brown advisory taxes and the elective process from the campaign trail to the sausage factory may 20,...

Brown AdvisoryBrown Advisory

TAXES AND THE ELECTIVE TAXES AND THE ELECTIVE PROCESSPROCESS

From the Campaign Trail to the Sausage From the Campaign Trail to the Sausage FactoryFactory

May 20, 2008May 20, 2008

John E. ChapotonJohn E. ChapotonAlice S. PaikAlice S. Paik

Brown AdvisoryBrown AdvisoryWashington, DCWashington, DC


Summary:Summary:

I. The setting in which the tax issues are being I. The setting in which the tax issues are being presentedpresented

II. The positions of the candidatesII. The positions of the candidates

III. The impact of the budget deficit on the next III. The impact of the budget deficit on the next presidentpresident

IV. What will happen?IV. What will happen?


I. I. The setting in which the tax issues are The setting in which the tax issues are being presentedbeing presented


Taxes – the immediate issuesTaxes – the immediate issues

Two events will force the new president to act on taxesTwo events will force the new president to act on taxes ::

– The expiring Bush tax cutsThe expiring Bush tax cuts

– The spreading AMT “blob”The spreading AMT “blob”

The next president must have positions on bothThe next president must have positions on both

– Each candidate doesEach candidate does

– But the ground is shifting as we speakBut the ground is shifting as we speak

And of course the candidates are advocating other tax changesAnd of course the candidates are advocating other tax changes

– That’s what candidates do….That’s what candidates do….

2


Tax confusion – sunset of the Bush tax cutsTax confusion – sunset of the Bush tax cuts

3

Tax legislation Tax legislation Rate Through 2010 Rate Through 2010 Rate After 2010Rate After 2010

Tax rate on dividendsTax rate on dividends 15%15% up to 39.6%up to 39.6%

Tax rate on LT capital gainsTax rate on LT capital gains 15%15% 20%20%

Individual Income Tax RatesIndividual Income Tax Rates 10%10% 15%15%

15%15% 15%15%

25%25% 28%28%

33%33% 36%36%

35%35% 39.6%39.6%

Estate TaxesEstate Taxes Top rate falls from current Top rate falls from current 55%55%

rate of 45% to 0% in 2010rate of 45% to 0% in 2010

Gift TaxesGift Taxes Top rate falls from Top rate falls from 55%55%current rate 45% current rate 45%

to 35% in 2010to 35% in 2010

Bush Tax Cuts & Sunsets: Current Law


Understanding the budget figuresUnderstanding the budget figures

OMB (the Office of Management & Budget – i.e., the OMB (the Office of Management & Budget – i.e., the Administration) produces a budget projection each yearAdministration) produces a budget projection each year– The past years reflect actual numbersThe past years reflect actual numbers

– The future years reflect the then current Administration’s policy The future years reflect the then current Administration’s policy proposals – however unlikely adoption might be – and the economic proposals – however unlikely adoption might be – and the economic impact thereofimpact thereof

CBO (Congressional Budget Office also produces a budget CBO (Congressional Budget Office also produces a budget projection each yearprojection each year– Assumes current law will remain unchanged for future years, however Assumes current law will remain unchanged for future years, however

unlikely that assumption isunlikely that assumption is

– CBO estimates are supposed to be untainted politically, but they are CBO estimates are supposed to be untainted politically, but they are also unrealistic in a sensealso unrealistic in a sense

4


Understanding the budget figures Understanding the budget figures (% of GDP)(% of GDP)

OMBOMB CBO CBO

Receipts

19.0

18.2

17.5

20.9

17.6

18.8

Outlays

21.7

21.3

22.1

18.4

20.5

18.5

Surplus/

Deficit(-)

-2.7

-3.1

-4.7

+2.4

-2.9

+0.3

Surplus/Deficit(-)

-2.7

-3.1

-4.7

+2.4

-2.5

+0.6

Year

1980

1988

1992

2000

2008E

2012E

Receipts

19.0

18.1

17.5

20.9

17.9

20.0

Outlays

21.7

21.2

22.1

18.4

20.4

19.4

Source: CBO; Joint Committee on Taxation5


Budget impact of extending the Bush tax cutsBudget impact of extending the Bush tax cuts

Individual tax ratesIndividual tax rates::Present law: 10%-35%Present law: 10%-35%2011:2011: 15%-39.6% 15%-39.6%

Cap gains & dividends:Cap gains & dividends:Present Law:Present Law: 15%15%2011-(LTCG):2011-(LTCG): 20%20%

(Div): (Div): 39.6%39.6%

(2008-2017)

-$1.22 Trillion*

-$208.5 Billion*

*Source: CBO; Joint Committee on Taxation

10-yr Budget Impact of keeping Bush rates

6


Budget impact of extending the Bush tax cuts Budget impact of extending the Bush tax cuts (cont’d)(cont’d)

Estate Tax/Gift TaxEstate Tax/Gift TaxPresent law: Present law:

