s changes
in tax treatment of health benefits would remove the incentive for
Ten Questions About Tax Policy for the Next Administration and Congress
14
employer-sponsored coverage, and cause most employers to cease
sponsoring health plans. The legislation would also include sweeping
authority for states to obtain waivers of any federal laws (e.g., ERISA)
or regulations related to health coverage. Eliminating the ERISA
requirement would subject employer-sponsored plans to state-by-state,
or even county or city regulation. Consequently, even though the
Wyden proposal allows employers to offer employee health plans, it
is difficult to see why employers would continue to do so unless they
are bound by existing labor contracts. If the Wyden Bill becomes law,
most remaining employer-sponsored plans would simply exist as backup options for those employees who choose not to enroll in one of the
state-sponsored plans.
Legislation has also been introduced in the Senate (e.g., S. 2795,
The Small Business Health Options Program Act of 2008) that would
provide small business employers with tax credits to cover part of
the cost of providing health care to their employees. However, in
the absence of comprehensive national health reform, the federal
government is likely to relegate more of the responsibility for health
insurance coverage to the states. To date, most attempts at health
reform have occurred at the state level (e.g., Massachusetts and
California) and have dramatically increased employers’ responsibility
for providing health coverage.
Assessment:
• O
ver the last decade, the schism between conservatives
favoring an employment-based health care coverage model
and liberals (e.g., labor unions) favoring national “single
payer” health care coverage has largely disappeared.
• In 2009, Congress and the White House may make a
serious effort to limit the tax exclusion for employer-provided
health care premiums, and to encourage the individual health
insurance market though tax deductions or tax credits.
• C
ongress and the White House may additionally advance
proposals to expand tax incentives for small businesses that
provide health insurance for their employees.
• In the absence of comprehensive national health reform,
the federal government is likely to relegate more of the
responsibility for health insurance coverage to the states.
Congress and the White House may seek to increase health
insurance coverage by encouraging expansion of existing
state health insurance programs (i.e., Medicaid and SCHIP).
• C
ongress and the courts may additionally move to weaken
the ERISA preemption so that states and municipalities can
implement more aggressive local health reform initiatives.
10. Where will the new President and Congress look for
additional revenue?
the tax code.49 The GAO indicates that the cost of tax expenditures
exceeded the cost of federal discretionary spending for half of
the last decade.50 In addition, many sophisticated taxpayers have
developed techniques to significantly reduce taxes in ways that some
characterize as taking advantage of “loopholes” in the tax code.
While comprehensive tax reform is unlikely in the near term, both
major presidential candidates have said that they will repeal and
reduce tax loopholes in an effort to broaden the base and raise
revenue. Senator McCain has called for closing billions of dollars
worth of “corporate tax loopholes,” and Senator Obama has said
that he will “level the playing field for all businesses by eliminating
special interest loopholes and deductions.”
Senate Finance Committee Chairman Baucus and Ranking Member
Grassley have identified the $345 billion annual “tax gap” – the
gulf between taxes legally owed and taxes actually collected in a
timely fashion – as a drain on the U.S. economy and as a source
of revenue to pay for U.S. priorities. In 2006, the rate of voluntary
tax compliance dropped from 85 percent to 83.7 percent. Each
percentage point drop in the rate of compliance amounts to a $25
billion increase in the annual tax gap. Since 2001, the federal
government has failed to collect more than $2 trillion in legally-owed
taxes. In addition to focusing on compliance to close the “tax gap,”
the Finance Committee has also aggressively looked at closing
loopholes and other tax shelters. On August 2, 2007, the Treasury
Department issued a report entitled “Reducing the Federal Tax Gap:
A Report on Improving Voluntary Compliance” setting forth a detailed
strategy for improving voluntary compliance.
“Eliminate corporate welfare in tax code.”
—-McCain Budget Plan
“The Tax Code is filled with corporate loopholes and preferential
regulations that benefit a handful of companies at the expense of
the rest of the business community as well as ordinary people who
are hit with higher effective tax rates.”
—Obama ’08 Tax Plan
“Some complain that improving tax compliance will burden
taxpayers and decrease their rights. But what about the rights of
honest, hard-working taxpayers who do pay the taxes that they
owe? Increasing our nation’s rate of voluntary tax compliance
is going to take some ingenuity. It will take some elbow grease.
