Surprise! Tax reform still on hold

Broad outlines of the debate over comprehensive tax reform are starting to emerge on Capitol Hill. The discussion, however, won’t begin in earnest until President Barack Obama weighs in, something he may not do until next year’s election campaign.

“The White House has got to lead on tax reform,” said Dean Zerbe, managing director of alliantgroup LP, a specialty tax service. “You’re not going to get anywhere without the president moving forward. That’s true on deficit reduction and tax reform.”

Neither the White House nor congressional Republican leaders have offered a concrete plan for tax overhaul, an issue that has gained momentum during the parallel debate on deficit reduction.

Last week, Rep. Dave Camp, R-Mich., chairman of the House Ways & Means Committee, called for a top individual and corporate rate of 25%, down from the current 35%. It was a trial balloon designed to set a parameter. Mr. Camp’s staff does not know when he might offer a legislative proposal.

On the other end of the spectrum, Rep. Jan Schakowsky, D-Ill., last week introduced a bill that would establish new tax brackets for income greater than $1 million. People making between $1 million and $10 million would have to pay a 45% rate; those making $1 billion and over would be taxed at 49%.

Beyond the ideas put forward by Mr. Camp and Ms. Schakowsky, there is a laundry list of bills that would do everything from making permanent the Bush tax cuts that were extended for two years in December, to abolishing the estate and alternative minimum taxes, to doing away with the income tax altogether.

None of these proposals is likely to gain immediate traction. Whenever Mr. Camp crafts a bill, he will have to get his colleagues in the Republican House majority on board. Even if it were to pass the House, it likely would face stiff resistance in the Democratic-majority Senate.

It’s difficult to see how Ms. Schakowsky’s proposal ever would make it out of the House.

When it comes to taxes, Congress has begun proposing but is likely to wait for input from the other end of Pennsylvania Avenue before it starts disposing.

“You’re not going to see the Congress want to make hard choices without the administration being in the dance,” Mr. Zerbe said.

It may take a while for the music to play — perhaps even until the late-starting presidential election is fully engaged next winter.

In the meantime, the parties will continue laying the tax policy groundwork.

“House Republicans are staking out a position that is clear and are articulating crisply what they will take to voters in 2012,” said Clint Stretch, managing principal of tax policy at Deloitte Tax LLP. “The task for Democrats is to come up with their competing vision so that voters can have a choice.”

Ms. Schakowsky’s idea might rally the Democratic liberal base. It’s not clear whether it will become part of a broader Democratic tax strategy.

“It’s questionable whether you can sustain those rates politically,” Mr. Stretch said. “Democrats have to struggle with basic questions of rate and base.”

Mr. Camp’s proposal also would pose a challenge for his party. If the top rate is going to come down by 10%, favorable tax treatment for capital gains, dividends, retirement plans and cash buildup in insurance policies likely would have to end.

The congressional Joint Committee on Taxation estimates that between fiscal years 2009 and 2013, shielding contributions to 401(k) plans would cost the government $184.3 billion, excluding employer-sponsored health care benefits would total $568.3 billion, and providing tax-deferred buildup of cash value in life insurance and annuity contracts would amount to $158.8 billion.

“Those are big numbers that have to be on the table if you’re going to 25% in a revenue-neutral way,” Mr. Stretch said.

Capital gains and dividends also would take a tax hit under such a plan, he said. Currently, both are taxed at 15%. But the rate likely would rise to the top individual level in order to avoid a huge revenue loss.

It’s too early, however, to start tolling the bells for tax expenditures. Congress had difficulty extending the Bush tax cuts last year. Taking on bigger tax issues this year is probably unrealistic, even within the context of deficit reduction
— an issue Congress is tackling now.

“It won’t be about fundamental tax reform, which is where we will get into elimination of tax expenditures,” said James Delaplane Jr., a partner at Davis & Harman LLP. “I would be surprised if really core attacks on tax incentives like inside buildup come in 2012.”

In the meantime, investment advisers find themselves guiding clients through a tax thicket that is set to change again when the Bush tax cuts expire next year.

“If you make tax laws one to two years at a time, it’s hard to plan around them,” said E. Michael McGervey, president of McGervey Wealth Management LLC. “Who knows what is going to happen.”

Mr. McGervey said that his clients are wary of the tax conversation in Washington, especially if it focuses on increasing the rates for the top brackets, which already account for nearly three-quarters of tax revenue.

“The wealthy are paying their fair share,” Mr. McGervey said. “I’m not sure [raising the rates] is fair to people who create jobs.”

Hanging over the tax debate is the red ink gushing out of the government budget. Gary Gilgen, director of financial planning at Rehmann Financial, doubts that Congress will have the wherewithal to undertake the kind of entitlement reform required to address the $1.6 trillion deficit.

“We’re going to see higher tax rates and a significantly reduced value of the dollar,” Mr. Gilgen said. “What’s coming is hyperinflation and a stagnant economy.”

If that prediction comes true, it’s unlikely that the problems will be addressed until after the presidential election.