Keep the Bush Tax Cuts for a Couple of Years, But Reshuffle the Dollars

It seems increasingly likely that Congress will extend most, if not all, of the Bush tax cuts for at least a year or two. As the economy shows growing signs of softening, lawmakers are less and less likely to take steps that will be seen as “raising taxes.” But there is a way Congress could maintain the magnitude of the Bush tax cuts while moving around some dollars to enhance their short-term economic benefit. The goal of this shift would be to focus tax cuts on those most likely to spend the money.

Here’s the problem: The Treasury Department figures that temporarily extending the 2001 and 2003 tax cuts would reduce federal revenues by roughly $200 billion in Fiscal 2011 and $260 billion in 2012. For technical reasons, those numbers may be off a bit, but you get the drift. Of that, about $75 billion would go to top-bracket taxpayers ($35 billion in 2011 and $40 billion in 2012). We know that higher income households are more likely to bank the cash than spend it. As a result, tax cuts for these high-earners will do relatively little to boost the economy in the short run.

So why not take that $75 billion and give it to those who are more likely to spend it—people with low- and moderate incomes. It would be simple to do. Congress could, for example, expand the Earned Income Credit. Or it could continue a scaled-back version of President Obama’s Making Work Pay (MWP) tax credit that is also due to expire at the end of the year.

My colleague Elaine Maag wrote recently about the benefits of extending a modified version of the MWP credit. But Elaine got me thinking: Instead of continuing the credit in addition to the Bush tax cuts, why not use it to replace some of the least stimulative provisions of the 2001 and 2003 tax laws. Btw, Making Work Pay also benefits some small businesses, including many self-employed people: Keep in mind the average amount of business income reported on individual tax returns is only about $40,000, far below the MWP threshhold.  
 
Extending Making Work Pay would cost about $60 billion-a-year. But by trimming it, and focusing its benefits on low- and moderate income households, Congress could fit these tax cuts into a two-year $75 billion bucket and still provide a modest boost to the economy.

There is a potential political benefit to moving these dollars around as well. Republicans could say they extended all of the Bush tax cuts (at least in magnitude, if not in specifics). And Democrats could take credit for retargeting those upper-bracket dollars.  

Economists generally agree that Washington is in a serious fiscal jam. It needs to boost an economy that may again be running out of steam. But given long-term deficit challenges, it also must conserve precious federal dollars. In this environment, it is imperative that policymakers get the biggest bang for the every stimulus buck.

So instead of squabbling over whether or not to continue $75 billion in tax cuts, Congress should simply retarget the dollars to those most likely to spend them.

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Selling_Inherited_Home

Today TaxMama hears from Jami from California in the TaxQuips Forum, who has this question. “My aunt left me her condo and I have to sell it. The deed passed to me a week after I turned 55. Will the 55 & over real estate rule apply to me when I file my tax return?”

Dear Jami,

Sorry to learn about your aunt dying. But how sweet of her to leave you her condo.

It’s not clear to me what over 55 rule you’re talking about? Never mind.

Here’s how it works. You need to get an appraisal for the value of the condominium on the date of your aunt’s death. That will be your ‘basis’ or tax cost when you sell the condo. It’s possible that the executor of the estate has already done this. Please find out.

When you sell the condo, your gain will be based on the sales price, less selling costs, less the basis at date of death.

If you lived in the condo with your aunt for at least two full years out of the last five years, you will also be entitled to the $250,000 exclusion of profits since the condo was your personal residence. But you probably won’t need that. There won’t be a gain if you sell it in the same year your aunt died. The real estate market isn’t that strong in California these days.

If you didn’t live in it…try to sell the condo THIS YEAR. The capital gain rate for IRS may be as low as ZERO.

California doesn’t have any special rates. So your gain will be taxed at 9.3% or less, depending on your tax bracket. If there is a gain at all?

And remember, you can find answers to all kinds of questions about inherited assets, and other tax issues, free. Where? Where else? At www.TaxMama.com.

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Do You Owe More Than $100,000 In Tax?

Often, before your tax problem is assigned to a revenue officer for collection “in the field”, tax collection is handled by a branch of the Internal Revenue Service called “ACS” (Automatic Collection Service). This is where the computer generated notices come from. ACS has developed this check sheet to help expedite the resolution on accounts in the Large Dollar Unit of ACS. The check sheet is for those accounts with a balance due of $100,000 or more.

To expedite the resolution on accounts in the Large Dollar Unit, please have the following information available when contacting ACS.