It is going to require a multi-faceted approach. It will require
addressing services, enforcement and technology.”
-—Max Baucus, April 18, 2007
“[W]hen somebody says: Well, you have got to raise taxes …
I say, no, you do not. Let us go after some of this stuff. Let us go
after these offshore tax havens. Let us go after these abusive tax
shelters. Let us go after this tax gap.”
-—Senator Kent Conrad, Chairman, Senate, Budget Committee
Background. The Tax Reform Act of 1986 dramatically expanded
the tax base by eliminating or reducing scores of tax preferences and
otherwise closing so-called tax “loopholes.” However, since 1986,
many new preferences have been adopted, with the Joint Committee
on Taxation calculating that there are now 170 “tax expenditures” in
Ten Questions About Tax Policy for the Next Administration and Congress
15
Proposals. Although the presidential candidates have spoken mostly
in general terms about “closing loopholes” or “shutting down special
interest provisions,” there are several sources that provide an initial
“menu” for potential revenue raising options next year.
First, many specific revenue-raising proposals have been made during
2007-08, with the House and Senate passing more than 30 revenueraising provisions that have not yet been enacted into law. Members
of the tax-writing committees have introduced several revenue-raising
proposals that are likely to receive serious consideration in the next
Congress. Some of the revenue-raising proposals include:
• c hanging the rules for hedge funds and private equity funds,
including treating certain types of publicly traded limited
partnerships as corporations and characterizing carried
interest as ordinary income rather than capital gain;
• repealing the section 199 manufacturing deduction;
• repealing or limiting tax provisions benefiting the oil and
gas industries;
• repealing lower of cost or market and “last-in, first-out” (LIFO)
methods of inventory accounting;
• c odifying the “economic substance doctrine” regarding
tax shelters;
entitled “Additional Options to Improve Tax Compliance,” dated
August 3, 2006. Additional revenue options can be gleaned
from congressional oversight activities and from congressional
support organizations like the Congressional Budget Office and the
Government Accountability Office.
Assessment:
• Regardless of the outcome of the presidential election, there will
be an intense search by the new Administration and Congress
for ways to increase federal tax receipts without broadly raising
tax rates. Consequently, politically palatable revenue options
that can be characterized as “loophole” closers or proposals to
reduce the tax gap will be high on the agenda.
• M
any of the likely revenue-raising proposals can be identified
today. The starting point is likely to be proposals that have
passed the House or Senate but not been enacted into law or
that have been made by major players such as the chairmen
of the tax committees, the Treasury Department, and the Joint
Committee on Taxation.
• It is likely that revenue-raising proposals will be embedded
in major tax initiatives put forth by the new Administration
and approved by Congress under the fast-track budget
reconciliation process. These offsets will be juxtaposed
against popular tax relief measures making it politically
difficult for adversaries to oppose them.
• further limiting deductibility of executive pay and curbing
deferred compensation;
• c hanging tax laws affecting international activities, including
delaying the implementation of worldwide interest allocation
and eligibility for reduced treaty withholding rates based on
residency of foreign parent;
• c hanging the tax treatment of various financial products;
• m
aking changes to clarify the classification of employees as
independent contractors;
• increasing the amortization period for intangibles from 15 to
20 years; and
• increasing various excise taxes, such as on tobacco products,
various aspects of air and highway transportation, and taxexempt organizations.
IV. Conclusion
It is clear that the next Administration and Congress will engage in the
most significant tax debate in a generation. At stake will be important
decisions regarding $4 trillion in tax law provisions, many of them
set to expire in 2010. Congress and a new Administration, whether
Democratic or Republican, will wrestle over whether to extend,
repeal or substantially modify scores of tax policies that benefit every
taxpayer. As this debate unfolds, undoubtedly there will be “winners”
and “losers.” Under newly reinstated budget rules, Congress will strive
to pay for changes to the tax code and minimize additional debt.
Since major spending cuts are unlikely, the practical result will be a
search for hundreds of billions of dollars in offsetting tax revenues. The
principal focus is likely to be on repealing so-called “tax loopholes.”
Particularly at risk are tax provisions that benefit perceived targets of
political opportunity, such as large multi-national corporations.
