Are we any nearer to tax reform in the USA? Why are there so many competing suggestions from the Democrats concerning tax changes? And which proposals have the most chance of being passed?
The 2020 Election Campaign
One of the recurring themes throughout the Biden presidential campaign was the need for tax reform. If elected, candidate Biden promised he would bring about: “Tax reform that rewards work, not wealth.” However, beyond some broad statements of intent, the campaign rhetoric threw very little light on the detail that Biden and his team had in mind.
Anyone expecting that the detail would emerge reasonably soon after President Biden assumed office would be disappointed. It took a couple of months before the President made any public pronouncement on the subject. Even then, his much-heralded speech was mainly about major plans to spend more money. Only a small amount of time was devoted to the detail of where (and how) the additional money would be raised. However, the White House did issue a supporting ‘fact sheet’ which filled in some of the blanks.
This delay in going public on nitty-gritty detail came about for two reasons:
During the campaign, the number one priority was to get elected. That, combined with everyone being very busy with their campaign involvements, meant that some element of detail was only going to be worked out after the election result had been assured.
The Democratic Party encompasses a wide coalition of political views. During the 2020 Presidential and Congressional election campaigns, it was important to avoid the distractions of internal Party differences and concentrate on winning the Presidency and gaining control of both the Senate and the House of Representatives (the House). All points of view were able to coalesce around soundbites, absent real detail of how those objectives were to be achieved.
Politics & Procedures in Washington DC
Tax reform is not in the gift of the President. The necessary legislative change must first be passed by both the House and the Senate. Only then can a Bill arrive on President Biden’s desk for him to sign the changes into law.
Prior to the 2020 elections, with a Republican President in the White House, the Republicans controlled the Senate, but the Democrats had a majority in the House. With the prevailing atmosphere of mutual distrust and dislike between the two Parties, that was a recipe for legislative gridlock. Irrespective of how much President Trump and the Republican Senate wanted to do anything on the tax front, that measure was incapable of being passed by the House.
Consequently, in the 2020 election campaign, the Democratic Party wanted to achieve full control of the legislative process. They were aiming for a Biden Presidency; accompanied by Democrat control in both the House and the Senate. This ‘triple win’ was achieved, but to a much lesser standard than had been hoped for. When the dust had settled, the Democrats emerged with a reduced majority in the House. Seats in the Senate were split 50:50.
The ‘Horse-Trading’ Begins
Once the detailed consideration of tax reform commenced, it quickly became apparent that the Democrats in Congress were not of a single mind on what tax changes were required. Clearly this suggested the potential for a serious barrier in the Senate. However, there has also been sufficient disagreement among Democrat members of the House to call into question what measures could be passed there.
What has happened since March of this year is a gradual watering down of what President Biden would really like to do, at least according to his earlier rhetoric. That dilution process has been accompanied by some reduction in the infrastructure spending which the Democrats want to initiate. However, the funding for a large part of remaining infrastructure spending still requires either new sources of revenue or a greater tax take from existing places.
The President’s first public speech about his tax agenda already showed him to be rowing back from one of the things he had spoken about on various occasions during his election campaign. No mention was made either in that speech or the accompanying ‘fact sheet’ of any change to the Federal Estate & Gift Tax. For what was proposed, some items came with a suggestion of having an effective date during 2021, whilst others were only intended to apply from the 2022 tax year onwards.
President Biden’s proposals included:
- An increased corporate tax rate, in effect reversing the corporate tax cut signed into law by President Trump in December 2017.
- The top rate of individual tax being increased from 37% to 39.6%, with that rate applying to taxable incomes of $400,000 or more.
- For individuals with taxable income of $1 million or more, capital gains to be taxed at 39.6%. The general presumption was that the additional 3.8% net investment income tax would continue to apply, thus delivering an effective rate of 43.4%.
- Abolition of the ‘step-up in basis’ for inherited assets.
- Basis is the monetary figure that reflects a taxpayer’s investment in property. The amount of basis determines the extent that gain or loss arises when there is a taxable disposal of the property.
- Under current rules, a person’s basis in an asset that is inherited on the death of its previous owner is the fair market value of the asset at the time of the previous owner’s death (e., a step-up to market value)
- In contrast, if an asset is received as a gift during the lifetime of its previous owner, current rules carry-over to the new owner whatever basis was held by the previous owner.
- Taxing the ‘carried interests’ of fund managers at ordinary income rates, rather than as capital gains.
- Increased funding of the Internal Revenue Service (IRS), among other reasons to enable a serious increase in the auditing of wealthy individuals.
Almost immediately, some Congressional Democrats began to indicate a part (or parts) of the package which they would be unable to support.