2008-09:2008-09: 45%;$2M($3.5)/45%;$1M45%;$2M($3.5)/45%;$1M

2010:2010: Repeal/35%;$1MRepeal/35%;$1M

20112011 55%;$1M/55%;$1M55%;$1M/55%;$1M

10-yr Budget Impact* (2008-2017)

(Billions)Possible legislative changes effective 2010:

1. Repeal estate tax….………………………………………..........-$498.8

2. $5M exemp./cap gains tax rate…(i.e., McCain)...………….......-$400.9

3. Same as #2, but 30% tax rate >$25M ….………………….........-$366.6

4. $3.5M exemp./45% tax rate.....(i.e., Clinton & Obama)………..-$231.9

(all dollar amounts indexed for inflation)

*Source: CBO; Joint Committee on Taxation– baseline is 2011 law7

Brown AdvisoryBrown Advisory 8


The Alternative Minimum Tax “Blob”The Alternative Minimum Tax “Blob”AMT originally designed (1969) to guarantee that high income AMT originally designed (1969) to guarantee that high income individuals pay some minimal level of taxindividuals pay some minimal level of tax– Excessive use of tax “preferences” (accel. depr., % depl., etc.) would Excessive use of tax “preferences” (accel. depr., % depl., etc.) would

trigger the AMTtrigger the AMT

It morphed into something quite differentIt morphed into something quite different– Exemptions were not indexed, so coverage has explodedExemptions were not indexed, so coverage has exploded

1970 -- 20,000 taxpayers affected1970 -- 20,000 taxpayers affected2007 – 23.4 million taxpayers (without stopgap “patch” legislation)2007 – 23.4 million taxpayers (without stopgap “patch” legislation)A third or more of taxpayers could eventually be coveredA third or more of taxpayers could eventually be coveredEncroaching on middle income taxpayersEncroaching on middle income taxpayers

– The top two “preferences” are now the personal exemption and state The top two “preferences” are now the personal exemption and state and local taxesand local taxes

Is having a large family or living in a high-tax state a tax avoidance Is having a large family or living in a high-tax state a tax avoidance technique?technique?Ridiculous that the tax system penalizes such situations Ridiculous that the tax system penalizes such situations

9


The Alternative Minimum Tax (cont’d)The Alternative Minimum Tax (cont’d)

Politicians hate it because their constituents hate itPoliticians hate it because their constituents hate it

But…repeal would dig a $668 billion hole in the budget over But…repeal would dig a $668 billion hole in the budget over 10 years (2008-2017)*10 years (2008-2017)*– And politicians have opted to allow a stealth tax increase vs. repeal And politicians have opted to allow a stealth tax increase vs. repeal

and having to deal with the issues that would present and having to deal with the issues that would present

Temporary legislated “patches” are applied to contain the growth Temporary legislated “patches” are applied to contain the growth of coverageof coverage

– And there’s the little-mentioned fact that repeal would be regressive – And there’s the little-mentioned fact that repeal would be regressive – benefiting only upper income and some middle income taxpayers benefiting only upper income and some middle income taxpayers

A problem for Clinton or Obama?A problem for Clinton or Obama?

*Assumes sunset of Bush tax rate cuts; if rates are extended, which seems likely, cost of AMT repeal would almost double. Stated differently, the pickup from the AMT hides the true revenue cost of the Bush tax cuts

10


II. The positions of the candidatesII. The positions of the candidates


The Candidates Step Forward… The Candidates Step Forward… -- positions on Bush tax rates & AMT-- positions on Bush tax rates & AMT

Hillary ClintonHillary Clinton

Repeal Bush tax Repeal Bush tax cuts for top two cuts for top two brackets (brackets (i.ei.e., ., reinstate 36% & reinstate 36% & 39.6% brackets)39.6% brackets)

Phil debatePhil debatepledge: no taxpledge: no taxincrease for increase for Incomes < $250,000 Incomes < $250,000

AMT – Prevent its AMT – Prevent its SpreadSpread

Barack Obama

Same as Hillary

Virtually same as Hillary (<$200,000?)

AMT -- Prevent its spread

John McCain

Extend Bush tax cuts in toto

AMT – Full repeal

11


The Candidates Step Forward… The Candidates Step Forward… -- positions on capital gains, dividends, -- positions on capital gains, dividends,

E&GE&G

CapitalCapital

GainsGains

DividendsDividends

E & G E & G TaxTax

Obama Increase to 28%, or recently 20% 0% rate for start-up businesses Low rate for sale to farmers

Return to ordinary income rates

Freeze ‘09 estate tax: 45%/ $3.5M

McCain Retain 15% rate

Retain 15% rate

15% rate/ $5M exemption

Clinton Increase to 20%

No specific proposal

Freeze ’09 estate tax: 45%/ $3.5M

12


The Candidates Step Forward… The Candidates Step Forward… -- tax benefit proposals-- tax benefit proposals

