Congress Faces Numerous Hurdles to Tax Overhaul

Posted August 1, 2012 at 12:00am

Lawmakers have been making promises that a sweeping overhaul of the tax system is around the corner, but many tax experts are skeptical such an ambitious undertaking is plausible in the current political environment.

In fact, with both parties proposing to continue at least some expiring tax cuts for another year, ostensibly to give Congress more time to figure out a long-term fix, there are increasing concerns that individual income tax rates could go the way of numerous other tax provisions and be decided on an annual or semi-annual basis.

That lawmakers could allow a basic feature of the tax code to become temporary may seem dangerous and unlikely, but “they can and they’ve done it for big items,” said John Buckley, a longtime chief tax counsel for Democrats on the House Ways and Means Committee who now teaches at Georgetown University.

The House will take up a measure that provides broad parameters for a tax overhaul and a kind of “fast track” to enactment this week as the chamber turns to the politically volatile issue of the extension of the 2001 and 2003 tax cuts (PL 107-16, PL 108-27).

In House votes Wednesday or Thursday, Republicans favor a one-year extension of all current tax rates. The one-year extension offered by Democrats would allow tax rates to increase on ordinary income above $200,000 for individuals and $250,000 for couples. It would also effectively raise taxes on capital gains and dividends.

A companion measure would set into motion the process for an overhaul of the tax code next year.

For all of their disagreements, the decision of Republicans and Democrats to offer one-year tax cut extensions reflects a shared skepticism that a long-term agreement will be possible in a lame-duck session after the November elections.

To varying degrees, both sides have talked about a broad restructuring of the tax system that scales back tax breaks and reduces rates in the mold of the landmark tax overhaul of 1986 (PL 99-515).

Next year, “we’ll be in a good position to decide how to reform our entire tax code in a simple way that lowers rates and helps our economy grow and brings down our deficit, because that’s something that we’re going to have to do for the long term,” President Obama said July 9.

Budget Window History

The origins of temporary tax rates on ordinary and capital income date to the early 2000s, when President George W. Bush used reconciliation to push his fiscal agenda through Congress.

While use of the tactic allowed Republicans to circumvent a filibuster in the Senate, it also meant their tax cuts needed to lapse at the end of 2010 to avoid adding to the deficit outside of the 10-year budget window.

That put those tax cuts into the basket of tax provisions that have needed periodic renewal, creating a kind of patchwork across the tax code.

For years, Congress has approved short-term fixes to the alternative minimum tax to prevent the levy, for instance, which was never indexed to inflation, from hitting large numbers of middle-income earners.

And lawmakers have consistently extended many relatively small tax breaks for a year or two at a time, never quite willing to confront the budgetary cost of making them permanent.

Facing the prospect of a large tax increase with the expiration of the Bush tax cuts in the midst of a fragile economic recovery at the end of 2010, President Obama agreed to continue the cuts on all income levels for two years.

In exchange for extending the tax cuts on household income above $250,000, Obama got Republicans to agree to his own preferred tax cut: a one-year reduction in employee payroll taxes that has since been prolonged through 2012.

There is widespread agreement that the tax code should be made more predictable and economically efficient, and that the best time to attempt a structural overhaul would probably be the first year of presumed GOP presidential nominee Mitt Romney’s presidency or in an Obama second term.

Doubts Steeped in Deep Divisions

Still, many tax experts doubt that a 1986-style tax overhaul can happen next year no matter what happens in the elections. Partisan divisions in Congress are too deep, they say, and the current structure of the tax system makes it much more difficult to craft the sort of legislation that was assembled a quarter century ago.

Congress was able to pay for lower rates then by raising taxes on corporations and closing glaring tax loopholes, but the same opportunities are not there this time around, said David Gamage, an assistant professor of law at the University of California and former tax counsel in the Treasury Department.

“Today, Republicans want to lower tax rates on capital, lower tax rates on corporate transactions, and there isn’t the money to be raised for shutting down abusive transactions like there was pre-1986,” Gamage said.

Today, broadening the tax base would likely mean scaling back large tax breaks such as the home mortgage interest deduction and the federal deduction for taxes paid to state and local governments, experts say. Drastic rate reductions of the sort proposed by House Republicans and Romney could require lawmakers to dip into the pool of tax breaks for low- and middle-income earners, such as the child tax credit and earned income tax credit. And lowering the top income tax rates without making the tax code less progressive would require raising tax rates on capital gains and dividends.

Despite the obstacles, many aides on the congressional tax-writing committees remain convinced that major tax legislation is possible. They note that Ways and Means Chairman Dave Camp, R-Mich., and Senate Finance Chairman Max Baucus, D-Mont., have a close working relationship. Camp was recently diagnosed with non-Hodgkin’s lymphoma, but he is expected to continue his work in Congress while undergoing treatment and make a full recovery.

In recent months, tax committee staffers have organized hearings on controversial subjects such as the taxation of capital gains. They have also engaged in the tax equivalent of war games, figuring out how different proposals might fit together and affect revenue collections on the chance that lawmakers decide to use them.

“The simple fact is that behind the scenes on both sides of the Capitol and on both ends of the political spectrum, serious work is being done on tax reform. The question is not if it happens, but how soon. The economy demands it,” a senior GOP aide said.

Although House Republicans are set to pass their bill setting tax overhaul procedures for next year, many believe Camp will not introduce legislation to rewrite the tax code unless political leaders can reach a broad deficit reduction agreement that includes cuts to entitlement programs.

Some say Congress could end up tweaking the tax system to at least reduce economic uncertainty. “Just solving the temporary nature of the code could theoretically be called reform,” said one former Democratic tax staffer who is now a lobbyist.