Washington News

As the November election nears, Congress has adjourned to permit Senators and Representatives to campaign full time.

On January 1, there is a scheduled massive tax increase and spending cut that Washington commentators are calling the "fiscal cliff." Department of Defense and Medicare spending cuts and tax increases on most taxpayers lead the Congressional Budget Office (CBO) to warn that the nation could return to recession in 2013.

On September 19, Federal Reserve Chair Ben Bernanke testified before the Senate Finance Committee. He cautioned the Senators to be careful in actions to address the fiscal cliff. The Senate Finance Committee is preparing for a November "lame-duck" session following the election. Bernanke is concerned that any substantial action by Congress during that time could hinder an already slow recovery.

Sen. Kent Conrad (D-ND) has led a "Gang of Six" Senators from both parties who have been seeking budget solutions for the past two years. Conrad advocates a "grand bargain" for the November legislative session. He suggests that the tax increases and spending reductions be deferred for six months to allow Congress to create a bipartisan plan with a $4 trillion target. The plan would include a combination of targeted tax increases and spending reductions, including limits on the growth of entitlements.

Senate Majority Leader Harry Reid (D-NV) stated, "I do not believe that we're going to go over the fiscal cliff. Everyone knows what needs to be done."

However, Speaker of the House John Boehner (R-OH) continues to maintain that he is "not confident" that Congress will be able to craft a major budget compromise.

In the rush to adjourn, the Senate did not vote on the Family and Business Tax Cuts Certainty Act of 2012 (S. 3521). This bill would extend most of the tax provisions that have not been passed for 2012. While there has been no Senate vote on the bill, it is expected that the tax extenders (including the IRA charitable rollover) will be part of the November legislative process.

Editor's Note: Congress will now wait for the election results before attempting to determine the course for taxes and spending during the lame-duck session. There is a general agreement to extend the tax cuts for the middle-class. However, there is great uncertainty about extending the current tax rates for those with higher incomes. In addition, not all of the tax extenders will be passed for 2012. While many tax extenders are likely to be part of the November bill, it now seems probable that some of these tax provisions will not be extended. The current Senate list of tax extenders (which includes the IRA charitable rollover) seems likely to be the list that may be enacted.

Rebuild the Entire Tax Code?

The Senate Finance Committee and House Ways and Means Committee held a joint session on September 20. The purpose of the session was to discuss tax reform options for capital gains. Sen. Max Baucus stated, "Our entire tax code - including its treatment of capital gains - needs to be rebuilt for the 21st Century economy. We need a system focused on broad-based economic growth and jobs."

Baucus focused on four specific objectives. He noted that reform must consider the capital gain rate as compared to the rate on ordinary income. It must review who benefits most from the lower rate for capital gains. Any reform should give thoughtful consideration to the need to increase the current low savings rate. Finally, with approximately 20,000 Internal Revenue Code pages (of the 40,000 total pages) defining all of the rules for reporting and paying tax on capital gains, he observes that the complexity of the system is not helpful.

The ranking member of the Senate Finance Committee is Sen. Orrin Hatch (R-UT). He pointed out that the current 15% capital gain rate is scheduled for a dramatic increase on January 1. First, the 3.8% Medicare rate will raise the rate from 15% to 18.8%. Next, the additional five percentage points of increase scheduled for January 1 would raise the rate to 23.8%. In many states, the combined federal and state capital gains rate could be 28% to 30% in 2013.

Hatch observed that there is a "locked-in gain" problem when the rates are that high. Taxpayers are unwilling to sell appreciated assets and that reduces liquidity, harms the economy and increases unemployment.

House Ranking Member Sander Levin (D-MI) agreed that "how to tax capital gains will be one of the biggest and likely most controversial" issues in the 2013 tax reform bill. He noted that the majority of the benefit of the reduced rates helps high-income taxpayers.

House Ways and Means Chair Dave Camp (R-MI) observed that the capital gain rate did not necessarily have to be increased in order to reform taxes. He believes that it may be possible to lower the income tax rate without increasing the capital gain rate.

Editor's Note: In the last comprehensive tax reform in 1986, there was a bipartisan cooperation between President Reagan and House Ways and Means Chair Dan Rostenkowski (D-IL). In order to lower the income tax rates, they agreed to increase the capital gain rate and both were taxed at 28%. This increase in capital gain rate had major impact on real estate for the next several years. If there is major tax reform in 2013 and the income tax rates are reduced, there may need to be a combination of reduced itemized deductions and higher capital gain rates to pay for the lower income tax rates.