ClintonClinton RefundableRefundableretirement creditretirement credit AmericanAmericanretirement accountsretirement accounts Care-giving creditCare-giving credit Long term care Long term care creditcredit Broaden R&E Broaden R&E credits credits Broaden EITCBroaden EITC Broaden Hope Broaden Hope CreditCredit Reform CDCTCReform CDCTC Double elderly Double elderly standard ded.standard ded. Suspend gas tax Suspend gas tax

for summerfor summer

Obama Eliminate income tax for seniors <$50,000 Payroll tax credit up to $8,100 Mortgage credit College expense credit Increase EITC Increase child care credit Savers credit Incentives for renewable energy

Business: 20% credit for investment in small bus (<$50,000)

McCain Double PE for dependents to $7,000 Suspend gas tax for summer Require 3/5 majority in Congress to raise taxes Suspend gas tax for summer

Business: 1st year expensing of equip. & technology costs Reduce corporate rate from 35% to 25%

13


The Candidates Step Forward… The Candidates Step Forward… -- loophole closing proposals-- loophole closing proposals

ClintonClinton End tax breaks for End tax breaks for companies moving companies moving abroadabroad

End tax deferral of End tax deferral of foreign subsforeign subs

Tighten transfer Tighten transfer pricing rulespricing rules

Tighten foreign Tighten foreign insurer rulesinsurer rules

Tax carriedTax carriedinterests as ordinaryinterests as ordinaryincomeincome

Obama Tighten offshore haven rules

Eliminate “special interest loopholes”

Remove $102,000 cap on FICA tax (top marginal rate on earned income would become 47.25%)

Tax carried interests as ordinary income

McCain “Close corporate tax loopholes”

14


Scoring the candidates tax proposalsScoring the candidates tax proposalsImpossible to score the tax proposals except in order of Impossible to score the tax proposals except in order of magnitudemagnitude– Insufficient detailsInsufficient details– Tax and spending proposals jumbled togetherTax and spending proposals jumbled together

In general terms:In general terms:– McCainMcCain is the grand winner – one cost estimate ot McCain’s tax is the grand winner – one cost estimate ot McCain’s tax

proposals – $5.7 trillion over 10 years (twice the cost of Bush 2001-03 proposals – $5.7 trillion over 10 years (twice the cost of Bush 2001-03 tax cuts)tax cuts)

– ClintonClinton & & ObamaObama proposals are similar to each other proposals are similar to each other Lost revenue is about one-third of McCain’s Lost revenue is about one-third of McCain’s Both provide specific pay-forsBoth provide specific pay-forsObama’s are somewhat more expensive, netObama’s are somewhat more expensive, net

On the spending side of the budget – who knows how much the candidates are promising to give away?

NoteNote: We are purposely avoiding discussion of the candidates’ health care proposals, : We are purposely avoiding discussion of the candidates’ health care proposals, even though tax law changes are involved.even though tax law changes are involved.

15


What are they thinking?What are they thinking?(Have they looked at the budget numbers?)(Have they looked at the budget numbers?)

The projected budget deficit is the 1000 pound gorilla The projected budget deficit is the 1000 pound gorilla in the roomin the room– Its consequences will significantly limit the next president’s optionsIts consequences will significantly limit the next president’s options– And will alter the candidates tax proposals long before they become And will alter the candidates tax proposals long before they become

law, or even specific proposals made to Congresslaw, or even specific proposals made to Congress

The Candidates are in denial, but understandably soThe Candidates are in denial, but understandably so——– No one ever has made it to the White House on promises of cutting No one ever has made it to the White House on promises of cutting

spending or raising taxes.spending or raising taxes.– Nevertheless, we may be witnessing a new record in candidate Nevertheless, we may be witnessing a new record in candidate

unreality….unreality….

16


III. III. The impact of the budget deficit on The impact of the budget deficit on the next presidentthe next president


The Budget Deficit & The Ever-Growing National Debt The Budget Deficit & The Ever-Growing National Debt

Federal Outlays as a Percent of GDP, 1965-2050

0%

10%

20%

30%

40%

50%

60%

1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050

Perc

ent

of G

DP

Source: Congressional Budget Office, December 2005, High spending outlook

Interest

All Other

Medicaid

Medicare

Social Security

Average Tax Revenue


The budget deficit & the ever-growing The budget deficit & the ever-growing national debt (cont’d)national debt (cont’d)

Lessons from previous slide:Lessons from previous slide:– Revenues --Revenues -- tend to bump along at 18-19% of GDP; averaging about tend to bump along at 18-19% of GDP; averaging about

18.3% since the 1980s18.3% since the 1980s

– Deficits --Deficits -- vary widely year-to-year – recently from 1.2% to 3.6% of vary widely year-to-year – recently from 1.2% to 3.6% of GDP; largest deficit was during Reagan, in early 80s, reaching 6% of GDP; largest deficit was during Reagan, in early 80s, reaching 6% of GDPGDP

But a train wreck is in our futureBut a train wreck is in our future– slide shows Medicare and interest on the debt will soon explodeslide shows Medicare and interest on the debt will soon explode

Next slide shows the principal culprit:Next slide shows the principal culprit:– Uncontrolled expendituresUncontrolled expenditures -- Increased interest on the debt, and ever- -- Increased interest on the debt, and ever-

increasing entitlements increasing entitlements No Congressional action required -- we’re on auto pilot No Congressional action required -- we’re on auto pilot

