Transcript taxes and the elective process

TAXES AND THE ELECTIVE
PROCESS
From the Campaign Trail to the Sausage
Factory
May 20, 2008
John E. Chapoton
Alice S. Paik
Brown Advisory
Washington, DC
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Summary:
I. The setting in which the tax issues are being
presented
II. The positions of the candidates
III. The impact of the budget deficit on the next
president
IV. What will happen?
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I. The setting in which the tax issues are
being presented
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Taxes – the immediate issues
Two events will force the new president to act on taxes:
– The expiring Bush tax cuts
– The spreading AMT “blob”
The next president must have positions on both
– Each candidate does
– But the ground is shifting as we speak
And of course the candidates are advocating other tax
changes
– That’s what candidates do….
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Tax confusion – sunset of the Bush tax cuts
Bush Tax Cuts & Sunsets: Current Law
Tax legislation
Rate Through 2010
Rate After 2010
Tax rate on dividends
15%
up to 39.6%
Tax rate on LT capital gains15%
20%
Individual Income Tax Rates
10%
15%
25%
33%
35%
15%
15%
28%
36%
39.6%
Estate Taxes
Top rate falls from current
rate of 45% to 0% in 2010
55%
Gift Taxes
Top rate falls from
current rate 45%
to 35% in 2010
55%
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Understanding the budget figures
OMB (the Office of Management & Budget – i.e., the
Administration) produces a budget projection each year
– The past years reflect actual numbers
– The future years reflect the then current Administration’s policy
proposals – however unlikely adoption might be – and the economic
impact thereof
CBO (Congressional Budget Office also produces a budget
projection each year
– Assumes current law will remain unchanged for future years, however
unlikely that assumption is
– CBO estimates are supposed to be untainted politically, but they are
also unrealistic in a sense
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Understanding the budget figures
(% of GDP)
OMB
CBO
Surplus/
Year
Receipts
Outlays
Deficit(-)
Receipts
Outlays
Surplus/
Deficit(-)
1980
19.0
21.7
-2.7
19.0
21.7
-2.7
1988
18.2
21.3
-3.1
18.1
21.2
-3.1
1992
17.5
22.1
-4.7
17.5
22.1
-4.7
2000
20.9
18.4
+2.4
20.9
18.4
+2.4
2008E
17.6
20.5
-2.9
17.9
20.4
-2.5
2012E
18.8
18.5
+0.3
20.0
19.4
+0.6
Source: CBO; Joint Committee on Taxation
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Budget impact of extending the Bush tax cuts
10-yr Budget Impact of keeping
Bush rates
(2008-2017)
Individual tax rates:
Present law: 10%-35%
2011:
15%-39.6%
-$1.22 Trillion*
Cap gains & dividends:
Present Law:
15%
2011-(LTCG):
20%
(Div):
39.6%
-$208.5 Billion*
*Source: CBO; Joint Committee on Taxation
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Budget impact of extending the Bush tax cuts
(cont’d)
Estate Tax/Gift Tax
Present law:
 2008-09:
45%;$2M($3.5)/45%;$1M
 2010:
Repeal/35%;$1M
 2011
55%;$1M/55%;$1M
10-yr Budget Impact*
(2008-2017)
Possible legislative changes effective 2010:
(Billions)
1. Repeal estate tax….………………………………………..........-$498.8
2. $5M exemp./cap gains tax rate…(i.e., McCain)...………….......-$400.9
3. Same as #2, but 30% tax rate >$25M ….………………….........-$366.6
4. $3.5M exemp./45% tax rate.....(i.e., Clinton & Obama)………..-$231.9
(all dollar amounts indexed for inflation)
*Source: CBO; Joint Committee on Taxation– baseline is 2011 law
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The Alternative Minimum Tax “Blob”
AMT originally designed (1969) to guarantee that high income
individuals pay some minimal level of tax
– Excessive use of tax “preferences” (accel. depr., % depl., etc.) would
trigger the AMT
It morphed into something quite different
– Exemptions were not indexed, so coverage has exploded
1970 -- 20,000 taxpayers affected
2007 – 23.4 million taxpayers (without stopgap “patch” legislation)
A third or more of taxpayers could eventually be covered
Encroaching on middle income taxpayers
– The top two “preferences” are now the personal exemption and state
and local taxes
Is having a large family or living in a high-tax state a tax avoidance
technique?
