This week, in our blog series on the President's budget, we have talked about the overall numbers in the President's budget and the amount of savings from each budget area. Today, we will go more in-depth into the largest area of savings in the budget: tax policy.
The President's budget includes about $1.6 trillion of net revenue-raising provisions over ten years (excluding the American Jobs Act). Of course, this is against a baseline that extends $4.5 trillion worth of tax cuts over the same period, but we'll stay out of baseline discussions in this blog (you're welcome). The policies are mostly familiar ones, holdovers from past budgets, but there are a few new ones.
The bulk of the added revenue comes from provisions related to the 2001/2003 tax cuts. As the President has long proposed, the tax cuts for people making over $250,000 would be allowed to expire, raising a total of $970 billion. This entails allowing the top two tax rates to rise from 33 and 35 percent to 36 and 39.6 percent, respectively; allowing the top capital gains rate to rise from 15 to 20 percent; reinstating phaseouts of the personal exemption and itemized deductions (PEP and Pease); lowering the estate and gift tax exemption from $5.12 million to $3.5 million and raising the tax rate from 35 to 45 percent; and taxing dividends as ordinary income. The only new proposal is the one involving dividends; the Administration previously treated qualified dividends in the same manner as capital gains, putting the top rate at 20 percent.
Other revenue-raising provisions involve limiting or eliminating tax expenditures. The budget raises $585 billion from the reprised 28 percent limitation on certain tax expenditures. In a change from last year's budget--but consistent with the President's Fall submission to the Super Committee--the limitation applies not only to itemized deductions, but certain above-the-line deductions and exclusions like the employer health exclusion and interest on tax-exempt bonds.
|Revenue Provisions in President's Budget (billions)|
|Expiration of Upper-Income Tax Cuts||$968|
|Tax Expenditure Limitation||$584|
|Tax Gap and Simplifications||$6|
There are a number of other scattershot tax expenditure changes. The Administration, as in past years, would make many changes to international taxation, limiting certain deductions or calculation methods that individuals or companies abroad may use to the tune of $150 billion. They would also eliminate tax preferences for oil, gas, and coal, collecting an additional $30 billion in the process (not including changes to the domestic production deduction for fossil fuels). Other revenue changes include taxing carried interest as ordinary income, reinstating the tax dedicated to the Superfund, repealing "last-in-first-out" accounting for businesses, and imposing a fee on large financial institutions.
Beyond revenue raisers, the budget includes a few roughly revenue-neutral pairings and some tax cuts. As mentioned in the State of the Union, the budget would eliminate the domestic production deduction for fossil fuels (a previously used proposal) and would double the deduction for advanced manufacturers. Also, it would disallow deduction for expenses related to businesses moving operations offshore and provide a 20 percent credit for expenses associated with bringing business back to the U.S. Both of these changes are designed to be about revenue-neutral. The tax cuts involve extending some of the 2009 tax cuts, such as the American Opportunity Tax Credit and the extension of the Earned Income Tax Credit. Also, the budget includes permanently eliminating taxation of small business capital gains and permanently extending the R&D tax credit.
The backdrop to this laundry list of policies is the promise of fundamental tax reform. President Obama lays out a number of principles for tax reform: reducing marginal rates, broadening the tax base, maintaining progressivity, raising at least $1.5 trillion of revenue, and observing the "Buffett Rule" that millionaires should pay at least a 30 percent tax rate (which we had anticipated would be put in the budget as a policy).
The reform the budget discusses involves lowering tax rates and having fewer tax brackets while reducing many tax expenditures, in part by eliminating them for millionaires. In terms of progressivity, the budget states that the reformed tax code must be as progressive as a code in which the 2001/2003 tax cuts expire for high-income earners. The Buffett Rule is also held up as the replacement for the AMT, not just an add-on to the current system.
In addition, there is supposed to be a corporate tax reform plan that the Administration will put out soon, although it is not clear yet whether it will be designed to be revenue-neutral or revenue-positive.
Although the revenue-raising provisions are necessary, we would prefer them done in the context of comprehensive tax reform that has the potential to boost growth and significantly reduce the costs of administering and complying with the tax code. The Administration seems willing to go this route but has not yet put forth a plan (the promised corporate reform is really only a small piece of that).
Check out our other posts on the President's budget here.