18


The budget deficit & the ever-growing The budget deficit & the ever-growing national debt (cont’d)national debt (cont’d)

24Brown Advisory19


The budget deficit & the ever-growing The budget deficit & the ever-growing national debt national debt (cont’d)(cont’d)

The next slide tells the same story, but brings it closer to us in The next slide tells the same story, but brings it closer to us in timetime

– Around 2016 -- during the next president’s 2Around 2016 -- during the next president’s 2ndnd term -- term --defense outlays, interest on the national debt, and defense outlays, interest on the national debt, and entitlements will consume all Federal revenuesentitlements will consume all Federal revenues

– Producing unprecedentedProducing unprecedented and unsustainable deficitsand unsustainable deficits

20


The budget deficit & the ever-growing The budget deficit & the ever-growing national debt national debt (cont’d)(cont’d)

The Current Squeeze

10.0%

11.0%

12.0%

13.0%

14.0%

15.0%

16.0%

17.0%

18.0%

19.0%

20.0%

21.0%

22.0%

23.0%

2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 2026 2028 2030

Perc

enta

ge o

f G

DP

Resources Left for Other Domestic Outlays

Source: C. Eugene Steuerle, Adam Carasso, and Gillian Reynolds, The Urban Institute, 2007. Authors' calculations based on data from CBO Budget Outlook (January 2007) and OASDI and HI-SMI Trustees Reports (2006). * Assumes extension of 2001 and 2003 tax cuts and of expiring tax provisions and a permanent fix to the alternative minimum tax. ̂Assumes a m oderate drop in defense and international spending as a percent of GDP.

Receipts(if tax cuts made permanent)*

Spending on Social Security, Medicare, Medicaid, Defense,

International^, and Interest

21


Projected budget deficits indicate tough Projected budget deficits indicate tough political choices aheadpolitical choices ahead

The good newsThe good news – these deficits won’t happen– these deficits won’t happen

But they will limit the next president’s options -- after about But they will limit the next president’s options -- after about 2016 2016 anyany spending on education, the environment, welfare, spending on education, the environment, welfare, infrastructure and most other domestic programs will infrastructure and most other domestic programs will require choosing to do one or more of the following:require choosing to do one or more of the following:

1.1. Increase the deficit (which can’t be sustained);Increase the deficit (which can’t be sustained);

2.2. Rescind tax cuts, or increase taxes;Rescind tax cuts, or increase taxes;

3.3. Reduce social security and health benefits (i.e., renege on Reduce social security and health benefits (i.e., renege on what has been promised taxpayers); and/orwhat has been promised taxpayers); and/or

4.4. Reduce defense spendingReduce defense spending

22


Can the new President simply ignore these Can the new President simply ignore these budget projections?budget projections?

Answer: Answer: NoNo

While there are complaints about budget forecasts – unreliable; not dynamic; While there are complaints about budget forecasts – unreliable; not dynamic; politically motivated, etc. – the forecasts cannot be totally dismissedpolitically motivated, etc. – the forecasts cannot be totally dismissed

– These are the official figures that Presidents (and Presidents-Elect) must These are the official figures that Presidents (and Presidents-Elect) must live by live by

– Candidates are obviously not so constrainedCandidates are obviously not so constrained

The data are available to all, and are closely examined by think tanks; The data are available to all, and are closely examined by think tanks; economists; etc.economists; etc.– Any major, off-the-wall deviations will condemn a president’s proposals Any major, off-the-wall deviations will condemn a president’s proposals

to ridiculeto ridicule– Minor deviations might work: Minor deviations might work:

Reagan assumed of 4% real growth for entire budget period, and Reagan assumed of 4% real growth for entire budget period, and promised spending cuts to be “supplied later”promised spending cuts to be “supplied later”

In this setting, use of the often-editorialized easy ways out -- the “fiscal In this setting, use of the often-editorialized easy ways out -- the “fiscal myths” -- won’t workmyths” -- won’t work 23


The Fiscal Myths*The Fiscal Myths*

1.1. We can grow our way out of difficult budget choices.We can grow our way out of difficult budget choices.2.2. Eliminating waste will solve the deficit problem.Eliminating waste will solve the deficit problem.3.3. The deficit problem can be solved by delivering health care more The deficit problem can be solved by delivering health care more

efficiently.efficiently.4.4. We just need to raise taxes, and roll back the Bush tax cuts.We just need to raise taxes, and roll back the Bush tax cuts.5.5. Cutting taxes will increase revenue.Cutting taxes will increase revenue.

Each of these approaches could help, but even all taken together would Each of these approaches could help, but even all taken together would not begin to solve the problemnot begin to solve the problem

– A meaningful solution will require telling the public there must be A meaningful solution will require telling the public there must be prioritization…leaving some promises unfulfilled, and inflicting prioritization…leaving some promises unfulfilled, and inflicting some painsome pain

Life will not be simple for our next leader; political leaders don’t Life will not be simple for our next leader; political leaders don’t like to inflict painlike to inflict pain

*Brookings-Heritage Fiscal Seminar, April 2008*Brookings-Heritage Fiscal Seminar, April 2008

24


IV. IV. What will happen?What will happen?


What will happen – as a practical matter?What will happen – as a practical matter?