Ridiculous that the tax system penalizes such situations
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The Alternative Minimum Tax (cont’d)
Politicians hate it because their constituents hate it
But…repeal would dig a $668 billion hole in the budget over
10 years (2008-2017)*
– And politicians have opted to allow a stealth tax increase vs. repeal
and having to deal with the issues that would present
Temporary legislated “patches” are applied to contain the growth
of coverage
– And there’s the little-mentioned fact that repeal would be regressive –
benefiting only upper income and some middle income taxpayers
A problem for Clinton or Obama?
*Assumes sunset of Bush tax rate cuts; if rates are extended, which seems
likely, cost of AMT repeal would almost double. Stated differently, the
pickup from the AMT hides the true revenue cost of the Bush tax cuts
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II. The positions of the candidates
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The Candidates Step Forward…
-- positions on Bush tax rates & AMT
Hillary Clinton
Barack Obama

Repeal Bush tax
cuts for top two
brackets (i.e.,
reinstate 36% &
39.6% brackets)
 Same as Hillary

Phil debate
pledge: no tax
increase for
Incomes < $250,000
 Virtually same as
Hillary (<$200,000?)
AMT – Prevent its
Spread
 AMT -- Prevent its
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
John McCain
 Extend Bush tax cuts
in toto
 AMT – Full repeal
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The Candidates Step Forward…
-- positions on capital gains, dividends,
E&G
Capital
Gains
Dividends
E & G Tax
Clinton
Obama
McCain



Increase to 20%
Increase to 28%,
or recently 20%
 0% rate for startup businesses
 Low rate for sale
to farmers
Retain 15% rate
 No specific
proposal
 Return to ordinary  Retain 15% rate
income rates
 Freeze ’09 estate
tax: 45%/ $3.5M
 Freeze ‘09 estate
tax: 45%/ $3.5M
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 15% rate/ $5M
exemption
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The Candidates Step Forward…
-- tax benefit proposals
Clinton
Obama
McCain

 Eliminate income tax
for seniors <$50,000
 Payroll tax credit up
to $8,100
 Mortgage credit
 College expense
credit
 Increase EITC
 Increase child care
credit
 Savers credit
 Incentives for
renewable energy
 Double PE for
dependents to $7,000
 Suspend gas tax for
summer
 Require 3/5 majority
in Congress to raise
taxes
 Suspend gas tax for
summer
Refundable
retirement credit
 American
retirement accounts
 Care-giving credit
 Long term care
credit
 Broaden R&E
credits
 Broaden EITC
 Broaden Hope
Credit
 Reform CDCTC
 Double elderly
standard ded.
 Suspend gas tax
for summer
Business:
 20% credit for
investment in small bus
(<$50,000)
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Business:
 1st year expensing of
equip. & technology
costs
 Reduce corporate
rate from 35% to 25%
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The Candidates Step Forward…
-- loophole closing proposals
Clinton
Obama
McCain

 Tighten offshore
haven rules
 “Close corporate
End tax breaks for
companies moving
abroad

End tax deferral of
foreign subs

Tighten transfer
pricing rules

Tighten foreign
insurer rules

Tax carried
interests as ordinary
income
tax loopholes”
 Eliminate “special
interest loopholes”
 Remove $102,000
cap on FICA tax (top
marginal rate on
earned income would
become 47.25%)
 Tax carried
interests as ordinary
income
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Scoring the candidates tax proposals
Impossible to score the tax proposals except in order of
magnitude
– Insufficient details
– Tax and spending proposals jumbled together
In general terms:
– McCain is the grand winner – one cost estimate ot McCain’s tax
proposals – $5.7 trillion over 10 years (twice the cost of Bush 2001-03
tax cuts)
– Clinton & Obama proposals are similar to each other
Lost revenue is about one-third of McCain’s
Both provide specific pay-fors
Obama’s are somewhat more expensive, net
On the spending side of the budget – who knows how much the
candidates are promising to give away?
