Will the next president: reform the tax code? A historical examination.
Given the broad-ranging income and estate tax issues that must be addressed during the next two to four years, the incoming president will need to consider overhauling the tax code. The income tax issues are but a handful of major issues that the next president will face, including the banking crisis, rising oil prices, rising inflation, terrorism, the wars in Afghanistan and Iraq, the home foreclosure crisis, the healthcare problem, and a growing federal budget deficit. Senators John McCain and Barack Obama outlined broad tax agendas during the campaign; they can be compared at the Tax Policy Center (www.taxpolicycenter.org/taxtopics/presidential_candidates.cfm).
Some historical context as to how major tax issues have been handled by previous presidents once they entered the White House can provide a blueprint for thinking about how future reform may be achieved. The last major tax reform effort of 1986--as well as the last abortive reform attempt in 2005--is worth looking at in detail to provide perspective on the potential shape of tax reform in 2009 under either a President McCain or a President Obama.
The Honeymoon Period: Tax Policy Opportunities
Every elected modern president since Franklin D. Roosevelt has entered the White House with a brief honeymoon period, during which they were able to move preferred items from the administration's agenda to Capitol Hill for legislative action. During this brief window of opportunity, many presidents have historically had success in shaping tax policy. Recent examples include the Economic Recovery Tax Act of 1981, the Deficit Reduction Act of 1993, and the Economic Growth and Tax Relief Reconciliation Act of 2001.
The Economic Recovery Tax Act of 1981. The Reagan administration enacted the Economic Recovery Tax Act (ERTA) in the late summer of 1981, which cut marginal income tax rates significantly for all taxpayers (the top marginal rate fell from 70% to 50%, while the bottom marginal rate fell from 14% to 11%). ERTA was not an easy legislative accomplishment; President Ronald Reagan personally pressured several conservative Democrats in the House of Representatives to support the bill, which ultimately passed by a relatively wide margin of 253 to 176. President Reagan had success even with a divided Congress (a Democratic majority in the House and a Republican-con trolled Senate). In addition to this honey-moon tax legislation, President Reagan signed several subsequent tax bills, most notably the Tax Reform Act of 1986, which will be discussed later.
The Deficit Reduction Act of 1993. Twelve years later, President Bill Clinton enacted the Deficit Reduction Act of 1993 with a unified Congress (both chambers were controlled by the president's Democratic Party). However, there was great resistance to the proposal. The bill contained several controversial elements, including an increase in gasoline taxes, an income tax on wealthier Social Security recipients, and an increase in the marginal tax rates on upper-income individuals (establishing a top rate of 39.6%). One of the reasons for resistance to the Clinton measure was his campaign promise to cut taxes for the middle class, which he abandoned after the election due to the realization of a significantly higher federal budget deficit. In the end, the bill barely passed the House by a vote of 218 to 216, while the bill passed the Senate only after Vice President Al Gore cast a tie-breaking vote. President Clinton enacted subsequent tax legislation, most notably the Taxpayer Relief Act of 1997.
Economic Growth and Tax Relief Reconciliation Act of 2001. President George W. Bush maneuvered one of the largest tax cuts in American history in 2001 after a very close and contentious election. The president inherited a huge federal budget surplus that allowed him to shape a $1.3 trillion tax cut, moving quickly as economic indicators projected a slowing economy. President Bush moved the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) through a closely unified Congress (the Senate was split 50-50). President Bush signed several subsequent tax bills, including the Jobs and Growth Tax Relief and Reconciliation Act of 2003 (JGTRRA).
Presidents Reagan, Clinton, and George W. Bush each moved tax policy during their first years in office from an agenda item though the complex legislative process to a signing ceremony. Author Paul C. Light argues that presidents often secure legislative victories during the honeymoon period or even during the first year: "Presidents can always expect at least a limited honeymoon. However, by the middle of the first summer the euphoria wears off, leaving the Washington community less willing to support the President's requests" (The President's Agenda: Domestic Policy Choice from Kennedy to Clinton, Third Edition, Johns Hopkins University Press, 1999). This is largely due to a newly elected president coming into office with relatively high approval ratings and political capital. Nevertheless, there is an earlier example when tax policy was largely postponed to the second year in office.