““Facts are difficult things”Facts are difficult things”The winner – the President-elect – will have to The winner – the President-elect – will have to reconfigure his or her campaign proposals reconfigure his or her campaign proposals – Proposing legislation to Congress different than spinning campaign Proposing legislation to Congress different than spinning campaign

rhetoric rhetoric – Must contain a greater degree of budget realism Must contain a greater degree of budget realism

Defer some pet tax and spending promises to the “out years”Defer some pet tax and spending promises to the “out years”– McCain advisor: “Don’t look at year 1 & 2 impacts; look longer McCain advisor: “Don’t look at year 1 & 2 impacts; look longer

term” term” Search for some almost-credible way to project a balanced budget during Search for some almost-credible way to project a balanced budget during his or her tenurehis or her tenure

And then begin the difficult negotiation process with And then begin the difficult negotiation process with CongressCongress

25


Recent Presidents…offer any lessons?Recent Presidents…offer any lessons?

Ronald Reagan (1981)Ronald Reagan (1981) – proposed a 30% across-the- – proposed a 30% across-the-board tax cut and dramatic increases in business board tax cut and dramatic increases in business depreciation deductionsdepreciation deductions– Budget deficit had been about 2.5% of GDP, but Congress gave him Budget deficit had been about 2.5% of GDP, but Congress gave him

most of what he requested – deficit rose to 6% by 1984most of what he requested – deficit rose to 6% by 1984– Reagan cooked the books slightly:Reagan cooked the books slightly:

Proposed major spending cuts, but balance the books with 4% Proposed major spending cuts, but balance the books with 4% “unidentified future cuts”“unidentified future cuts”Also, made the deficit problem much smaller by assuming huge real Also, made the deficit problem much smaller by assuming huge real growth in the economy (4% for his budget years)growth in the economy (4% for his budget years)

Geo. H.W. Bush (1988)Geo. H.W. Bush (1988) – promised “no new taxes” – promised “no new taxes”– Deficit was well over 3% of GDPDeficit was well over 3% of GDP– Reality required a compromise budget deal including tax increases, Reality required a compromise budget deal including tax increases,

along with spending cuts in 1990 – destroyed his credibilityalong with spending cuts in 1990 – destroyed his credibility

26


Recent Presidents…any lesson?Recent Presidents…any lesson?Bill ClintonBill Clinton (1992)– deficit was high; campaigned on fiscal (1992)– deficit was high; campaigned on fiscal responsibilityresponsibility– Deficit 4.5% of GDP; economy struggling from 90-91 recessionDeficit 4.5% of GDP; economy struggling from 90-91 recession– Proposed significant tax increases in his first year – raised top rate to Proposed significant tax increases in his first year – raised top rate to

36%; 10% surcharge (effective 39.6% rate); removed cap on Medicare 36%; 10% surcharge (effective 39.6% rate); removed cap on Medicare 2.9% withholding; raised corp. rate to 35%; increased tax on SS; 2.9% withholding; raised corp. rate to 35%; increased tax on SS; increased gas taxincreased gas tax

Economy still did very well; stock market boomedEconomy still did very well; stock market boomed– 1994 Republicans seized control of House and in ’97 lowered cap gains 1994 Republicans seized control of House and in ’97 lowered cap gains

rate to 20%; increased IRA limitsrate to 20%; increased IRA limitsEconomy and stock market boomed furtherEconomy and stock market boomed further

Geo. W. BushGeo. W. Bush (2000) – came to town riding his predecessor’s (2000) – came to town riding his predecessor’s surplus – no deficit, budget in surplussurplus – no deficit, budget in surplus– Campaigned on tax cuts to return the surplus to the taxpayersCampaigned on tax cuts to return the surplus to the taxpayers– Achieved virtually all he requested in record time – by May of his Achieved virtually all he requested in record time – by May of his

initial year as Presidentinitial year as President– Had an encore two years later – a second round of major tax cuts was Had an encore two years later – a second round of major tax cuts was

proposed and passedproposed and passed27


Big Spending PresidentsBig Spending Presidents

Nixon 4.97Hoover 4.00Eisenhower 2.90G.H.W. Bush 1.47G.W. Bush* 1.44Truman 1.38Johnson 0.93Wilson 0.80JFK 0.70Carter 0.40Harrison 0.40Arthur 0.20Cleveland 0.20Coolidge 0.20Ford 0.16Hayes 0.00Garfield 0.00Cleveland -0.20McKinely -0.20Roosevelt -0.20Taft -0.20Harding -0.30Clinton -0.45Reagan -2.11FDR -4.16

AdministrationPercentage Point

Change

Percentage Point Change in Domestic Outlays as a Percent of GDPPercentage Point Change in Domestic Outlays as a Percent of GDP

Big SpendersBig Spenders

PikersPikers*2001-2006 only

28


How we raise the money they spend – mainly income and payroll taxes

Federal Revenues by Source as a Percentage of GDP,1934-2012

Individual Income Taxes

Corporate Income Tax

Social Insurance and Retirement Receipts

Excise Taxes* Other**

0%

3%

6%

9%

12%

15%

18%

21%

1934 1939 1944 1949 1954 1959 1964 1969 1974 1979 1984 1989 1994 1999 2004 2009* Includes receipts from highway, airport, telephone, alcohol, and tobacco receipts.** Includes estate and gift taxes, customs duties, and miscellaneous receipts.Source: Eugene Steuerle, Adam Carasso and Gillian Reynolds, The Urban Institute, 2007. Historical data based on the Budget of the UnitedStates Government, FY 2008.

