No reduction in individual rax rates appears likely in 2007. Although some Democrats favor rate decreases for middle and lower-income individuals, Mr. Bush has long been a proponent of across-the-board decreases. Conversely, tax increases for high income individuals also appears improbable at the present, despite vocal support from some Democratic leaders, including incoming House Majority Leader Speaker Nancy Pelosi (D-Calif.).
Senator Clinton recently remarked that “[t]ax cuts are not the cure-all for everything that ails the American economy.” Nevertheless, Ms. Clinton has also implied that tax increases should be imposed on wealthier Americans, despite the strong economy and stock market, and low unemployment. Ms. Clinton has long called for increased government spending on health care and education, which would require new revenues.
Senator Clinton voted against, and Senator McCain (R-Ariz.) for, cutting taxes by $1.35 trillion over 11 years in 2001. On other tax issues, the Senators have parallel voting records. In 2003, both voted against a $350 billion tax cut and against extending the preferential rates for capital gains and dividends. However, Mr. McCain on other occasions has expressed support for a lower capital gains rate. Senator McCain also favors a flat tax of 15% for all middle-class Americans. In 2001, both voted in favor of eliminating the marriage tax penalty and increasing tax deductions for college tuition. In the past, both Senators have also expressed interest in maintaining the estate tax with a higher exemption amount of about $5 million, although Ms. Clinton’s position on this issue is no longer clear. President Clinton strongly opposed elimination of the estate tax.
Rep. Charles B. Rangel (D-NY), new chairman of the tax-writing House Ways and Means Committee, recently remarked that Democrats do not favor “retroactively rolling back the tax cut,” but would permit the tax incentives to remain effective until their scheduled expiration in 2010. Mr. Rangel stated that he “cannot think of one tax cut” he would extend beyond 2010. Representative Rangel, among others, also favors a sweeping revision of the alternative minimum tax (AMT).
Mr. Rangel also favors “ending tax shelters that move jobs overseas.” However, Representative Rangel — although clearly opposing an extension of lower capital gains and dividend rates — may not actually seek vast changes in tax policy, at least until after 2008. Mark Bloomfield of the Economic Council on Capital Formation believes that Mr. Rangel will be a “centrist legislator” who “understands the importance of economic growth.”
In contrast to the themes expressed by Senator Clinton and Representative Rangel, Rep. Nancy Pelosi (D-Calif.), who will preside as the new Speaker of the House, has urged immediate tax relief for some, recently stating that “[w]e will revisit the tax cuts at the high end in order to give tax cuts to the middle class.” Representative Pelosi believes that tax rates for individuals whose incomes are $250,000 or higher should be rolled back to Clinton era levels. Ms. Pelosi has also vowed to seek an end to “tax subsidies” for oil companies, and has criticized what she terms “Republican tax breaks for the super rich that have led to a budget that is grossly out of balance and a national debt that is morally indefensible.”
The Democratic Congress will probably focus on providing relief for lower and middle-income families. Non-controversial initiatives such as a child credit, a lower tax rate of 10% for low-income taxpayers, and relief from the “marriage penalty” appear to interest most Democrats. Many in Congress, both Democrats and Republicans, also favor reducing the burden of the AMT, whose reach now extends to a far greater number of taxpayers than initially intended. However, shifting the entire AMT burden to high-income taxpayers and corporations would be difficult, because expected federal tax revenues currently rely on AMT projections. Reducing the burden of the AMT could cost the government $1 trillion over ten years.
The ultimate fate of most tax cuts enacted under President Bush will likely not be decided until after 2008. If a Democrat is elected, lower capital gains and dividend rates will probably terminate in 2010. However, the same could be true even if a Republican is elected. Prominent Democratic House leaders, including Representative Pelosi, have expressed support for raising income tax rates of high income individuals. However, many other newly-elected Democratic House members may not support any increase in IRC § 1 tax rates, even for taxpayers who earn $250,000 or more. Assuming such a measure could clear the House, the Senate would likely approve.
The estate tax, scheduled to expire in 2010 — but for only a year — would, if nothing were done, return in 2011 with a pre-EGTRRA exemption amount of $1 million. The current exemption of $2 million is scheduled to increase to $3.5 million in 2009. Congress may decide to increase the exemption to $4 or $5 million, and perhaps reduce the present tax rate which can reach as high as 47%. A reduction in the rate of estate tax to 20% or 25% has been discussed. However, the estate tax currently generates significant revenues, and at some point, increasing the exemption while decreasing the tax rate would eviscerate the tax. Therefore, permanent repeal of the estate tax, or a dramatic decrease in the rate of tax appears remote in the foreseeable future. On the other hand, relief from the estate tax burden for closely held businesses and farms appears likely.
The gift tax, never slated for elimination, provides a $1 million lifetime exemption. The tax rate imposed on taxable gifts in excess of that amount is scheduled to decrease to 35% in 2010. However, like the estate tax, if no legislative action is taken, the rate will revert to 47% on January 1, 2011.
The probable reluctance of the new Congress to raise income, capital gains, or dividend rates before 2008, will likely lead Congress to seek other revenue-producing measures. Many Democrats favor closing some tax-shelter loopholes, as well as eliminating tax incentives for multinational and oil companies.
The Joint Committee on Taxation has considered ways of increasing federal tax revenues to close the estimated $290 billion tax gap. One proposal by the Committee, prepared at the request of Senate Finance Committee Chairman, Charles Grassley (R-Iowa) and Senator Max Baucus (D-Iowa), calls for rules requiring brokers to report the adjusted basis of publicly-traded securities sold during the preceding taxable year to the IRS. This measure, which brokers would surely oppose, would produce new records which could document significant capital gains. The IRS estimates that underreporting of capital gains resulted in $11 billion in uncollected taxes in 2001. Since new reporting requirements would be difficult to administer with respect to existing accounts, the suggestion has been made that the new rules be prospective in nature. Senators Grassley, Baucus and Bayh (D-Indiana) have introduced basis reporting bills this year.
The Joint Committee also recommended changes in the mortgage interest deduction allowed to homeowners when refinancing. Points associated with refinancing must be prorated over the life of the loan. Interest on home equity loans of up to $100,000 is deductible. The Committee proposes rules to clarify the limits and timing of deductions, since it believes that some taxpayers may be claiming more deductions than are allowed.
Finally, the Joint Committee report proposed changes in the manner in which S corporations pay self-employment tax. Currently, S corporations owned by family firms may pay family members a salary and distribute remaining profits as a dividend. Such dividends are not currently subject to self-employment tax. The Committee report proposes that S corporations be subject to the same rules regarding self-employment tax as are currently applicable to partnerships and sole proprietorships.