President Jimmy Carter campaigned in 1976 on reforming the tax code. Once he took office in 1977, President Carter frustrated leaders on Capitol Hill largely by his tendency to propose legislation only to later retract the request. During his first 100 days in office, he proposed a $50 per taxpayer rebate to stimulate the economy. Members on the Hill began deliberating on the measure only to later be informed that the Carter administration was retracting the bill because it would adversely affect inflation. President Carter also decided to postpone his tax bill to his second year in office in order to first handle Social Security reform legislation. When he attempted to move the bill through Congress in 1978, President Carter was met with significant resistance from both parties as the congressional midterm election approached. While he ultimately got a tax bill passed, it was significantly different than what he originally proposed. President Carter signed the Revenue Act of 1978 at Camp David with no fanfare.
Presidents Reagan, Clinton, and Bush each expended a portion of their political capital on tax legislation. However, President Carter had a more difficult time enacting his tax bill by postponing it to the second year. These examples would indicate that the next president should act early in his first year in office if he wants to secure congressional action on tax legislation.
However, given the magnitude of the tax issues, including the expiring tax cuts, the alternative minimum tax, healthcare, and the constraint of a rising federal budget deficit, the next president should consider wholesale reform of the tax code.
A Brief Look at the Tax Reform Act of 1986
More than two decades have passed since the Tax Reform Act of 1986 (TRA) was signed into law. Since then, three presidents have significantly added complexity back to the IRC, making it again look like "Swiss cheese" (Nicholas Confessore, "Breaking the Code," New York Times Magazine, January 16, 2005). The TRA, one of the most significant pieces of tax one of the most significant pieces of tax legislation ever passed, was composed of a blending of rate cuts along with reductions and eliminations of specific tax loopholes and deductions that ultimately attempted to broaden the tax base and simplify tax compliance.
The 1986 tax reform effort largely evolved out of several competing arguments over the U.S. tax system that began in the late 1970s. First, the passage of Proposition 13 in California in June 1978 sent a national message that the public had lost its tolerance for high taxes. Second, several tax loopholes existed in the code that were used by millionaires to avoid paying taxes. While taxpayers were displeased with the high rate of taxation, the secondary part of the issue focused on "equity and fairness" in the tax code (John W. Kingdon, Agendas, Alternatives, and Public Policy, 2d Ed., Longman Press, 2003). These tax shelters largely discouraged investment in productive assets and instead allowed monies to be "sheltered" in "mediocre or even losing ventures ... adding to economic stagnation" (C.E. Steuerle, Contemporary U.S. Tax Policy, Urban Institute Press, 2004.). This national antitax sentiment helped Ronald Reagan defeat incumbent Jimmy Carter in the 1980 presidential election.
Trimming 'equity ornaments.' The idea of reforming the tax code actually occurred in the proposal stages of the 1981 ERTA debate. President Reagan's first budget director, David Stockman, believed that the administration's supply-side policies contained economic projections that were based on overly optimistic assumptions. He proposed an idea to President Reagan as a means of countering its impact on the rising federal budget deficit. William Greider ("The Education of David Stockman," Atlantic Monthly, December 1981, www.theatlantic.com/politics/budget/stockman.htm) wrote that Stockman revealed proposals to channel additional savings by closing or reducing tax expenditures in the existing tax code. Specifically, the budget chief called many of these tax deductions "equity ornaments," and viewed trimming specific deductions, exclusions, and credits as a way to generate $20 billion in additional savings. President Reagan rejected the idea, believing it would be difficult to sell on Capitol Hill. However this pre-tax reform idea was not lost on the president, who one year later needed to find additional ways to raise revenues to counter a greater-than-expected rise in the federal budget deficit.
The deficit increased so rapidly that President Reagan had to scale back some of the scheduled ERTA rate cuts, leading to two additional tax acts: in 1982, the Tax Equity and Fiscal Responsibility Act (TEFRA), and in 1984, the Deficit Reduction Act (DEFRA). The budget deficit became a major political constraint for both parties and was central to the push for tax reform.
