Debt deal puts off tax decisions for another day

August 3, 2011

The legislation to lift the debt ceiling gives the country a framework for more than $2 trillion in budget cuts over 10 years and avoids default. But it also puts off discussion of taxes for another day — and it’s unlikely that we’ll see any movement on tax reform or significant tax changes until 2012.

“If I were at a roulette table in Vegas, I would put almost all my chips on a square marked ‘Lame Duck,’” says Clint Stretch, managing principal of tax policy in Deloitte Tax’s national office in Washington, D.C. “I see nothing that Congress will regard as a ‘must do’ in the tax area before a lame-duck session in 2012.”

In the second stage of the deficit reduction, a new Congressional super-committee will have a mandate to come up with some $1.5 trillion of savings by late-November. But while taxes could be part of that discussion, there are many obstacles: The two sides are very far apart, the timetable for the super-committee to do its work is very short (especially in tax terms), and the Republican victory on getting taxes off the table in the current deal makes it likely they’ll stay off a few months hence.

The tax reform efforts of 1986, 1993 and 2001 were all debated during their respective Presidential elections, and that’s likely to be the case today, too. While there have begun to be tax-reform proposals bandied about — from the Gang of Six, among others — these remain preliminary. “We have not begun a serious conversation about tax reform,” Stretch says. “It’s going to be the discussion of the next election. The President will eventually have a tax proposal, and the Republicans will have their competing proposal. Then we’ll have a bloody fight over it.”

At stake are key issues surrounding who should pay for the government to do its work, and at what level — issues of fairness and of complexity. What are the right tax rates, and should they be higher or lower than today? Should the wealthy pay higher rates? Should investment income be taxed like wages or at a lower level? Should homeowners continue to benefit from the mortgage interest deduction? Should taxpayers still be allowed to write off state and local taxes? And what about the Alternative Minimum Tax, the complicated alternate tax system? And those are just some of the questions for individual taxpayers.

In the meantime, of course, the Bush tax cuts are slated to expire at the end of next year, when the two-year extension they received last year runs out. Republicans favor continuing those cuts, while the Obama Administration had hoped to eliminate them for high-income taxpayers. Deloitte’s Stretch argues that as tax reform gets pushed off, the Bush tax cuts are likely to get another one-year extension and come up for discussion as part of broader tax-reform.

Also set to expire at the end of 2012 — though barely discussed during the recent deficit discussions — are the changes to the federal estate tax, which increased the exemption amount to $5 million and lowered the tax rate due.

Mary Kay Foss, an accountant with Sweeney Kovar in Danville, California, says for now she’s telling her clients to assume that current tax policy will stand. “That’s about the only thing we can do, I guess,” she says. “I don’t think we’re going to have a lot of tax changes between here and November.”

Longer term, however, is a different story, with momentum building for significant tax reform since the fiscal commission, chaired by Erskine Bowles (former White House chief of staff under Bill Clinton) and Alan Simpson (former Republican Senator from Wyoming) released its recommendations late last year. As tax analysts at CCH note in a tax briefing this week: “[T]he deficit reduction debate has generated a significant number of tax proposals. Many of these proposals would have been considered ‘extreme’ only a few years ago, but are now under serious discussion due to the deficit. The deficit reduction debate has allowed tax reform proposals to become mainstream and has made tax reform a more likely component of any long-term solution.”

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