29


The Crystal Ball – tax changes under the The Crystal Ball – tax changes under the next presidentnext president

My assumption: both Houses of Congress will be controlled My assumption: both Houses of Congress will be controlled by Democratsby Democrats

If Clinton or Obama is elected…If Clinton or Obama is elected…– The pressure to increase tax revenues will be tremendous The pressure to increase tax revenues will be tremendous

To support new and enhanced benefit programs and tax cuts at the To support new and enhanced benefit programs and tax cuts at the bottom; & contain deficitbottom; & contain deficit

– But don’t ignore power of the Republican minority’s oppositionBut don’t ignore power of the Republican minority’s opposition““The power of 41 Senators….” The power of 41 Senators….” As a practical matter, it will take 60 votes to increase taxesAs a practical matter, it will take 60 votes to increase taxes

30


Tax changes under the next president – Tax changes under the next president – Clinton & ObamaClinton & Obama

– Income tax rates…Income tax rates…Rates at top very likely to go up – 36% and 39% Rates at top very likely to go up – 36% and 39% brackets likely to be reinstated (as promised by the brackets likely to be reinstated (as promised by the candidates)candidates)

– Note: Second-to-top rate kicks in at $200,300 Note: Second-to-top rate kicks in at $200,300

Perhaps increase in rates in some lower brackets as wellPerhaps increase in rates in some lower brackets as well

Both candidates have said no increases for taxpayers Both candidates have said no increases for taxpayers under $250k of income (Obama $200k?) under $250k of income (Obama $200k?)

– But that excludes 97% of all taxpayers But that excludes 97% of all taxpayers

Makes meeting their budget projections hard, and a Makes meeting their budget projections hard, and a meaningful compromise on spending and taxes difficult meaningful compromise on spending and taxes difficult

31


The Crystal Ball – tax changes under the The Crystal Ball – tax changes under the next president (cont’d)next president (cont’d)

– Payroll taxes…Payroll taxes…If Obama elected, $102,000 cap on FICA likely to be adjusted If Obama elected, $102,000 cap on FICA likely to be adjusted upward, but I doubt removed entirelyupward, but I doubt removed entirely

– Would cause top rate on earned income to become 47.25%Would cause top rate on earned income to become 47.25%– ““Doughnut” protection for taxpayers $102,000 to $250,000? Doughnut” protection for taxpayers $102,000 to $250,000? – Could graduate the increase in the cap as incomes go upCould graduate the increase in the cap as incomes go up

Clinton has staked out no campaign position on payroll taxes, but Clinton has staked out no campaign position on payroll taxes, but this will be a tempting target – would raise billions over 10 yearsthis will be a tempting target – would raise billions over 10 years

– A step toward means testing social securityA step toward means testing social security

– AMT repeal…AMT repeal…Unlikely by either Democrat candidate – far easier to temporize; there’s Unlikely by either Democrat candidate – far easier to temporize; there’s simply no room in the budget and deferring repeal is very temptingsimply no room in the budget and deferring repeal is very tempting

32



– Capital gains…Capital gains…Rate definitely rises – but well short of 28%; more likely to 20% or Rate definitely rises – but well short of 28%; more likely to 20% or 25%25%This is not a major revenue raiser, but neither does it affect a large This is not a major revenue raiser, but neither does it affect a large group of taxpayers (only 14 million taxpayers reported capital group of taxpayers (only 14 million taxpayers reported capital gains in 2005)gains in 2005)

– Remember, all gains inside a qualified plan (IRA, 401(k)), etc., are Remember, all gains inside a qualified plan (IRA, 401(k)), etc., are taxed as ordinary income eventuallytaxed as ordinary income eventually

– Dividends…Dividends…15% rate at extreme risk15% rate at extreme riskOnly hope is some tie to the capital gains rate, but don’t bet on it; Only hope is some tie to the capital gains rate, but don’t bet on it; no historical supportno historical supportAgain, 15% rate is no benefit to qualified plansAgain, 15% rate is no benefit to qualified plans

33



– Candidates tax benefit proposals…Candidates tax benefit proposals…Some will make it but many won’t, at least in the first round Some will make it but many won’t, at least in the first round -- No room in the budget-- No room in the budgetRules of the lobbying jungle will determine winnersRules of the lobbying jungle will determine winners

– Candidates loophole closers…Candidates loophole closers…Not a slam dunk even in times of budget crisisNot a slam dunk even in times of budget crisis