With the passage of TEFRA, President Reagan realized he could quietly raise taxes by scaling back or eliminating "tax expenditures" (tax deductions and credits, like that for state and local income taxes paid, that allow taxpayers to lower their tax liability) instead of increasing tax rates--'"enhancing revenues,' eliminating tax loopholes and unintended benefits, favoring compliance measures, and curtailing tax abuse" (C.E. Steuerle, The Tax Decade: How Taxes Came to Dominate the Public Agenda, Urban Institute Press, 1992). From 1982 to 1984, several bills had been introduced that dealt with tax reform. While each of these bills differed, a common theme emerged: Significantly reducing individual tax rates would broaden the tax base, making tax deductions and credits less valuable, and would make more sources of income subject to taxation (see Steuerle 2004 and Kingdon 2003).
Reducing the top marginal rate. The concept of reducing tax rates greatly appealed to President Reagan. From 1984 through 1986, the Reagan administration forged tax reform legislation through a divided Congress. The 1986 TRA is often considered a case study in presidential leadership, as the bill was considered unlikely to secure passage at various stages. President Reagan, who possessed a high public approval and a rare ability to persuade, pushed members of Congress hard for their support (Samuel Kernell, Going Public: New Strategies of Presidential Leadership, Congressional Quarterly Press, 1997). The House passed the tax reform legislation in a bipartisan effort (292 to 136), as did the Senate (74 to 23). On October 22, 1986, President Reagan signed the Tax Reform Act of 1986 into law, a crown jewel in his domestic policy legacy. The top marginal tax rate was reduced from 50% to 28%, while several tax deductions and credits were reduced or eliminated. President Reagan proclaimed that the law provided taxpayers with the "lowest marginal tax rates among major industrialized nations" (J.W. White and A. Wildavsky, The Deficit and Public Interest: The Search for Responsible Budgeting in the 1980s, University of California Press, 1989). In order to prevent a shock to the system, many deductions that were eliminated were not immediately repealed, but were phased-out over a period of three to five years.
The goal of TRA was to make the tax code revenue-neutral, meaning that as tax rates were lowered, tax deductions and credits were simultaneously pared back or eliminated, causing the overall tax burden to remain unchanged. The 1986 TRA is considered distinct compared to previous tax bills because it "attacked those special interests that have long been assumed to 'control' the tax committees" (Sheldon D. Pollack, The Failure of U.S. Tax Policy: Revenue and Politics, Pennsylvania State University Press, 1996). Likewise, the tax act can best be remembered as a major tradeoff: eliminating tax shelters (sought by Democrats), while significantly lowering individual and corporate tax rates (sought by Republicans) (Steuerle 1992).
Bush Tax Reform Panel
One of the conditions for tax reform in the 1980s was high tax rates. When President Reagan cut taxes in 1981, the highest marginal rate was 70%, and there were 14 different tax brackets. When he left office in 1989, there were only two marginal rates (15% and 28%). Today, there are six marginal tax rates (ranging from 10% to 35%). After 1986, the highest marginal rate was 39.6%, which was reduced to 35% percent in the 2001 EGTRRA (but is currently scheduled to sunset and revert to 39.6% on January 1, 2011). Marginal income tax rates since 1986 TRA have been held to historically low levels. Nonetheless, because of the sunset provisions of EGTRRA and JGTRRA, these rates will increase in 2011 if no legislative action is taken. President Bush attempted, but failed to make his tax cuts permanent.
Besides the significant tax legislation discussed above, President Bush also attempted reforming the tax code by appointing the President's Advisory Panel on Tax Reform in 2005.
While the panel's final recommendations never translated into legislation, some of its central findings were noteworthy and might find fertile ground in the next administration. Three broad problems cited in the panel's report include the following:
Taxpayers cannot plan ahead. Several tax provisions, rates, credits, and so forth, in the tax provisions, rates, credits and so forth, in the tax code are temporary in nature (i.e., subject to a specific expiration date). Many of the provisions contained in the 2001 and 2003 tax bills are temporary; the majority of these tax cuts are set to expire after December 31, 2010. The panel argued that this uncertainty contributes to potentially unwise tax planning and the waste of economic resources.