Note: We are purposely avoiding discussion of the candidates’ health care proposals,
even though tax law changes are involved.
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What are they thinking?
(Have they looked at the budget numbers?)
The projected budget deficit is the 1000 pound gorilla
in the room
– Its consequences will significantly limit the next president’s options
– And will alter the candidates tax proposals long before they become
law, or even specific proposals made to Congress
The Candidates are in denial, but understandably
so—
– No one ever has made it to the White House on promises of cutting
spending or raising taxes.
– Nevertheless, we may be witnessing a new record in candidate
unreality….
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III. The impact of the budget deficit on
the next president
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The Budget Deficit & The Ever-Growing National Debt
Federal Outlays as a Percent of GDP, 1965-2050
60%
Percent of GDP
50%
40%
Interest
30%
All Other
Medicaid
20%
10%
Medicare
Average Tax Revenue
Social Security
0%
1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050
Source: Congressional Budget Office, December 2005, High spending outlook
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The budget deficit & the ever-growing
national debt (cont’d)
Lessons from previous slide:
– Revenues -- tend to bump along at 18-19% of GDP; averaging about
18.3% since the 1980s
– Deficits -- vary widely year-to-year – recently from 1.2% to 3.6% of
GDP; largest deficit was during Reagan, in early 80s, reaching 6% of
GDP
But a train wreck is in our future
– slide shows Medicare and interest on the debt will soon explode
Next slide shows the principal culprit:
– Uncontrolled expenditures -- Increased interest on the debt, and everincreasing entitlements
No Congressional action required -- we’re on auto pilot
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The budget deficit & the ever-growing
national debt (cont’d)
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The budget deficit & the ever-growing
national debt (cont’d)
The next slide tells the same story, but brings it closer to us in
time
– Around 2016 -- during the next president’s 2nd term -defense outlays, interest on the national debt, and
entitlements will consume all Federal revenues
– Producing unprecedented and unsustainable deficits
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The budget deficit & the ever-growing
national debt (cont’d)
The Current Squeeze
23.0%
22.0%
Receipts
(if tax cuts made permanent)*
21.0%
20.0%
Percentage of GDP
19.0%
18.0%
17.0%
16.0%
15.0%
Resources
Left for Other
Domestic Outlays
14.0%
13.0%
12.0%
11.0%
Spending on Social Security,
M edicare, M edicaid, Defense,
International^, and Interest
10.0%
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 2026 2028 2030
Source: C. Eugene Steuerle, Adam Carasso, and Gillian Reynolds, The Urban Institute, 2007. Authors' calculations based on
data from CBO Budget Outlook (January 2007) and OASDI and HI-SMI Trustees Reports (2006).
* Assumes extension of 2001 and 2003 tax cuts and of expiring tax provisions and a permanent fix to the alternative minimum tax.
^ Assumes a m oderate drop in defense and international spending as a percent of GDP.
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Projected budget deficits indicate tough
political choices ahead
The good news – these deficits won’t happen
But they will limit the next president’s options -- after about
2016 any spending on education, the environment, welfare,
infrastructure and most other domestic programs will require
choosing to do one or more of the following:
1. Increase the deficit (which can’t be sustained);
2. Rescind tax cuts, or increase taxes;
3. Reduce social security and health benefits (i.e., renege on
what has been promised taxpayers); and/or
4. Reduce defense spending
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Can the new President simply ignore these
budget projections?
Answer: No
While there are complaints about budget forecasts – unreliable; not dynamic;
politically motivated, etc. – the forecasts cannot be totally dismissed
– These are the official figures that Presidents (and Presidents-Elect) must
live by
– Candidates are obviously not so constrained
The data are available to all, and are closely examined by think tanks;
economists; etc.
– Any major, off-the-wall deviations will condemn a president’s proposals
to ridicule
– Minor deviations might work:
Reagan assumed of 4% real growth for entire budget period, and
promised spending cuts to be “supplied later”
In this setting, use of the often-editorialized easy ways out -- the “fiscal
myths” -- won’t work
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The Fiscal Myths*
1.