– Most raise relatively little revenueMost raise relatively little revenue– And for most lobbyists opposing these changes, “This is not their And for most lobbyists opposing these changes, “This is not their

first rodeo”first rodeo”– Yet they have reason for concern…a national mood of righteous Yet they have reason for concern…a national mood of righteous

indignation could develop if many are being asked to pay more indignation could develop if many are being asked to pay more E.g.E.g., carried interests likely to receive much attention, carried interests likely to receive much attention

34



Estate & Gift taxesEstate & Gift taxes– A compromise will clearly be worked out by 2010 A compromise will clearly be worked out by 2010

Many Democrat members have a dog in this fightMany Democrat members have a dog in this fight

– Something more beneficial than the Clinton and Obama Something more beneficial than the Clinton and Obama proposals seems likely proposals seems likely

Their proposal: freeze the 2009 rules (45% rate & $3.5M Their proposal: freeze the 2009 rules (45% rate & $3.5M exemption) going forwardexemption) going forwardTraditional wisdom: Democrats want larger Traditional wisdom: Democrats want larger exemption/Republicans want lower ratesexemption/Republicans want lower rates

But many Dems want lower rates as wellBut many Dems want lower rates as wellMore generous compromise – More generous compromise – e.g.e.g., rate 35%-40%; exemption , rate 35%-40%; exemption $3.5M to $5M –seems doable even under a Democrat $3.5M to $5M –seems doable even under a Democrat administrationadministration

35


Tax changes under the next president -- Tax changes under the next president -- McCainMcCain

If McCain is elected…If McCain is elected…– The budget picture will be the same, but the tax result is The budget picture will be the same, but the tax result is

likely to be very differentlikely to be very differentAs stated, I assume Democrats will control both the House and the SenateAs stated, I assume Democrats will control both the House and the SenateBut even if that is correct, it doesn’t mean McCain’s proposals can be But even if that is correct, it doesn’t mean McCain’s proposals can be written off.written off.

– Never overlook the clout of a newly-elected President to get his initial program Never overlook the clout of a newly-elected President to get his initial program through, even with an opposing Congressthrough, even with an opposing Congress

– The people – and thus the Congress – want to give him a chance to see what he The people – and thus the Congress – want to give him a chance to see what he can docan do

– McCain has staked out a deep tax-cutting agendaMcCain has staked out a deep tax-cutting agendaOnce he’s the president-elect his tax agenda cannot be treated seriously Once he’s the president-elect his tax agenda cannot be treated seriously without accompanying proposals for deep – unprecedented – cuts in without accompanying proposals for deep – unprecedented – cuts in spendingspending

– He would exempt Defense spending from the knifeHe would exempt Defense spending from the knife– Hard to see how he could avoid a cut in entitlementsHard to see how he could avoid a cut in entitlements

36



McCain’s situation is very similar to Reagan in 1981McCain’s situation is very similar to Reagan in 1981

– Reagan 1981 proposals to Congress:Reagan 1981 proposals to Congress:Unprecedented tax cuts for both individuals and corporationsUnprecedented tax cuts for both individuals and corporationsHuge spending cuts, but Defense (and entitlements) untouched Huge spending cuts, but Defense (and entitlements) untouched

– Reagan faced a Democrat House, but Republicans had Reagan faced a Democrat House, but Republicans had seized the Senateseized the Senate

He rode in on a wave of hope He rode in on a wave of hope And Congress gave him almost all he proposedAnd Congress gave him almost all he proposedBut it produced unprecedented deficits But it produced unprecedented deficits

– 6% in FY 19836% in FY 1983– The long term budget squeeze was nowhere near as bleak as it is todayThe long term budget squeeze was nowhere near as bleak as it is today

– Likely this history not lost on McCainLikely this history not lost on McCain

McCain’s team will need lots of smoke and mirrorsMcCain’s team will need lots of smoke and mirrors

37



– How would a Democrat-controlled Congress react to How would a Democrat-controlled Congress react to McCain’s proposals?McCain’s proposals?

Strong opposition; but the Democrats do not want all of Strong opposition; but the Democrats do not want all of the Bush tax cuts to be killedthe Bush tax cuts to be killed

– McCain could threaten veto of tax increases McCain could threaten veto of tax increases Congress might enact, and override would be Congress might enact, and override would be unlikely unlikely

– The credibility of his spending cuts to offset tax cuts The credibility of his spending cuts to offset tax cuts would be a factorwould be a factor

McCain may be compelled to compromise compelled McCain may be compelled to compromise compelled by sunset scenario: Without legislation all rates increase by sunset scenario: Without legislation all rates increase to 2000 levels in 2011 – neither side wants that, so each to 2000 levels in 2011 – neither side wants that, so each side has leverageside has leverage

38



– Specifics:Specifics:Bush cuts in tax brackets…Bush cuts in tax brackets…

– McCain could save most but would likely need to McCain could save most but would likely need to concede at the edges – top rate might inch higherconcede at the edges – top rate might inch higher

AMT – likely continue the “patch”; he has bigger fish to AMT – likely continue the “patch”; he has bigger fish to fryfry