• Valid Power of Attorney (Form 2848) covering all tax periods
• Explain in detail why the taxpayer is not able to full pay or borrow to full pay
• Completed Collection Information Statement (Form 433- A, B or F)
• Number of individual’s living in the house hold
• Value of 401K/Retirement
• Copies of delinquent tax returns and /or ASFR returns
• Rental income
• Spouse’s income and source with name/address/phone number
• Three months of current bank statements (all accounts)
• Investment income
• Year make of vehicles, value, equity, balance owed, and monthly payments
• Employer’s information including work number
• Secured loan(s) – amount of loan and remaining balance(s)
• Life insurance policies, (whole or term), any borrowing ability? And/or value of policy
• Profit and Loss statements for self-employed taxpayers
• Three months of current pay stubs for both the taxpayer and the taxpayer’s wife
• Out-of-pocket medical expenses
• Commission statement
• Value of all property and/or available equity
• Substantiation of Court ordered payments
• Substantiation of payments being made
• Pension income and/or Social Security income

For additional help, call a tax attorney. Call Mitchell A. Port at (310) 559-5259.

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Lowering the Heat Around Raising Retirement Age

In commentary to the San Francisco Chronicle, Gene Steurle asserts that all the following myths about Social Security retirement ages are wrong: (1) Increasing the retirement age will reduce benefits; (2) Increasing the retirement age discriminates against lower-income workers with shorter life expectancies; (3) Increasing the retirement age makes Social Security reform regressive; (4) Social Security Old Age Insurance goes to the old; and (5) the elderly need to fear such Social Security reforms as increasing the retirement age.

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Uncompassionate Economics: Blaming Unemployment Compensation for Our Job Woes

In a Wall Street Journal op-ed this morning, Robert Barro lays blame for the nation’s stubbornly high unemployment rate squarely on President Obama’s doorstep. The outspoken Harvard economist asserts that unemployment would stand at 6.8 percent—well below today’s 9.5 percent—if only the president and Congress hadn’t extended unemployment compensation to 99 weeks.

Barro does acknowledge the need for compassion in tough times:

Yet, he goes on to say, unemployed workers would find jobs more quickly and companies would boost hiring faster if we sharply constrained the maximum duration of jobless benefits and held down the taxes that pay for them. Barro cites as evidence what happened to long-term unemployment in 1982. Then the unemployment rate peaked at 10.8 percent, higher that in our current Great Recession. Congress extended the maximum duration of unemployment compensation that year to 39 weeks—60 weeks less than the current limit.  The mean length of jobless spells hit 21.2 weeks and 24.5 percent of workers had had gone jobless for more than 26 weeks, compared to 35.2 weeks and 46.2 percent this past June. Today’s historically high numbers result entirely from the 99-week limit, says Barro. Cut that back to 39 weeks and the jobless would find work, dropping the overall unemployment rate by nearly a third to 6.8 percent.

That conclusion might follow if the two situations fit economists’ simplifying assumption of ceteris paribus—“all else the same.” But the two recessions, though both horrible, differ significantly. Both were worldwide but there was no financial market meltdown in 1982: firms could borrow, albeit at extraordinarily high interest rates. High mortgage rates, approaching 20 percent, caused house sales to fall by roughly half in 1982, but foreclosures didn’t soar as they have this time around. And firms weren’t sitting on piles of cash, unwilling to invest until the economy strengthens.

Research by Rob Valletta and Katherine Kuan at the Federal Reserve Bank of San Francisco suggests that the effect of extended benefits would be much smaller than Barro’s estimate, probably less than half a percentage point. They found only small differences between how quickly job losers (who qualify for unemployment benefits) and job quitters (who don’t) find new jobs, suggesting that duration of benefits has only a small effect on today’s high unemployment rate.

Sure, people may take a little longer to find a job when they have benefits to support them. But those benefits are meager, averaging less than $300 a week. That benefit may lead low-wage and secondary workers to wait longer to take a job but not primary and more skilled workers.  The problem is that jobs just aren’t available—the Bureau of Labor Statistics reports only one job opening for every five unemployed workers. That’s more than double the next highest ratio since the BLS started collecting data on job openings but that was only in 2000 so we can’t compare the value with 1982. Regardless of how today’s ratio stacks up against the past, cutting benefits off earlier won’t change that ratio or create new jobs. But it would leave unemployed workers with less cash, leading them to cut spending and weakening our already anemic economic recovery.

Given the continued weakness of the economy and the dearth of available work, now’s the time to emphasize compassion and defer hard-hearted economic efficiency.