2.
3.
4.
5.
We can grow our way out of difficult budget choices.
Eliminating waste will solve the deficit problem.
The deficit problem can be solved by delivering health care more
efficiently.
We just need to raise taxes, and roll back the Bush tax cuts.
Cutting taxes will increase revenue.
Each of these approaches could help, but even all taken together would
not begin to solve the problem
–
A meaningful solution will require telling the public there must be
prioritization…leaving some promises unfulfilled, and inflicting some
pain
Life will not be simple for our next leader; political leaders don’t
like to inflict pain
*Brookings-Heritage Fiscal Seminar, April 2008
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IV. What will happen?
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What will happen – as a practical matter?
“Facts are difficult things”
The winner – the President-elect – will have to
reconfigure his or her campaign proposals
– Proposing legislation to Congress different than spinning campaign
rhetoric
– Must contain a greater degree of budget realism
Defer some pet tax and spending promises to the “out years”
– McCain advisor: “Don’t look at year 1 & 2 impacts; look longer
term”
Search for some almost-credible way to project a balanced budget during
his or her tenure
And then begin the difficult negotiation process with
Congress
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Recent Presidents…offer any lessons?
Ronald Reagan (1981) – proposed a 30% across-theboard tax cut and dramatic increases in business
depreciation deductions
– Budget deficit had been about 2.5% of GDP, but Congress gave him
most of what he requested – deficit rose to 6% by 1984
– Reagan cooked the books slightly:
Proposed major spending cuts, but balance the books with 4%
“unidentified future cuts”
Also, made the deficit problem much smaller by assuming huge real
growth in the economy (4% for his budget years)
Geo. H.W. Bush (1988) – promised “no new taxes”
– Deficit was well over 3% of GDP
– Reality required a compromise budget deal including tax increases,
along with spending cuts in 1990 – destroyed his credibility
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Recent Presidents…any lesson?
Bill Clinton (1992)– deficit was high; campaigned on fiscal
responsibility
– Deficit 4.5% of GDP; economy struggling from 90-91 recession
– Proposed significant tax increases in his first year – raised top rate to
36%; 10% surcharge (effective 39.6% rate); removed cap on Medicare
2.9% withholding; raised corp. rate to 35%; increased tax on SS;
increased gas tax
Economy still did very well; stock market boomed
– 1994 Republicans seized control of House and in ’97 lowered cap gains
rate to 20%; increased IRA limits
Economy and stock market boomed further
Geo. W. Bush (2000) – came to town riding his predecessor’s
surplus – no deficit, budget in surplus
– Campaigned on tax cuts to return the surplus to the taxpayers
– Achieved virtually all he requested in record time – by May of his initial
year as President
– Had an encore two years later – a second round of major tax cuts was
proposed and passed
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Big Spending Presidents
Percentage Point Change in Domestic Outlays as a Percent of GDP
Administration
Big Spenders
*2001-2006 only
Percentage Point
Change
Nixon
4.97
Hoover
4.00
Eisenhower
2.90
G.H.W. Bush
1.47
G.W. Bush*
1.44
Truman
1.38
Johnson
0.93
Wilson
0.80
JFK
0.70
Carter
0.40
Harrison
0.40
Arthur
0.20
Cleveland
0.20
Coolidge
0.20
Ford
0.16
Hayes
0.00
Garfield
0.00
Cleveland
-0.20
McKinely
-0.20
Roosevelt
-0.20
Taft
-0.20
Harding
-0.30
Clinton
-0.45
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Reagan
-2.11
FDR
-4.16
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How we raise the money they spend –
mainly income and payroll taxes
Federal Revenues by Source as a Percentage of GDP,
1934-2012
21%
Other**
Excise Taxes*
18%
15%
Social Insurance and
Retirement Receipts
12%
Corporate Income
Tax
9%
6%
Individual Income
Taxes
3%
0%
1934
1939
1944
1949
1954
1959
1964
1969
1974
1979
1984
1989
1994
1999
2004
2009
* Includes receipts from highway, airport, telephone, alcohol, and tobacco receipts.