Capital gains & dividends…Capital gains & dividends…

– McCain would oppose increases, but might have to McCain would oppose increases, but might have to compromisecompromise

38A



McCain’s goodies…McCain’s goodies…– Double exemption for dependentsDouble exemption for dependents

PossiblePossible– Corporate rate cut (35% to 25%)Corporate rate cut (35% to 25%)

Very doubtful even with a strong McCain administration pushVery doubtful even with a strong McCain administration pushProposal does have strong corporate backersProposal does have strong corporate backers

– 11stst year “expensing” for business equipment & technology year “expensing” for business equipment & technology investmentsinvestments

Loophole closers…Loophole closers…– Clinton/Obama list would virtually disappearClinton/Obama list would virtually disappear– If the “tax increase” label can be avoided, some might pass If the “tax increase” label can be avoided, some might pass

-- even Reagan supported raising revenue by closing many -- even Reagan supported raising revenue by closing many tax avoidance techniquestax avoidance techniques

39



Estate & Gift taxesEstate & Gift taxes

– Doubtful McCain could maintain his campaign position – Doubtful McCain could maintain his campaign position – 15% rate and $5M exemption per spouse15% rate and $5M exemption per spouse

Tantamount to repeal in revenue termsTantamount to repeal in revenue terms

– But ultimate compromise under a McCain administration But ultimate compromise under a McCain administration would likely be more generous than under a Democratic would likely be more generous than under a Democratic administrationadministration

– Again, our guess: Exemption of $3.5M to $5.0M; tax rate Again, our guess: Exemption of $3.5M to $5.0M; tax rate of 35% to 40%of 35% to 40%

40


The Crystal Ball…The Crystal Ball…becomes fuzzybecomes fuzzy

In the end, any new president’s legislative success In the end, any new president’s legislative success will depend on the mood of the countrywill depend on the mood of the country– Congress reluctant to appear defiant to the new boy in townCongress reluctant to appear defiant to the new boy in town

Most of the tax issues are not new, nor are the Most of the tax issues are not new, nor are the arguments pro and conarguments pro and con– The results will probably swing onThe results will probably swing on……

The procedural uniqueness of the sunsets, andThe procedural uniqueness of the sunsets, andThe power of 41Republican minority senatorsThe power of 41Republican minority senators

Is a stalemate on taxes possible?Is a stalemate on taxes possible?– Not likely; America has made clear--Not likely; America has made clear--We want government to functionWe want government to function

WHY WOULD ANYONE WANT TO BE PRESIDENT?WHY WOULD ANYONE WANT TO BE PRESIDENT?

41


Take AwaysTake Aways

If Clinton or Obama is presidentIf Clinton or Obama is president– The won’t get all they want even with control of both The won’t get all they want even with control of both

Houses – power of 41 Republican Senators (?)Houses – power of 41 Republican Senators (?)

Likely outcomesLikely outcomes– Individual rates higher for upper incomesIndividual rates higher for upper incomes– Cap gains up – 20% to 25%Cap gains up – 20% to 25%– Dividends – ordinary tax ratesDividends – ordinary tax rates– E&G taxes – level with 2009 or slightly lowerE&G taxes – level with 2009 or slightly lower– Business:Business:

Overall bias to small, domestic businessesOverall bias to small, domestic businesses


Take AwaysTake Aways

If McCain becomes president –If McCain becomes president –– He will be forced to compromiseHe will be forced to compromise– Democrats will control both Houses and have sunset leverageDemocrats will control both Houses and have sunset leverage

Likely outcomes:Likely outcomes:– Individual rates – status quo, or perhaps slightly higher for upper Individual rates – status quo, or perhaps slightly higher for upper

incomesincomes– Cap gains – 15% Cap gains – 15% – Dividends – somewhat higher, perhaps full ordinary ratesDividends – somewhat higher, perhaps full ordinary rates– E&G taxes – compromise in the $3.5 - $5M exemption/35%-40% E&G taxes – compromise in the $3.5 - $5M exemption/35%-40%

rangerange– Business:Business:

Some benefit for large business but he won’t get 25% corporate rate Some benefit for large business but he won’t get 25% corporate rate or 1or 1stst year expensing year expensing


Take AwaysTake AwaysThe deficit will limit what our next president can The deficit will limit what our next president can do, whoever it isdo, whoever it is– Tax benefit proposals will be curtailedTax benefit proposals will be curtailed– Spending programs will be fewer and less generousSpending programs will be fewer and less generous– Real question – will he or she have the nerve to take Real question – will he or she have the nerve to take

on Medicare and Social Security?on Medicare and Social Security?

AMT – will be with us either way because repeal AMT – will be with us either way because repeal is too costlyis too costly– There will be more “patches” to contain its spreadThere will be more “patches” to contain its spread


Thank You!Thank You!

brown advisory taxes and the elective process from the campaign trail to the sausage factory may 20,...

Documents

tax issues

tax changesthats

current rate

repeal estate tax

gains tax ratei

bush tax cuts sunsets

tax confusion sunset

expiring bush tax cutsthe