Congressional approval to raise the debt ceiling will not end the war in Congress over taxes, spending and the deficit. Under the new law extending the debt ceiling, the federal government will reduce spending by $900 billion over a 10-year period and delegate responsibility for even more cuts to a bipartisan 12-member congressional committee, often referred to as the "Super Congress."
The Super Congress, consisting of six senators and six representatives equally divided by party, will have until Nov. 23, 2011, to develop a plan to reduce the budget deficit by at least $1.5 trillion over 10 years.
If the Super Congress can come up with a plan that seven members agree to, it will go to a vote in both houses of Congress by Dec. 23, 2011. The Super Congress’s proposal will go to an "up or down vote" — that is, it can pass with a simple majority of each house.
And in an exception to most bills that Congress considers, no filibustering or amendments will be allowed. If the Super Congress cannot agree on a plan, or it doesn’t pass Congress, draconian across-the-board spending cuts of about $1.2 trillion will be automatically triggered — something no one wants.
So what will this Super Congress come up with? No one knows. However, in addition to cutting spending, there is a strong possibility it will enact some sort of tax reform. One type of reform often talked about is lowering the overall tax rates in return to broaden the revenue base.
This approach was recommended by the "Gang of Six" — six senators who attempted to come up with a comprehensive deficit reduction plan earlier this year. That group proposed replacing the current individual marginal income tax rate schedule consisting of three new tax brackets: 8-12 percent; 14-22 percent; and 23-29 percent. To help fund these lower rates, various "tax expenditures" would be reduced or eliminated.
"Tax expenditure" is a term you’ll be hearing a lot in the next few months. A tax expenditure is essentially any reduction in income tax liability that results from an exclusion, exemption, or deduction from gross income; or a credit, preferential tax rate, or tax deferral.
As a practical matter, a tax expenditure has the same impact as a government spending program. For example, assume that a homeowner with a 25 percent tax rate pays $10,000 in mortgage interest and that the government wants to provide a subsidy for homeownership.
It could do this in two ways:
1. Allow the taxpayer to deduct the $10,000 of mortgage interest from his gross income, which would produce a tax reduction of $2,500; or
2. Make a direct payment of $2,500 to the taxpayer instead of the tax deduction. The taxpayer ends up in the same economic position either way.
So what are the big expenditures that could get cut or eliminated? They are the tax deductions, "loopholes," credits, and benefits we all know and love. Here is a list of the largest tax expenditures (the dollar figures are based on the projected spending over the next 10 years):
- Exclusion of employer contributions for health care, health insurance premiums, and long-term care insurance ($659.4 billion);
- Exclusion for retirement plan contributions and earnings ($596.5 billion);
- Mortgage interest deduction for owner-occupied housing ($484.1 billion);
- Reduced rates of tax on dividends and long-term capital gains ($402.9 billion);
- Exclusion for various Medicare benefits ($337.1 billion);
- Earned income tax credit ($268.8 billion);
- Deduction for nonbusiness state and local taxes ($237.3 billion);
- Exclusion of capital gains at death ($194 billion), and
- Deduction for charitable contributions ($187.5 billion).
Famed bank robber Willie Sutton said he robbed banks because "that was where the money was." Popular tax expenditures such as the mortgage interest exclusion are where the money is when it comes to raising revenue without raising tax rates.
Look forward to a battle royale over whether and how much to reduce these cherished tax breaks.
Stephen Fishman is a tax expert, attorney and author who has published 18 books, including "Working for Yourself: Law & Taxes for Contractors, Freelancers and Consultants," "Deduct It," "Working as an Independent Contractor," and "Working with Independent Contractors." He welcomes your questions for this weekly column.