** Includes estate and gift taxes, customs duties, and miscellaneous receipts.
Source: Eugene Steuerle, Adam Carasso and Gillian Reynolds, The Urban Institute, 2007. Historical data based on the Budget of the United
States Government, FY 2008.
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The Crystal Ball – tax changes under the
next president
My assumption: both Houses of Congress will be controlled
by Democrats
If Clinton or Obama is elected…
– The pressure to increase tax revenues will be tremendous
To support new and enhanced benefit programs and tax cuts at the
bottom; & contain deficit
– But don’t ignore power of the Republican minority’s opposition
“The power of 41 Senators….”
As a practical matter, it will take 60 votes to increase taxes
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Tax changes under the next president –
Clinton & Obama
– Income tax rates…
Rates at top very likely to go up – 36% and 39%
brackets likely to be reinstated (as promised by the
candidates)
– Note: Second-to-top rate kicks in at $200,300
Perhaps increase in rates in some lower brackets as well
Both candidates have said no increases for taxpayers
under $250k of income (Obama $200k?)
– But that excludes 97% of all taxpayers
Makes meeting their budget projections hard, and a
meaningful compromise on spending and taxes difficult
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The Crystal Ball – tax changes under the
next president (cont’d)
– Payroll taxes…
If Obama elected, $102,000 cap on FICA likely to be adjusted
upward, but I doubt removed entirely
– Would cause top rate on earned income to become 47.25%
– “Doughnut” protection for taxpayers $102,000 to $250,000?
– Could graduate the increase in the cap as incomes go up
Clinton has staked out no campaign position on payroll taxes, but
this will be a tempting target – would raise billions over 10 years
– A step toward means testing social security
– AMT repeal…
Unlikely by either Democrat candidate – far easier to temporize; there’s
simply no room in the budget and deferring repeal is very tempting
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The Crystal Ball – tax changes under the
next president (cont’d)
– Capital gains…
Rate definitely rises – but well short of 28%; more likely to 20% or
25%
This is not a major revenue raiser, but neither does it affect a large
group of taxpayers (only 14 million taxpayers reported capital gains
in 2005)
– Remember, all gains inside a qualified plan (IRA, 401(k)), etc., are
taxed as ordinary income eventually
– Dividends…
15% rate at extreme risk
Only hope is some tie to the capital gains rate, but don’t bet on it;
no historical support
Again, 15% rate is no benefit to qualified plans
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The Crystal Ball – tax changes under the
next president (cont’d)
– Candidates tax benefit proposals…
Some will make it but many won’t, at least in the first
round -- No room in the budget
Rules of the lobbying jungle will determine winners
– Candidates loophole closers…
Not a slam dunk even in times of budget crisis
– Most raise relatively little revenue
– And for most lobbyists opposing these changes, “This is not
their first rodeo”
– Yet they have reason for concern…a national mood of
righteous indignation could develop if many are being asked to
pay more
E.g., carried interests likely to receive much attention
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The Crystal Ball – tax changes under the
next president (cont’d)
Estate & Gift taxes
– A compromise will clearly be worked out by 2010
Many Democrat members have a dog in this fight
– Something more beneficial than the Clinton and Obama
proposals seems likely
Their proposal: freeze the 2009 rules (45% rate & $3.5M
exemption) going forward
Traditional wisdom: Democrats want larger exemption/Republicans
want lower rates
But many Dems want lower rates as well
More generous compromise – e.g., rate 35%-40%; exemption
$3.5M to $5M –seems doable even under a Democrat
administration
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Tax changes under the next president -McCain
If McCain is elected…
– The budget picture will be the same, but the tax result is
likely to be very different
As stated, I assume Democrats will control both the House and the Senate
But even if that is correct, it doesn’t mean McCain’s proposals can be
written off.