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Loss on Surrender

Today TaxMama hears from Karla in the TaxQuips Forum, with this question. “Is the loss on surrender of life insurance deductible on 1040?”

Dear Karla,

It’s not clear why you would have a loss when you surrender a life insurance policy. Of course, I don’t have much experience in this area.

Chapter 12 of IRS Publication 17 covers IRS rules about the <a

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Obama’s Tax Reform Panel: A Missed Opportunity

You buy what you think will be a state-of-the-art GPS device to give you driving directions. The gizmo was designed by a committee of the nation’s smartest highway engineers. But instead of telling you to turn right now, the e-voice says something like this: “You could turn right now. It would be better than going straight, which is a really bad choice but, on the other hand, the road might be a little bumpier and besides, you could also get where you want to go by turning left three blocks from here. So I’m not actually recommending what to do.”

That’s the feeling I got reading the long-delayed Report on Tax Reform Options from the President’s Economic Recovery Advisory Board (PERAB in Washington-ese). The paper, approved by the panel this afternoon, is filled with lots of useful information about our flawed tax system but leads nowhere. There are no recommendations. No revenue estimates. And no ownership by President Obama, even though he picked the panel’s members and staffed it with White House aides.

As a result, this report is a huge missed opportunity. Obama might have used this exercise to jump-start a debate over fundamental tax reform. Instead, the report does nothing to fill the policy vacuum that is being filled by an argument over what to do about the decade-old Bush tax cuts.

Imagine if Obama used this group to start the process of doing what President Reagan did, develop a broad-based reform plan. Or even if he had allowed the panel to design full-blown alternative tax structures—a step George W. Bush took in 2005 (although, it must be noted that Bush ultimately ignored the suggestions of his own commission).

This panel might have had some clout. Former Fed chairman Paul Volcker headed the group, which included economic heavyweights such as Marty Feldstein and Laura Tyson, as well as business executives such as John Doerr and Jeff Immelt. But Obama hamstrung them from the beginning by prohibiting the committee from considering any changes that would raise taxes on those making less than $250,000-a-year. He also limited its charge to simplification, compliance, and corporate taxes—the first two, at least, relatively low-hanging fruit.

There is nothing wrong with the report’s focus: These are important issues, though obviously not the whole story. But per White House instructions, the committee makes no recommendations at all, instead merely describing general options for change and outlining both the benefits and disadvantages to each.

As if that was not enough, the report comes with not one but two disclaimers:

First: “It is important to emphasize at the outset that the PERAB is an outside advisory panel and is not part of the Obama Administration. Our report is meant to provide helpful advice to the Administration as it considers options for tax reform in the future.”

And if you didn’t get it, there is also this: “The report does not represent Administration policy.” 

Thus, the study was thrown under the bus.

While there is almost nothing in this paper that has not been hashed over by prior studies, including the Bush commission, the PERAB report does a nice job describing what is wrong with the current tax code. And it includes some valuable hints, at least, about possible future policy choices. But, in the end, it does little to advance a debate the nation desperately needs to have.  

 

. 

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Comments on Social Security Reform

We’ve gotten some interesting comments on our recent post about Social Security reform. In the post, we note that many reform options would slow the growth of benefits from one age cohort to the next, but not cut lifetime benefits relative to what people receive today. We didn’t focus on the specific issue of raising the retirement age, but used that option as an example of how benefits could continue to grow over time, but at a slower rate than what is currently being promised.

Regardless of the reform option in question, we certainly agree with those commenters who urged that we consider how reform might affect different groups in the population. We have long advocated proposals such as a minimum benefit level to maintain and increase progressivity—and offset the impact of other changes such as any increase in retirement age.

As a technical matter, however, it should be noted that adjusting the retirement age for life expectancy does not disproportionately affect lower-income groups, mainly because it does not affect disability insurance, and the disabled come disproportionately from lower-income groups. However, one should be debating the effects of the package as a whole on different groups—not one aspect of reform at a time.

The bottom line, though is that benefit reforms–whether increasing the retirement age, indexing benefit growth differently, or a variety of other schemes– can be designed so that on average lifetime benefits continue to increase over time, though at a slower rate. That still leaves open the issue of how to distribute any particular level of benefits.

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Stand and Deliver: Do Lawmakers Want to Cut the Deficit or Not?

We will soon learn whether all the political talk about controlling the federal deficit is serious or just noise. The next several months will provide an acid test for those pols who are bloviating about out-of control government. My advice: Pay no attention whatever to what they say, just watch how they vote.

