THE TAX ATTIC with Jerry Coon

Looking at how to cut the deficit

Jerry Coon

Last week, I began discussing the implications of what our Congress has wrought by passing the Budget Control Act. The Act’s intention is to reduce the deficit by a total of $2.5 trillion over the next 10 years. They are going about this in two ways. Part A calls for trimming $1 trillion of expenditures over that 10-year period. Part B calls for creating a bipartisan, joint, 12-member committee that will find ways to cut an additional $1.5 trillion off the deficit over that 10-year time frame.

This Joint Committee on Deficit Reduction must bring their recommendations to Congress by November 23, and Congress must approve their recommendations by December 23 or else. The “or else” part is that automatic spending cuts will kick in if the Joint Committee doesn’t bring recommendations or if Congress doesn’t pass the recommendations they do bring.

These automatic spending cuts have not been defined as yet, but they are supposed to be so onerous that the Joint Committee and the whole Congress will do just about anything to not allow the cuts to take effect. It sounds like this 12-member committee is going to be sitting in a very powerful position. What they propose will most likely go into effect. It sounds like a mini-Supreme Court. In theory, at least, they will answer to no one. What will their recommendations look like?

It is important to remember that this is a 10-year plan and there are some significant events that occur within that 10-year time frame. The Bush Tax Cuts that were extended at the end of 2010 expire on December 31, 2012. The committee will most likely recommend that most of the tax cuts not be extended after 2012, especially those provisions affecting “rich” taxpayers—those with incomes above $200,000 for singles and $250,000 for families.

However, that won’t raise $1.5 trillion in 50 years, let alone 10 years, so what else will the committee recommend?

The big dollars can be saved by eliminating select tax deductions. For many taxpayers, this is will be a de facto tax increase. In government language, these tax deductions are considered tax expenditures, i.e. the government is spending money when we taxpayers save tax dollars by claiming the deductions.

Which deductions might the commission look at eliminating or phasing back? The thinking is that they would go for three or four large changes. Why change 1,000 small provisions when changing three or four provisions would yield the same tax savings? For example, eliminating the home mortgage deduction will increase revenues by up to $79 billion per year. It might tick off a few million taxpayers who claim that deduction, but it does save the federal government $79 billion per year. Eliminating the capital gains deduction will bring in another $53 billion. Ditto for ticking off quite a few taxpayers, but $53 billion is $53 billion. And when you are looking for $1.5 trillion, the commission has to think big.

An extremely big item not on the books at all right now would call for taxing employer contributions to health care insurance. That could bring in an estimated $144 billion per year in revenue.

Taxing those three items would increase revenues by $276 billion per year.

Partially offsetting those tax increases would be a lowering of the tax rates and elimination of the alternative minimum tax. The tax rates would decrease to approximately 8, 14 and 23 percent. That’s down from a maximum of 35 percent. The preferential capital gains tax rates of today would be totally eliminated so capital gains would be taxed at the ordinary tax rates.

Another way to cut expenditures is to fiddle with the rate of inflation. There are many payments and tax provisions, such as Social Security payments, federal pensions, the exemption deduction, the earned income credit amounts, the Individual Retirement Account deduction limits, etc., that are adjusted by the rate of inflation. If this rate of inflation calculation is adjusted so the calculation is lower, the government will save money. One report indicates the total effect of lowering the rate of inflation will be $59 billion. That is, the federal government will pay out $59 billion less over the next 10 years. This rate of inflation adjustment may be one of the stickiest provisions the committee would recommend, but it is most likely one of the provisions, among others, that the committee will recommend.

To some extent, Congress has us where they want us. By their overspending of the last several years, they are forced to cut spending and/or raise revenues. It’s not totally this Congress’ fault, but there are many Congressmen in this Congress that have been there during the whole debacle, and it is their fault.

I sincerely hope 12 people with some wisdom somehow are assigned to the Bipartisan Joint Committee on Deficit Reduction. We need some fair but effective ways to cut the deficit. I wish them good luck in finding those fair methods. This is Jerry Coon signing off.

Jerry Coon is an Enrolled Agent. He owns Action Tax Service in Rockford. Contact Jerry at www.actiontaxservice.com.

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