– Never overlook the clout of a newly-elected President to get his initial
program through, even with an opposing Congress
– The people – and thus the Congress – want to give him a chance to see what
he can do
– McCain has staked out a deep tax-cutting agenda
Once he’s the president-elect his tax agenda cannot be treated seriously
without accompanying proposals for deep – unprecedented – cuts in
spending
– He would exempt Defense spending from the knife
– Hard to see how he could avoid a cut in entitlements
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The Crystal Ball – tax changes under the
next president (cont’d)
McCain’s situation is very similar to Reagan in 1981
– Reagan 1981 proposals to Congress:
Unprecedented tax cuts for both individuals and corporations
Huge spending cuts, but Defense (and entitlements) untouched
– Reagan faced a Democrat House, but Republicans had
seized the Senate
He rode in on a wave of hope
And Congress gave him almost all he proposed
But it produced unprecedented deficits
– 6% in FY 1983
– The long term budget squeeze was nowhere near as bleak as it is today
– Likely this history not lost on McCain
McCain’s team will need lots of smoke and mirrors
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The Crystal Ball – tax changes under the
next president (cont’d)
– How would a Democrat-controlled Congress react to
McCain’s proposals?
Strong opposition; but the Democrats do not want all of
the Bush tax cuts to be killed
– McCain could threaten veto of tax increases
Congress might enact, and override would be
unlikely
– The credibility of his spending cuts to offset tax cuts
would be a factor
McCain may be compelled to compromise compelled
by sunset scenario: Without legislation all rates increase
to 2000 levels in 2011 – neither side wants that, so each
side has leverage
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The Crystal Ball – tax changes under the
next president (cont’d)
– Specifics:
Bush cuts in tax brackets…
– McCain could save most but would likely need to
concede at the edges – top rate might inch higher
AMT – likely continue the “patch”; he has bigger fish to
fry
Capital gains & dividends…
– McCain would oppose increases, but might have to
compromise
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The Crystal Ball – tax changes under the
next president (cont’d)
McCain’s goodies…
– Double exemption for dependents
Possible
– Corporate rate cut (35% to 25%)
Very doubtful even with a strong McCain administration push
Proposal does have strong corporate backers
– 1st year “expensing” for business equipment & technology
investments
Loophole closers…
– Clinton/Obama list would virtually disappear
– If the “tax increase” label can be avoided, some might pass
-- even Reagan supported raising revenue by closing many
tax avoidance techniques
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The Crystal Ball – tax changes under the
next president (cont’d)
Estate & Gift taxes
– Doubtful McCain could maintain his campaign position –
15% rate and $5M exemption per spouse
Tantamount to repeal in revenue terms
– But ultimate compromise under a McCain administration
would likely be more generous than under a Democratic
administration
– Again, our guess: Exemption of $3.5M to $5.0M; tax rate
of 35% to 40%
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The Crystal Ball…becomes fuzzy
In the end, any new president’s legislative success
will depend on the mood of the country
– Congress reluctant to appear defiant to the new boy in town
Most of the tax issues are not new, nor are the
arguments pro and con
– The results will probably swing on…
The procedural uniqueness of the sunsets, and
The power of 41Republican minority senators
Is a stalemate on taxes possible?
– Not likely; America has made clear--We want government to function
WHY WOULD ANYONE WANT TO BE PRESIDENT?
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Take Aways
If Clinton or Obama is president
– The won’t get all they want even with control of both
Houses – power of 41 Republican Senators (?)
Likely outcomes
–
–
–
–
–
Individual rates higher for upper incomes
Cap gains up – 20% to 25%
Dividends – ordinary tax rates
E&G taxes – level with 2009 or slightly lower
Business:
Overall bias to small, domestic businesses
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Take Aways
If McCain becomes president –
– He will be forced to compromise
– Democrats will control both Houses and have sunset leverage
Likely outcomes:
– Individual rates – status quo, or perhaps slightly higher for upper
incomes
– Cap gains – 15%
– Dividends – somewhat higher, perhaps full ordinary rates
– E&G taxes – compromise in the $3.5 - $5M exemption/35%-40%
range
– Business:
Some benefit for large business but he won’t get 25% corporate rate
or 1st year expensing
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Take Aways
The deficit will limit what our next president can
do, whoever it is
– Tax benefit proposals will be curtailed
– Spending programs will be fewer and less generous
– Real question – will he or she have the nerve to take
on Medicare and Social Security?
AMT – will be with us either way because repeal
is too costly
– There will be more “patches” to contain its spread
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Thank You!
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