Even though the conventional wisdom in Washington is that Congress won't get around to major tax reform until after the presidential election, financial and insurance companies, and adviser groups are working feverishly to build the foundation for that policy battle.
In the next year or so, the only tangible sign of progress is likely to be hearings. But what is going on behind the scenes is an effort to frame the debate in a way that protects favorable tax treatment for retirement savings and the buildup of cash value in insurance products.
Meanwhile, the Obama administration has indicated that it wants to launch corporate tax reform. In anticipation, the Financial Planning Association is plying Congress in defense of small firms organized as partnerships and S corporations.
So-called tax expenditures like those for retirement and insurance products, which collectively total more than $1 trillion annually, are on the table for review, if not yet on the chopping block, as Congress begins wrestling with ways to reduce the burgeoning federal deficit and debt.
“Any time something like this is brought up for discussion, you have to be on the offensive,” said Robert L. Reynolds, chief executive of Putnam Investments, who has made defending retirement savings vehicles such as 401(k) plans a priority.
Congress and the administration have struggled over the past few months to achieve modest levels of deficit reduction. Overhauling the tax system is something that would take months — or even years — of work.
But a recommendation last winter by the presidential deficit commission to eliminate all tax expenditures as a way to reduce the deficit and lower rates across the board has Democrats and Republicans alike at least talking about the issue and inserting it into legislation.
“It's not a good time to be complacent,” said Judy Miller, chief of actuarial issues and director of retirement policy at the American Society of Pension Professionals and Actuaries.
She is trying to persuade lawmakers not to swing the deficit-reduction scythe at retirement products.
“Plans are being made and positions being taken,” she said. “If we were to wait until after the election, it would be too late.”
John Little, chief operating officer and senior vice president for federal affairs at the Insured Retirement Institute, has conducted more than 100 meetings on Capitol Hill since January to protect cash buildup within annuities and life insurance from immediate taxation. “We want to play good, strong defense and get ahead of everything,” he said.
When full-fledged tax reform starts, “it's not the first time we're talking to them,” Mr. Little said.
TAX DEFERRALS
In his visits with members of Congress, Mr. Reynolds tries to change the thinking about tax expenditures. First, he wants lawmakers to consider costs beyond the usual 10-year window in which most budgets are written, and he wants them to stop thinking of tax breaks for retirement savings as expenditures in the first place.
Those who establish 401(k) accounts can put money into them for a 10-year budget period tax-free, he noted. But when they withdraw the funds for their retirement in 30 years, they will have to pony up to Uncle Sam.
“The thing Washington is missing in this whole discussion is that these are tax deferrals,” Mr. Reynolds said. “The government collects all the taxes on this money.”
More important is that the retirement products meet a critical need, Mr. Reynolds said. The nest eggs of millions of people were shattered during the financial crisis.
“Anything in the way of personal savings, to me, is a crime,” he said. “Having a tax deferral encourages people to save.”
Retirement tax expenditures totaled $117.7 billion in 2008. Still, there are signs that Congress isn't in a mood to rip them up and start over.
Sen. Dan Coats, R-Ind., and Sen. Ron Wyden, D-Ore., introduced a tax reform bill last month that attempts to bring many of the deficit commission's proposals to life.
Just as the deficit panel carved out something of a safe harbor for retirement savings — allowing the lesser of 20% of pay or $20,000 annually to be set aside without taxation — the senators included provisions for favorable tax treatment for retirement savings.
“They kept 401(k) plans in place,” Ms. Miller said. “That's a hopeful sign.”
The insurance industry seeks similar acknowledgement in future legislation for annuities and life insurance, expenditures for which are estimated to total $158.8 billion between 2009 and 2013.
“We think we should be lumped in with the other retirement products,” Mr. Little said.
“We're very similar,” Ms. Miller said. “That's why the incentives are there for our products.”
The Wyden-Coats bill hasn't yet garnered co-sponsors and may be a long way even from a hearing. Movement on corporate tax reform may be faster, coming as soon as the summer.
The FPA wants to make sure that sole proprietorships, small partnerships and S corporations that are taxed through an individual's return aren't crushed in the stampede to lower the top corporate rate by eliminating credits and deductions.
“The problem is that if you get rid of those credits, and pass-throughs don't get a reduction in their rates, they've gotten a de facto tax increase,” said Phillips Hinch, the FPA's assistant director of government relations.
The organization signed onto a May 11 letter from several business groups to the leaders of the Senate and House tax-writing committees asserting that small businesses are the primary job creators in the economy and pay more in taxes “than all the publicly traded corporations combined.”
Rep. Dave Reichert, R-Wash., has introduced a bill that would streamline S-corporation taxation. He intends to be one of their champions on the House Ways and Means Committee.
“I believe that tax reform should address both the corporate and individual rates,” he wrote in an e-mailed statement. “It's insufficient to focus solely on corporate tax reform when so many small businesses, the backbone of our economy, pay individual rates.”
Although corporate tax reform may proceed, overhauling the whole code will have to be fueled by the presidential election, observers agree.
“One party needs to feel it has gotten the stamp of approval from voters to move ahead,” Mr. Hinch said.
E-mail Mark Schoeff Jr. at [email protected].
