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Election Impact on Expiring Tax Cuts and Other Tax Issues
Today’s tax quote:
“Our forefathers made one mistake. What they should have fought for was representation without taxation.”  -- Fletcher Knebel.
Tuesday’s historic election, which returned Republicans to control of the U.S. House of Representatives and severely weakened Democrats’ control of the Senate, will have an uncertain effect on many pending issues. Among those are the fate of the 2001 and 2003 tax cuts, which are scheduled to expire at the end of 2010. If no action is taken, the top tax rate will jump from 35% to 39.6%, the top dividend tax rate will rise from 15% to 39.6%, and the top capital gains rate will go from 15% to 20%. In addition, the estate tax will spring back to life at its pre-2001 levels. And, Congress must also wrestle with the Alternative Minimum Tax, whose exemption levels it has periodically raised on a temporary basis. If no action is taken, the AMT exemption for married couples will fall from $70,950 to $45,000, and for singles from $46,700 to $33,750, potentially subjecting millions of additional taxpayers to the AMT.
Speculation is rampant in both Parties as to what will happen when Congress reconvenes on November 15, 2010, for a lame duck session lasting about four weeks. Democrats will maintain their present majority in the House for that session, and it appears that only one new Senator (Kirk, R. Illinois) will be seated for the lame duck session, but even that lone Republican senatorial addition will make it more difficult for returning Senate Majority leader Reid to achieve the 60 votes that are needed in the Senate to move any legislation that has significant opposition. Nor is anything likely to pass the House without some Republican cooperation.
In the months leading up to the election, Republicans had been insisting on at least a temporary extension of all of the tax cuts, while Democrats have pursued a permanent extension of tax cuts for all taxpayers except those earning more than $200,000 ($250,000 in the case of families). Complicating the issue is the fact that under statutory “pay as you go” rules enacted by Congress last year, continuing the tax cuts for the higher income taxpayers must be paid for, while paying for continuing the other tax cuts is not required.
Observers are split as to how, or whether, these differences can be reconciled during the lame duck session. Depending upon the analyst one listens to, either Party could simply throw up its hands and defer the issue to the new Congress, if it cannot get what it wants in the lame duck session. Democrats might take the position that it is now up to the incoming Republican majority to deal with the costs of extending the cuts for all taxpayers (a ten-year extension of all the cuts would cost about $3.3 trillion, according to the Congressional Budget Office) in an environment of public dissatisfaction with enormous budget deficits. Republicans might decide that deferring the issue to a time when they have more ability to shape the outcome may be the preferred political path. The President, while adamantly against extending the tax cuts for higher income individuals, has never threatened to veto legislation that does so.
It is also possible that the two Parties will arrive at some compromise during the lame duck session. Those in each Party pushing for such an outcome point to the harm to the economy that might occur if the tax cuts are not extended, and the short term detriment that uncertainty as to future tax rates will cause. Some have suggested that perhaps a compromise might be reached for a one-year extension of all the cuts, or a longer extension of cuts but excluding those earning some amount higher than the $250,000 advocated by Democrats, for example, $500,000. Vice-President Biden said recently during an interview that the Administration would be open to negotiating higher income limits if the cuts could be made permanent for the middle class. In the meantime, states have also begun to enter the fray. Many states permit a deduction for federal taxes, and those states would lose substantial revenue if federal taxes go up.
Unfortunately, there is abundant precedent for Congress failing to make decisions on fundamental things like tax rates until well into the next year, which may well happen here. Under that scenario, the tax cuts would be extended some time in 2011, retroactive to the first of the year. Obviously, this is not a good solution from the standpoint of either tax or economic policy, but it would be better than no extension at all, and as noted either Party may prefer it to the alternative of not getting what they want in the lame duck session. Based on the state of play after the election, it is somewhat likely that what will occur is a temporary extension of all of the current tax rates for all taxpayers, but that this will not happen until some time after the new Congress convenes in January.
Further clouding the crystal ball is the expected December 1, 2010, delivery of the deficit reduction report of the President’s bipartisan National Commission of Fiscal Responsibility and Reform, which may well contain recommendations concerning tax rates and the Tax Code. Democrats have previously promised to hold a vote on the Commission’s recommendations during the lame duck session.
The tax rate issue has fundamental impacts on the mobility industry, as companies must know the tax rates to compute gross-ups, and determine the costs of moving employees. Higher tax rates mean higher gross-ups, which increases relocation costs. Higher tax rates, or uncertainty as to tax rates, may also affect an already struggling real estate market. And they affect such issues as cost of living allowances and mortgage differentials.
In addition to tax rates and AMT, during the lame duck session, Congress must agree on some method of funding government operations beyond the current expiration date of December 3, 2010, possibly with some sort of continuing resolution to fund government operations at current levels until a budget can be adopted next year. However, many Republicans are averse to continued funding at current levels, pushing for some sort of reduction. If no compromise can be reached, the government would be forced to shut down until funding is provided.
Also on the lame duck agenda is legislation to extend some 45 provisions other than the tax cuts, which also expire (or have already expired). These include, for example, the deduction for state and local sales taxes and the additional standard deduction for property taxes.
So we are facing substantial uncertainty, perhaps until well into next year. We at Worldwide ERC will be watching the unfolding events very closely and providing continuing reports to members as to what they might expect, and when.
Stay tuned!


Tax Rates

I still do not understand why we, as a country, do not institute a flat tax. The rates are stable - no uncertainty - and loopholes are greatly diminshed. Government buracracy could be significantly cut, leading to substantial savings for the government and a reduction of debt. Is this just too simple and logical?
Kimberly Gamero at 11/9/2010 1:48 PM

flat tax

Thanks for the comment, Kimberly, and it certainly reflects a sentiment shared by others.  Ever since Professors Hall & Rabushka suggested a flat tax in 1983, there have been flat tax proposals debated and introduced in Congress nearly every year.  The principal argument against a flat tax is that it is highly regressive, and tends to greatly reduce tax at the upper end of the income scale while greatly increasing it at other levels.  Opponents also argue that it will not greatly reduce complexity, since most of the complexity in the current law relates to the determination of what is "income" (for example, a great part of the code is devoted to exemptions and exclusions, such as the one for capital gains on home sales) or to tax breaks that likely would remain (like deductions for mortgage interest and charitable giving), or to business tax issues.  In any event, it is an interesting debate that likely will be renewed in Congress in the next couple of years.  If you'd like to look at the kind of arguments opponents make, you could go to this report of Citizens for Tax Justice, a tax think tank in Washington.  Again, thanks for the thoughtful comment.

Pete Scott
Peter Scott at 11/9/2010 9:44 PM

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