Second, revenue-raising options may be drawn from proposals made
by the Treasury Department, including, in the case of a Democratic
Administration, those made during the Clinton Administration.51
The Joint Committee on Taxation has made revenue-raising
recommendations in various reports, like its report entitled “Options
to Improve Tax Compliance and Reform Tax Expenditures,” dated
January 27, 2005 (JCS-02-05) and letter to the Finance Committee
Ten Questions About Tax Policy for the Next Administration and Congress
16
End Notes
1
2001 Tax Cuts: Economic Growth and Tax Relief Reconciliation Act of 2001, Pub.
14
S. Rep. No. 97-494, Vol. 1, at 108 (1982).
15
AMT Coalition for Economic Growth. Written Comments Submitted to the President’s
L. No. 107-16, 115 Stat. 38 (2001); 2003 Tax Cuts: Jobs and Growth Tax Relief
Reconciliation Act of 2003, Pub. L. No. 108-27, 117 Stat. 752 (2003).
Advisory Panel on Federal Tax Reform, at 3 (March 17, 2005).
2
The current (October 2008) “conventional wisdom” is that Democrats will significantly
expand their majority in both the House (net gain of 10-20 seats), where they currently
16
have an advantage of 235-198 and in the Senate (net gain of 4-7 seats), where they
H.R. 3970. The amount above which the benefits of the AMT would be denied, by
currently have an advantage of 51-49.
replacing the AMT with the replacement tax, would be set by the Treasury Secretary, but
This provision is included in Congressman Rangel’s “Tax Reduction and Reform Act,”
could not be less than $200,000.
3
Office of Management and Budget. Mid-Session Review, Budget of the U.S.
Government, Fiscal Year 2009, at 34 (July 28, 2008).
17
AMT Relief Act of 2007 (Passed/Agreed to by House on December 12, 2007), H.R.
4351, 110th Cong. Sec. 103 (2007).
4
For example, pay-go rules were waived for the following: Stimulus Bill: Economic
Stimulus Act of 2008, Pub. L. No. 110-185, 122 Stat. 614, (2008); 2007 AMT Patch:
18
Revenue Act of 1916, Pub. L. No. 64-271, 39 Stat. 756 (2008).
19
For example: Death Tax Repeal Permanency Act of 2003 (Passed/Agreed to in the
Tax Increase Prevention Act of 2007, Pub. L. No. 110-166, 121 Stat. 2461 (2007);
War Supplemental Bills: U.S. Troop Readiness, Veterans’ Care, Katrina Recovery, and
Iraq Accountability Appropriations Act of 2007. Pub. L. No. 110-28, 121 Stat. 112,
House on June 18, 2003), H.R. 8, 108th Cong. (2003); Death Tax Repeal Permanency
at Title VIII (2007); Military Construction and Veterans Affairs Appropriations Act, 2008,
Act of 2005 (Passed/Agreed to in the House on April 13, 2005), H.R. 8, 109th Cong.
Pub. L. No. 110-252, 122 Stat. 2323 (2008).
(2006); Family Heritage Preservation Act (Introduced in the House on January 4, 2005),
H.R. 64, 109th Cong. (2006); Estate Tax and Extension of Tax Relief Act of 2006
5
Senator McCain was one of only two Republican Senators to vote against the 2001
(Passed/Agreed to by the House on July 29, 2006), H.R. 5970, 109th Cong. (2006).
tax cuts (107th Congress, 1st Session, Record Vote 170); he was also one of only 3
Republican Senators to vote against the 2003 tax cuts (108th Congress, 1st Session,
Record Vote 196).
6
Kathy Kiely, McCain Calls for Tax Cuts, Corporate Responsibility, USA Today, April 15,
2008, http://www.usatoday.com/news/politics/election2008/2008-04-15-mccain-
20
Estate Tax and Extension of Tax Relief Act of 2006 (Passed/Agreed to by the House
on July 29, 2006), H.R. 5970, 109th Cong., Senate Roll Call Vote 229 (2006).
21
Sensible Estate Tax Act of 2008 (As Introduced in the House on July 15, 2007), H.R.
6499, 110th Cong. Sec. 4 (2008).
economy_N.htm.
7
22
Id.
23
U.S. Department of the Treasury, Treasury Conference on Business Taxation and Global
Another issue, but outside the scope of this memo, is the tax implications of legislation to
reduce the impact of greenhouse gases.