Here are three issues to watch:

Pentagon Spending. Defense Secretary Robert Gates, who unlike most cabinet secretaries seems serious about reducing waste in his own department, would shift $100 billion in overhead over the next five years (from a cumulative budget of more than $3 trillion). Be clear, even Gates is not proposing to cut overall Pentagon spending. But he recognizes that in what is likely to become an era of constrained federal spending, the Defense Deptartment needs to use its funds more wisely. So he’d make the military a bit less top heavy, fire some contractors, and eliminate a few useless weapons systems. His most controversial proposal: Eliminate the Joint Forces Command in Norfolk, Va., which despite its grand name commands no forces at all.

Gates’ proposal, which any business person would recognize as eminently sensible, has so far succeeded only in bringing Virginia’s Democrats and Republicans together—to howl in outrage. They will try to kill it at the first opportunity–maybe this year, maybe in 2011. Even self-proclaimed fiscal conservatives such as Representative Eric Cantor (R-VA) are lining up to bury the idea.

Before the Defense Secretary rolled out his scheme, Cantor wrote this:

“The time has come for Congress to finally show political courage. American families have been forced to face tough financial realities and make difficult but necessary decisions. Why should their government act any differently?”

Hint: “Because it preserves political pork for my home state” is not a good answer.

Medicare: The Patient Protection and Affordable Care Act contains plenty of new health spending. But it also includes a provision that holds the promise of slowing Medicare growth. According to the new law, if Medicare exceeds certain spending targets, an independent board will recommend ways to reduce furture costs. This board hardly has a free hand. It is barred from proposing changes that would ration care, raise taxes, limit eligibility or benefits, or increase cost-sharing. In other words, about all it can propose is cutting payments to providers. Still, it is something.

Sadly, even these small steps are too much for top Senate Republicans who introduced the “Health Care Bureaucrats Elimination Act” that would abolish the Board. Once again, self-proclaimed fiscal conservatives such as John Cornyn (R-TX), Orrin Hatch (R-UT), and even Tom Coburn (R-OK) are out to kill a modest effort to control government spending. Their bill may never get a vote. But it should. I’d love to see the roll call.

The Bush tax cuts: TaxVox has had plenty to say about this one already. But the argument we’ll hear this fall is pretty simple: Do we want to permanently extend all the Bush tax cuts and increase the deficit by $3.7 trillion over the next decade, do we want to do so for all but the highest earners and increase the deficit by merely $3 trillion, or do we want to extend some or all of the Bush tax cuts for just a year or two and raise the deficit by a few hundred billion dollars? Hardly anyone on Capitol Hill would let them expire.    

Watch these votes, and learn who is really a fiscal conservative and who is not.

 

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Save the Making Work Pay Tax Credit but Narrow It

While Washington seems obsessed with the fate of the Bush tax cuts, it has paid little attention to a soon-to-expire Obama tax cut: the Making Work Pay credit (MWP). Like the 2001 and 2003 tax cuts, this credit, which was enacted as part of the 2009 stimulus, is also scheduled to expire at the end of this year. President Obama has proposed extending it through 2011. But Congress has been largely silent about what it plans to do, in part because extending the credit for another year would reduce federal revenues by more than $60 billion

The fully-refundable MWP provides workers with a credit of 6.2 percent of earnings, up to $400 ($800 for married couples). The credit phases out at a rate of 2 percent of income over $75,000 ($150,000 if married). The credit was originally proposed as a worker subsidy based on individual earnings. As enacted, MWP follows the lead of almost every other provision in the tax code and is based on joint earnings in the case of couples. This year, the credit will deliver almost $60 billion.

When Congress was debating the stimulus bill, MWP scored TPC’s top grade. That wasn’t because everyone here at TPC was excited to see Obama make good on his promise to cut taxes for 95 percent of Americans. The credit scored high because it did two things that TPC analysts felt were essential to economic stimulus: it raised take-home pay quickly via a change in the withholding tables (subject to some controversy) and it did so for people who would spend it. Of course, our enthusiasm for the policy was dampened by the fact that the credit went to many higher income families who would save much or all of it, rather than spend it and boost our then struggling economy.

Congress will soon have to get serious about dealing with the expiring tax provisions, and MWP demands a close look. Although I’ve previously advocated for an individual worker credit, MWP doesn’t fit the bill. It does, however, provide the only substantial work incentive for families without children that covers a reasonable range of earnings. (Childless families can also qualify for an EITC worth up to $457, but that credit applies to only a very narrow income range.) In the spirit of supporting work incentives while also recognizing our current fiscal situation, perhaps Congress should consider extending MWP only for low-income families. This might be just what the doctor ordered.

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