The code treats similar taxpayers in different ways. The availability of various provisions in the tax code is inconsistent for many taxpayers. For example, the panel noted that taxpayers residing in states with high state income and property taxes receive, on average, greater deductions than taxpayers residing in lower-tax states. In addition, taxpayers who participate in employer-provided health insurance receive the amount on a pre-tax basis while "those who buy the same health insurance on their own usually pay tax on the income used to purchase the insurance."
The code treats similar income differently. The marginal income tax rates are progressive in that, as one's income increases, it is taxed at a higher rate (up to 35%). The panel argued that this becomes more complicated by various income ceilings on tax deductions and credits. For example, there is an adjusted gross income (AGI) limitation on itemized deductions as well as the standard deduction, the child tax credit, education tax credits, tuition tax deduction, individual retirement accounts, and many other provisions. The higher one's AGI, generally, the less one's ability to qualify for certain tax deductions and credits. The panel cited the reasoning for such treatment: "One can earn before claiming certain deductions and credits is to target the benefits to those perceived to have the greatest need ... creat[ing] a set of counterintuitive and counterproductive economic consequences that may keep many families from trying to earn more than they currently do."
Lastly, the panel recommended complete repeal of the alternative minimum tax. The report did serve as the first major attempt since 1986 to undertake federal tax reform, but political constraints prevented the Bush administration from making the issue a priority on its legislative agenda.
Will the Next President Reform the Tax Code?
The next president may have a rare opportunity to make a major impact on tax policy for years to come. The next year presents a perfect storm that may accelerate tax proposals into law. First, a new president possesses political capital early in his term, particularly with respect to economic policies, that can often be used to pass items on the legislative agenda. Second, the expiring Bush tax cuts and the AMT issue alone will significantly impact taxes for the next decade. Each year, Congress has passed one-year patches, raising the AMT exemption amount. If the AMT were to be repealed, it could cost the government an estimated $750 billion through 2016, should the Bush tax cuts expire after 2010, and $1.3 trillion if the Bush tax cuts are extended (Len Burman, Julianna Koch, and Greg Leiserson, "The Individual Alternative Minimum Tax (AMT): 11 Key Facts and Projections," Tax Policy Center, December 1, 2006, www.taxpolicycenter.org/publications/url.cfm?ID=1001046). Each presidential candidate wishes to handle the expiring tax cuts by holding them in place for middle-income taxpayers, but McCain's plan would also keep the Bush tax cuts for higher-income taxpayers while Obama's plan would revert to the pre-Bush rates for higher-income taxpayers.
In the author's opinion, the most salient approach in 2009 to handling this perfect storm is to overhaul the entire tax code, not add to it. There are so many equity ornaments that have been added since 1990 that are most likely quite important to individual taxpayers and the political interest groups that influenced their insertion into legislation. By eliminating many of these deductions and credits, lawmakers may be able to raise the standard deduction and personal exemption amounts. Such an effort could dramatically simplify the tax code and offset the revenue loss from repealing the AMT or holding tax rates at their current levels. Some tax deductions, including the deduction for state and local income taxes, could be targeted for repeal. (It was targeted in 1986, but survived.) Many tax provisions are social and economic in nature, but the time and cost associated with recordkeeping and preparing the tax return may exceed the benefit received. There has even been the idea of simplifying tax filing to the point that millions of filers would not need to file a tax return, because many of their items of income and deductions are in the IRS's database.
When President Reagan moved the 1986 TRA though Congress, tax rates were much higher than they are today; he used the reform bill to significantly lower rates. This time, the reform effort would most likely be focused on eliminating or significantly adjusting the AMT, while holding individual tax rates in place. The next president of the United States will face some of the most important issues facing this nation in years. By moving on tax reform in the first year (particularly during the first 100 days), he may have an opportunity to reform the tax code in ways that make it simpler, fairer, and more equitable.
Benjamin R. Silliman, CPA, EdD, MAcc, MTax, is an assistant professor in the department of accounting and taxation at the Peter J. Tobin College of Business, St. John's University, New York, N.Y.
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|Title Annotation:||In Focus|
|Author:||Silliman, Benjamin R.|
|Publication:||The CPA Journal|
|Date:||Nov 1, 2008|
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