Competitiveness Background Paper, at 3 (Jul. 23, 2007).
8
153 Cong. Rec. S5835 (daily ed. June 19, 2008) (Remarks by Sen. Voinovich).
9
Chairman Rangel also has proposed to restore the phaseouts that have the effect of
24
Brookings Institution. Press Release, Corporate Taxes, in Need of Reform: Taxes,
Competitiveness, Corporate Taxes, Business (Oct. 27, 2007) (on file with author).
raising the marginal rate on higher incomes (Tax Reduction and Reform Act of 2007, H.R.
3970, 110th Cong. § 1023 (2007)) (revenue numbers retrieved from JCT).
10
25
U.S. Government Accountability Office, Tax Administration. Comparison of the
Reported Tax Liabilities of Foreign- and U.S.-Controlled Corporations, 1998-2005.
Supplemental Appropriations Act, 2008 (Engrossed Amendment as Agreed to by
GAO-08-957, at 2 (July 2008).
House on May 15, 2008), H.R. 2642, 110th Cong. Sec. 7001 (2008).
26
11
During floor debate, Sen. Graham (R-SC) preferred to the bill as costing $52 or $53
billion. 153 Cong. Rec. S4715 (daily ed. May 22, 2008).
12
Distribution of Tax Units with Small Business Income, 2007. Tax Policy Center.
T07-0131 (April 27, 2007).
13
In a June 27, 2007, published statement upon the introduction of S. 55 (AMT patch
bill), Senate Finance Committee Chairman Max Baucus noted, “2001 IRS numbers show
U.S. Department of the Treasury, Office of Tax Policy. Approaches to Improve the
Competitiveness of the U.S. Business Tax System for the 21st Century, at 44 (December
20, 2007).
27
President’s Advisory Panel on Federal Tax Reform. Simple, Fair, and Pro-Growth:
Proposals to Fix America’s Tax System, at 62 (2005).
28
House Committee on Ways and Means. Press Release, Chairman Rangel Introduces
H.R. 3970, “Tax Reduction and Reform Act of 2007” (Oct. 25, 2007).
that about 4,500 people with incomes of more that $200,000 still did not pay either the
regular income tax or the AMT. The AMT has strayed from its original purpose.”
Ten Questions About Tax Policy for the Next Administration and Congress
17
29
Corporate Inversion: Hearing Before the S. Appropriations Subcommittee on Treasury
and General Government, 107th Cong. (2002) (statement of Paula Olson, Assistant
41
The Foundation of International Tax Reform: Worldwide, Territorial, and Something in
Between: Hearing Before the Finance Committee, 110th Cong. (June 26, 2008).
Secretary [Tax Policy], U.S. Department of the Treasury).
42
Renewable Energy and Job Creation Act of 2008, H.R. 6049, 110th Cong. (2008).
43
153 Cong. Rec. H4383 (daily ed. May 21, 2008) (Remarks by Rep. Rangel).
available at http://www.nytimes.com/2008/04/22/business/22sorkin.
44
See S. 41 (R&D); H.R. 571/ S. 561 (adoption); H.R. 1509/S. 940 (active
html?scp=1&sq=Hedge%20Fund%20Investing%20and%20Politics%20&st=cse#.
financing); H.R. 3976/S. 689 (donations of food inventory); H.R. 1840/S. 1130
30
31
Export Products Not Jobs Act, S. 96, 110th Cong. (2007).
Andrew Ross, Hedge Fund Investing and Politics, N.Y. Times, Apr. 22, 2008,
(group legal services); H.R. 2014/S. 1361 (leasehold improvements); H.R. 1813/S.
32
This provision is included in Congressman Rangel’s “Tax Reduction and Reform Act,”
1416 (mortgage insurance premiums); H.R. 3951/S. 2375 (film production expenses).
H.R. 3970.
45
33
The House version of the farm bill included a provision that would provide that, in
Explain. Congressional Research Service, CRS Report for Congress. The Budget
Reconciliation Process: The Senate’s “Byrd Rule.” RL 30862, at 1 (March 20, 2008).
the case of payments from a U.S. subsidiary to a foreign subsidiary of a U.S. parent,
the tax withholding rate will be the higher of either the rate that applies in the country in
46
Energy Policy Act of 2005, Pub. L. No. 109-58, 119 Stat. 594 (2005).
