Despite the record number of taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. cuts enacted over the past two years, I’m often asked, What is it going to take to get Washington to finally consider fundamental tax reform? While the primary ingredient for such a debate is presidential leadership, we will also need a confluence of events to motivate lawmakers to take on such a Herculean task.
That confluence of events could occur in just a few years when most of the tax cuts enacted in 2001 and 2003 are due to expire and Congress is simultaneously faced with the need to fix the Alternative Minimum Tax (AMT) before 30 million taxpayers are trapped in this parallel tax system.
When George W. Bush signed the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) into law on June 7, 2001, few Americans were aware that every provision within the $1.35 trillion tax bill was set to expire after December 31, 2010. The reason for this was that lawmakers were forced to adhere to an arcane but politically important Senate rule called the “Byrd Rule,” named for Senator Robert C. Byrd (D-WV), who introduced it in 1985. In simple terms, the Byrd Rule says that any provision in a tax bill that permanently affects net federal receipts is subject to a “point of order” and can be struck from the bill. Since Republicans were unable to muster the 60 votes it takes in the Senate to waive a point of order, they chose instead to sunset all of the provisions in the bill after 2010.
If lawmakers do not make the 2001 Act permanent, millions of families will see a dramatic increase in their tax bills in 2011. Tax Foundation economists have estimated that the typical family of four will see their income tax bill increase by $2,222, or 42 percent, between 2010 and 2011.
As serious as the sunsetting of tax cuts is for families, it is most troubling for those seniors who must plan for passing their estates on to their children. The 2001 bill gradually phased out the estate taxAn estate tax is imposed on the net value of an individual’s taxable estate, after any exclusions or credits, at the time of death. The tax is paid by the estate itself before assets are distributed to heirs. between 2002 and 2009 and fully repealed the tax in 2010. But unless lawmakers make the repeal permanent, the tax will spring back to life in 2011, taxing estates at rates as high as 55 percent. Needless to say, this uncertainty has made estate planning impossible and led to dark jokes that children will hasten their parents’ departure in 2010 before the old rates kick in.
The complexity spawned by the 2001 bill was made even worse when President Bush recently signed this year’s $350 billion tax cut bill into law. This bill accelerates the phased-in tax cuts in the 2001 bill—including the reduction of marginal tax rates and the expansion of the child credit—into this year. However, to comply with the demands of a handful of Senators that the bill be no greater than $350 billion over ten years, lawmakers once again reverted to sunsets to make the bill appear less costly than it really is.
For example, the bill immediately expands the 15 percent tax bracketA tax bracket is the range of incomes taxed at given rates, which typically differ depending on filing status. In a progressive individual or corporate income tax system, rates rise as income increases. There are seven federal individual income tax brackets; the federal corporate income tax system is flat. and increases the standard deductionThe standard deduction reduces a taxpayer’s taxable income by a set amount determined by the government. It was nearly doubled for all classes of filers by the 2017 Tax Cuts and Jobs Act (TCJA) as an incentive for taxpayers not to itemize deductions when filing their federal income taxes. for modest-income families impacted by the so-called marriage penaltyA marriage penalty is when a household’s overall tax bill increases due to a couple marrying and filing taxes jointly. A marriage penalty typically occurs when two individuals with similar incomes marry; this is true for both high- and low-income couples. . But in order to reduce the bill’s overall “cost” to the U.S. Treasury, lawmakers will revert these provisions in 2005 to the phased-in schedule outlined in the 2001 Act”– effectively raising those families’ taxes in 2005. Similarly, the bill’s most significant features – cutting the tax rate on dividends and capital gains to 15 percent – are both temporary. Both sunset after December 31, 2008.
About the same time as lawmakers are forced to grapple with making these provisions permanent, millions of families will find themselves captured by the AMT. The AMT was enacted in 1969 after press reports revealed that a handful of wealthy taxpayers were avoiding paying income taxes through the use of aggressive tax shelters. The AMT is triggered when your deductions exceed a pre-set percentage of your income. The AMT limits the amount of deductions you can benefit from—including the home mortgage interest deductionThe mortgage interest deduction is an itemized deduction for interest paid on home mortgages. It reduces households’ taxable incomes and, consequently, their total taxes paid. The Tax Cuts and Jobs Act (TCJA) reduced the amount of principal and limited the types of loans that qualify for the deduction. , child credits and health care costs—and requires you to pay a fixed tax rate of 26 percent. It is especially punishing to families who live in high-tax states and areas with high property values.
Congress’s Joint Committee on Taxation estimates that 2.2 million families will be hit by the AMT this year. If Congress fails to fix this punitive tax system, 30 million families could be affected by 2010 – roughly 1 out of every 5 taxpayers.
The collision of the need to fix the AMT and the need to make the 2001 and 2003 tax cuts permanent could be the spark that ignites a real debate over fundamental tax reform.
But a little publicized effect of the 2001 and 2003 tax cuts could undermine any efforts to overhaul the tax code. These bills were effective in knocking nearly 10 million taxpayers off the tax roles. Because these tax cut bills so generously expanded the child credit and the Earned Income Tax CreditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. (EITC), Tax Foundation economists estimate that nearly 40 million families will file a tax return this year but owe no income taxes, and many of these families will receive a “refund” check from the IRS even though they owe no taxes.
The case for fundamental tax reform is severely compromised when 30 percent of all taxpayers not only do not have a stake in the process, but could be harmed as a result. While most Americans fear and loathe the IRS, many of these 40 million taxpayers now look upon the IRS as a sugar daddy –dispensing generous refund checks.
The stars may be aligning for the cause of fundamental tax reform, but the widening gulf between those who bear the burden of income taxes and those who pay nothing threatens to make it a highly charged debate.
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