So what has actually been happening since spring?
If stripped back to the essentials, what has been happening between spring and autumn is as follows:
- Two separate Bills are involved. The first deals with infrastructure spending. The second, and potentially a much trickier proposition, will contain both tax matters (to raise more revenue) and spending commitments.
- The ‘easier’ of these two measures was passed by the Senate in late Summer but faced considerable difficulty in the House before being passed in the first week of November.
- The more ‘difficult’ measure remains outstanding.
- The connection between raising revenue and the extent of spending commitments in new legislation is twofold:
- Congress must agree any increase in the maximum permitted federal deficit. At present, there does not appear to be an appetite for an increase.
- Procedures in the Senate allow a measure to be ‘talked out’ by a Senatorial filibuster.. The only way to block a filibuster is by 67 votes in the Senate in favour. The Democrats have nowhere near that level of support in the Senate, so to pass a tax measure they will need for it to be included in a Reconciliation Bill.
- The essence of a Reconciliation Bill is that it has to be self-funding. (i.e., its spending commitments do not exceed the amount of additional tax revenue that its other measures will bring in.) The ‘scoring’ process of quantifying spending versus revenues is done by an independent body.
The practical requirement for tax changes to be in a Reconciliation Bill explains both the ‘horse trading’ in Congress and the emergence of ideas for new taxes. In simple terms, if the lawmakers want to spend money but disapprove of the President’s suggested ways to raise the necessary funds, the Reconciliation Bill format requires they find a new source of revenue for the Federal Government to ‘balance-the-books’.
October 2021 saw in quick succession, the suggestion for a ‘Billionaires’ Tax’ and then a ‘Millionaires’ Surcharge’. The former, suggested by the Chair of the Senate Finance Committee, would tax unrealised capital gains of the super-rich. The claim is that this proposed tax would impact only about 700 individuals but raise large amounts of revenue. Before that idea could be properly digested, and amidst mutterings that some elements were unconstitutional, along came a new suggestion from the President:
- The current 37% top rate of tax to remain, but:
- A 5% surtax on incomes above $10 million and
- An additional 3% on incomes above $25 million
- A minimum tax of 15% on corporations
At the time of writing, his suggestion from the President is still ‘live’. That is to say, it has yet to be overtaken by any further proposal and, despite having its opponents, is not yet seen in Congress as ‘dead-in-the-water’.
Where does this leave us?
The last time there was such an open question about tax reform was in the first year of the Trump Presidency. President Trump and the Republican Party-controlled Congress wanted tax reform but spent most of 2017 talking about it and apparently getting nowhere. Finally, things came together, and new tax laws were enacted just prior to Christmas 2017. Large elements of that change had retroactive effect to 1 January 2017.
Will there be a similar eleventh hour consensus amongst the Democrats in 2021? The one difference between now and then is that in 2017 Republicans had much political capital invested in the soundbite: “Tax reform by Christmas”. The potential loss of face for failing to honour that soundbite became a powerful catalyst to forging the pre-Christmas consensus.
President Biden and the Democrats have not given themselves such a public timetable for action. However, in the event of not legislating any tax reform during 2021, Democrats will find it galling to be compared unfavourably with what was achieved in the first year of the Trump Presidency.
A further catalyst for action may have occurred on Election Day (2 November) 2021.
Although there were no elections for Federal officials this year, a couple of State Governor contests produced results that were bad for the Democrats, when compared to how those places polled in the 2020 Presidential Election.
Those results, if repeated at the mid-term elections in 2022 would result in Democrats losing control of the Senate and possibly of the House too. That realisation may have concentrated some minds in Washington DC. With the present dearth of bi-partisan co-operation, a Democrat President will likely get none of his outstanding agenda through a Republican-controlled Congress.
Do not expect much movement prior to the Thanksgiving Day holiday. However, there may be a renewed momentum afterwards. If the Democrats believe it is really important to get the President’s pledges on infrastructure spending enacted while they still have nominal control of both House and Senate, then the only way to get there is by coming to a consensus on taxes.
Don’t be completely surprised if some of President Biden’s ideas presented in March 2021 make a reappearance, perhaps blended with elements of the more recent ‘Millionaires Surcharge’.
However, it will only take one Democrat in the Senate feeling unable to vote for what is otherwise the consensus view, and there will be no changes.
Unfortunately, we don’t have a crystal ball by which to check on the eventual outcome.
Would you like to know more?
If you would like to discuss any of the above and how it may impact you, please get in touch with your usual Blick Rothenberg contact or John Bull or John Havard or Dan using the details on this page or the form below.