47
The Farm Bill that was passed in the summer included a reduction in the ethanol credit
which the foreign subsidiary is located, or the rate that applies in the country in which the
foreign parent is located; the effect would be to prevent many foreign parent companies
from setting up subsidiaries in foreign countries that have tax treaties with the U.S.
and the creation of a credit for cellulosic ethanol production. Although ethanol has
eliminating the 30% withholding tax, even though the foreign parent company is located
recently suffered from negative publicity regarding its possible link to the rise in fuel prices,
in a country that does not benefit from such a tax treaty. The provision was estimated,
serious attempts at further curtailing ethanol benefits, either through tax credits or changes
by the Joint Committee on Taxation, to raise $7.5 billion over ten years. The provision
in trade policy, are not expected in the near future.
passed the House but became very controversial and was not retained in the final version
of the farm bill.
34
48
See, e.g., Jobs, Energy, Family, and Tax Relief Act of 2008 (As Introduced in the
Senate on July 25, 2008), S.3335, 110th Cong, Title I (2008); Renewable Energy and
In 2004, when Congress enacted a series of provisions liberalizing the subpart F rules,
Jobs Creation Act of 2008 (As Passed by the House on May 21, 2008), H.R. 6049,
many House Democrats opposed the provisions. For example, House Democrats have
110th Cong, Title I (2008); Renewable Energy and Energy Conservation Act of 2007 (As
proposed to delay the implementation of worldwide interest allocation.
Passed/Agreed to in the House on August 4, 2007), H.R. 2776, 110th Cong. (2008).
35
For example, Senator Byron Dorgan (D-ND), a member of the Senate Democratic
Leadership, has introduced a bill, S. 396, that would treat a controlled foreign
49
Joint Committee on Taxation. Estimates of Federal Tax Expenditures for Fiscal Years
2007-2011. JCS-3-07, at 24 (September 24, 2007).
corporation located in a listed tax haven country as if it were a U.S. domestic
corporation, and thereby deny the corporation the benefit of deferral of tax on its non-U.S.
income.
36
Voinovich Bill: MADE in the USA Tax Act. S. 3162, 110th Cong. (2008). Neal Bill:
H.R. 2937, 110th Cong. (2007).
37
50
United States Government Accountability Office, U.S. Financial Condition and Fiscal
Future Briefing. GAO-08-417CG, at 12 (Jan. 9, 2008).
51
For example, Joint Committee on Taxation. Description of Revenue Provisions Contained
in the President’s Fiscal Year 2001 Budget Proposal, JCS-2-00 (March 6, 2000).
The Voinovich bill, S. 3162, includes provisions adding royalty income and financial
services income to the category of passive income subject to a separate foreign tax credit
limitation and treating a foreign corporation with a single owner as a U.S. corporation.
38
The Foundation of International Tax Reform: Worldwide, Territorial, and Something in
Between: Hearing Before the Finance Committee, 110th Cong. (June 26, 2008).
39
U.S. Department of the Treasury, Report to the Congress on Earnings Stripping, Transfer
Pricing and U.S. Income Tax Treaties (Nov. 28, 2007).
40
Charles Rangel and John Buckley. International Tax Rules Provide Incentives for
Moving Jobs Offshore. BNA, Daily Report for Executives. March 22, 2004. In the
article, Rangel and Buckley criticize the current tax system, saying that “our current tax
rules, in combination with favorable accounting rules, provide powerful incentives for
U.S. companies to shift capital and jobs overseas.” More specifically, they describe
four features that they consider particularly troublesome: transfer pricing, cost-sharing
arrangements, hybrid entities, and “cross-crediting.” They conclude by calling for “a
reform of our international tax rules with the goal of reducing the current law incentives to
move jobs offshore.”
Ten Questions About Tax Policy for the Next Administration and Congress
18
Authors:
Michael W. Evans
Partner
202.661.3807
michael.evans@klgates.com
Patrick G. Heck
Partner
202.778.9450
patrick.heck@klgates.com
William A. Kirk
Partner
202.661.3814
william.kirk@klgates.com
The authors wish to thank Brandon Audap for his contributions to this paper.
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