Friday, March 15, 2013

Tax Reform on the Horizon

The Washington Post reported yesterday that Congress has begun meetings on Tax Reform. And, for the grammarians who are reading this, I capitalized tax reform for emphasis, not because we have anything formal yet.

Could we have tax reform? And, if we do, what might it do to the world of benefits and compensation?

Let's focus on my first question first. Could we have tax reform? Of course we could. The better question is will we? I think it is as likely as not. Although some measures say that it has picked up, the economy, in the opinion of your humble (well, I try to be humble most of the time) correspondent, it is still abysmal. Republicans in Congress want to balance the budget, but without raising tax rates. Democrats in Congress and the White House generally want to get the budget closer to being balanced, but would like to do it without cutting back social programs which would require more revenue. More revenue comes from three places:

  • Growing the tax base (the two parties do not agree on how to do this)
  • Raising tax rates (Republicans say this will not raise revenue and will filibuster such a bill in the Senate and vote it down in the House)
  • Decreasing tax expenditures (regular people refer to this as closing loopholes and cutting back on deductions)
The third one seems to be the way to go. I head similar sentiments way back at the beginning of 1985. And, guess what, that was the first year of a President's second term. He was a President who inherited a terrible economy. And, before the mid-term elections, we had the Tax Reform Act of 1986. What did it do, generally? It decreased marginal tax rates, cut the number of marginal rates from a lot (I don't recall how many) to two and eliminated a tremendous number of deductions.


In fact, suppose we look at the first half of the last few two-term President's second terms (I am going to count Nixon as two-term since he was elected a second time).
  • Nixon -- ERISA was passed and signed into law shortly before the mid-term election of his second term (actually Ford was President by then and if you don't know why, then either you are very young or have been living under a rock).
  • Reagan -- In the first two years of his second term, we got COBRA as well as TRA86, and a plethora of smaller bills. TRA86 as I noted above was signed into law shortly before the mid-term elections.
  • Clinton -- This is the apparent anomaly and perhaps we should note that he is a Democrat who was working with a Republican-controlled Congress. We got some smaller bills, but nothing of the magnitude of TRA86 or ERISA. But, even in what was then a booming economy, the first half of Clinton's second term brought us the Taxpayer Relief Act, the Balanced Budget Act, and the ever-memorable Child Support Performance and Incentive Act.
  • Bush (43) -- Nearly halfway through his second term, we were greeted with the landmark Pension Protection Act of 2006, shortly before Congress recessed to campaign for the mid-term elections.
Do you detect a pattern here? I know that my readers are very observant, so as they say in the math textbooks, the observation of the pattern is left to the reader.

It could happen. And, if it does, what can I tell you about what it will look like?
  • It will be thick. Major legislation that has come out of the Obama White House has been fairly universally thick. Consider that both PPACA and Dodd-Frank weighed in in exess of four full reams of paper apiece. Should we truly get a comprehensive tax reform bill (perhaps it would be called the Comprehensive Reform And Policy ACT ... if you can't work that out, go back to the beginning), I would take the over if five full reams were the betting threshold.
  • It will focus on what the media will call loopholes. This is one thing that the two parties can agree on is that there are too many loopholes in the current Internal Revenue Code. It will attempt to simplify, but once it goes to a Conference Committee and each member appeases his or her favorite special interest, simplicity is not going to happen.
When you hear about loopholes in the media, they tend to focus on two things: deductions for corporations that allow what we know to be highly profitable ones to pay no federal income taxes; and deductions for very high earners that are just not available to the rest of us.  Bearing those two things in mind, consider these potential changes:
  • Reduction in corporate tax deductions for employer-provided health benefits either by simply limiting the deduction, disallowing the deduction for a far tighter definition of discriminatory plans, or not allowing a deduction with respect to all but preventive health benefits for highly compensated employees. This would be somewhat analogous to the limits that were placed on long-term disability benefits about 25 years ago.
  • Reductions in the pay cap and 415 limits (maximum benefits and contributions limits) for qualified retirement plans. Additionally, we could see a reduction in the 402(g) limit, the annual limit on elective deferrals to a 401(k) plan.
  • A tighter definition of what constitutes a nondiscriminatory retirement plan thereby reducing the level of deductions attributable to highly compensated employees.
  • A reduction in the compensation threshold under Code Section 162(m). This would be a significant appeasement to the major labor unions.
  • Tying deductions for executive compensation to the Dodd-Frank Say-on-Pay votes. I went out on a limb on this one, but voting for this would not cost any elected official many votes.
So, that's what I see the style of such a bill to be. Even at Congress's worst, though, that would only fill up 100-200 pages. They would still need almost five reams more for me to be on the winning side of the over-under bet. What's your opinion? If you have one, and I know you do, please comment, be it here, on Twitter, on LinkedIn, or on Facebook. Or, if you don't want to go public, send me an e-mail.

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