Wednesday, September 5, 2007

Prospects for Tax Reform in the Next Administration

In November 2008, Americans will elect a new president, a new House of Representatives, and a third of the Senate. A new administration provides an opportunity to review, renew, modify, or repeal existing legislation. Taxes are always on the minds of voters, politicians, investors, businesses, and workers. What will the next administration bring? Key items on the political agenda include expiration of President Bush’s tax cuts—cuts in marginal rates, capital gains, and dividends— that were enacted in June 2001, but are due to expire at the end of 2010, addressing the alternative minimum tax (AMT), the parallel income tax that imposes a minimum level of taxes on high-income individuals but which is ensnaring millions of middle-income taxpayers in its net, and the campaign promises of the next president.

Since President Reagan signed the Tax Reform Act of 1986, subsequent legislation has proliferated new provisions and added thousands of additional pages of explanation and interpretation. Federal income tax forms for individuals number in the hundreds and the explanations for completing many of them are lengthy and often unintelligible. The tax gap, the difference between what is owed in law and collected is estimated around $300 billion. Compliance costs exceed $100 billion. Thousands earn their living assisting individuals with tax planning and reporting. Although politicians rail against the complexity of the tax code, they rarely enact real simplification.

What do the Democratic and Republican candidates for president propose? Most political analysts expect Democrats to retain control of both houses of Congress. A Democratic president is thus more likely to succeed than a Republican in enacting her/his campaign promises. The candidates’ official web sites, statements made on the campaign trail, and past votes provide sources of information.

The three leading Democratic candidates are Hillary Clinton, Barack Obama, and John Edwards (which assumes that Al Gore will not enter the race). Hillary Clinton, the prospective nominee, has not offered any details on her income tax policy in speeches, press releases, or web site. She suggests reducing, but not repealing, the AMT. She voted against repeal of and raising the estate tax exemption to $5 million. She objected to the Bush tax cuts on income, dividends, and capital gains, but has not yet said if she would allow its provisions to expire, in whole or in part. On a separate matter, Social Security, she has questioned the $100,000 income limit subject to payroll tax.

Barack Obama is more specific in his statements, though taxation is not an issue topic on his web site. Having voted against Bush’s tax cuts, Obama propose unspecified reductions to pay for health and other programs. He objects to repeal, and a higher exemption, of the estate tax. He supports unspecified tax incentives to create jobs in the U.S. instead of offshore.
Edwards, alone among the first tier, includes the issue of taxation on his web site. He advocates repealing the Bush tax cuts to pay for universal health care, supports tax preferences for the middle class (savings tax credit, expanded child care credit, increase in the earned income tax credit, reduction in the marriage penalty, and tax deductions for college tuition). The unlikely remaining candidates, Joe Biden, Chris Dodd, Mike Gravel, Dennis Kucinich, and Bill Richardson, agree on retaining the estate tax, raising rates on income, capital gains, and dividends, and favoring middle class cuts.

Among leading Republicans, none has posted their positions on taxation. Rudy Giuliani favors unspecified low rates, a lower AMT, and repealing the estate tax. Romney supports the elimination of tax on capital gains, interest, and dividends for an unspecified middle class, and has pledged no new taxes. Thompson speaks about unspecified low rates and reform to keep the U.S. economy competitive. Despite having voted against the Bush tax cuts in the first instance, John McCain, whose campaign has faltered, now supports their extension and favors repeal of the estate tax. Among second tier candidates, only Tom Tancredo and Mike Huckabee have posted details on their sites. Both support the "Fair Tax," a 34 percent retail sales tax in place of both income and payroll taxes. Sam Brownback supports an alternative flat tax.

What can we surmise from this review about the prospects for broad tax reform in the next administration? A Democratic president is likely to claw back some or all of the Bush tax cuts, especially for upper-income households, retain the estate tax will be retained, perhaps with a several million dollar exemption and slightly lower rates. If the AMT is reduced or repealed, the lost revenue will have to be replaced with higher taxes on income. A Democratic administration and Congress are likely to increases rates on capital income and earnings of high-income persons. Should a Democratic president address Social Security, she/he may propose increasing the level of income subject to payroll tax.

A Republican president will emphasize extending the Bush tax cuts. A compliant Congress could compromise on this, retaining some, but not all, of the reductions. That no top-tier candidate is proposing bold reform means that a Republican administration would tinker with, but not overhaul, the tax code. From the vantage of just over a year before the election, prospects for the next administration suggest higher rates and more complexity. Real reform and simplification will remain a will-o’-the-wisp for some years to come.

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