Now that
sequestration is a reality, Congress and the President already are moving on to
the next big thing. Tax reform appears to be capturing the interest of the
Congressional tax writing committees — the House Ways and Means Committee and
the Senate Finance Committee. Rep. Dave Camp (R-MI), Chair of Ways
and Means, announced on March 11, 2013, that he is pursuing a full-blown effort
to reform and simplify the tax code. He states that “[t]he current tax code is
a nightmare. It’s too complex, too costly and riddled with too many loopholes.
Clearly, we need to close loopholes and fix the tax code. It should be simpler
and fairer for families and it should help create more jobs and higher
paychecks.” See his press release at http://camp.house.gov/news/documentsingle.aspx?DocumentID=323220.
The question is whether
Congress can accomplish the lofty goal of tax reform, given its recent, poor track
record in handling the budget deficit? (Tax increases were imposed on the
“wealthy” and tax cuts were made permanent in ATRA 2012 – see my previous blog
at /2013/01/house-and-senate-pass-fiscal-cliff-relief.html#more – and sequestration
was allowed to take effect.) The answer lies within the ability and willingness
of the President and the Congress to compromise and not only tackle tax reform,
but also wrestle with the spending demons that haunt our country. In this
author’s humble view, all spending must be addressed, including the
hyper-sensitive areas involving “entitlements”, such as Social Security,
Medicare and Medicaid.
These items were on
the table when the Joint Select Committee on Deficit Reduction (the “super
committee”) unsuccessfully attempted to marry spending cuts with tax increases
in November 2011. Now, it appears that Congress is going to brawl over the
significant issues the super committee was unable to handle.
Tax reform
necessarily will have to deal with corporate tax reform. In fact, this was the first item on Rep. Camp’s agenda last when tax reform
resurfaced. Many of our trading partners
tax their corporations at much lower rates, and only on income earned within
their territories. In contrast, our system taxes the worldwide income of
corporations. How do our trading partners get away with this? Most likely,
foreign tax rates are lower because foreign also assess a form of consumption
or national sales tax, known as a value-added tax (“VAT”). What is the likelihood of our Congress
enacting a VAT to enable lower corporate tax rates? The issue has been debated for decades, and
likely will be debated in the wake of recent tax reform, but enactment of a VAT
does not appear likely in the near term.
To achieve corporate
tax rate reductions, Congress likely will have to raise revenue by eliminating
certain subsidies businesses currently enjoy. The largest business tax
subsidies include accelerated depreciation for equipment, the ability of
multinational corporations to defer their foreign income in certain cases, and
various tax accounting deductions and credits.
What about individual
tax reform? The tax code was made even
more complex in ATRA 2012 (e.g., now we have 7 individual tax brackets, instead
of five before the tax law was amended). How do you really grapple with tax
reform without making some very hard choices? Which tax expenditures (i.e., deductions,
exemptions, exclusions, credits, etc., and other subsidies and loopholes) will
be discarded and which will be retained?
Again, to simplify
and reduce tax rates, deductions, exemptions, exclusions and credits will have
to be eliminated. The largest single tax subsidy individuals enjoy is the
ability to exclude the cost of employer-provided health care from their
incomes. Another huge tax subsidy relates to the ability to contribute to
qualified retirement plans and defer the earnings until retirement. Yet another
subsidy is the ability to avoid income taxation on the inside build-up of cash
surrender value in life insurance policies and the further ability to withdraw
the appreciation from the policies tax-free before death. If these sacred cows
are not on the chopping block, then will Congress further cut back the mortgage
interest deduction, charitable contribution deductions, reduced rates on
capital gains and dividends, child care credits, and other tax subsidies to pay
for meaningful tax reform?
Congress must struggle
with these and other questions in the coming months. As a tax lawyer, you would think I would be
opposed to reforming and simplifying the tax code. After all, I make my living
finding legal ways to reduce taxes in this byzantine system. Nothing could be further from the truth. If
we can cut the deficit by coupling meaningful spending reductions, including
entitlement spending, with tax increases and simplification, I am completely on
board with that approach. We all should be. The future of our children and
grandchildren depend on making some tough decisions and choices. Everyone will incur some pain, but the
long-term, positive effects on our economy and society will far exceed the
short-term sting we must incur from these important choices.
For more information on tax reform and tax
planning, please email me at wayne.zell@ofplaw.com or call me at 703-218-2177.