FISCAL DÉJÀ VU

The battlements in Congress seem all too familiar. The present confrontation feels like one of those instances when I begin to watch a movie on TV to realize after a few scenes that I’ve already seen it. Some movies like Casablanca or The Third Man, I can watch over and over. The theatre in Washington is definitely not a play we are pleased to see revived. A recent Bizarro cartoon (Miami Herald, 5/23/12) depicts blue and red cars following alternative road-signs to the Capitol. The blue car heads towards, “Washington A.C. (Left Lane). The red car proceeds towards “Washington D.C. (Right Lane). The parties may believe they occupy separate camps. Still there is one country to govern and the corrosive atmosphere in D.C. in not conducive to governing which necessarily involves compromise.

This malaise of congressional inaction brings to mind Russian writer Ivan Goncharov’s novel Oblamov, a satire of Russian nobility. Oblamov is also the central character, a perfectly superfluous man incapable of making important decisions. Oblomovism has come to describe a self-neglectful lack of motivation that could be applied to congress. Although it is not quite that congress lacks motivation but that it is motivated in the wrong direction. Not towards resolving long standing fiscal issues but in pursuing political gain at our expense. Recalling the wisdom of John Adams, “In my many years I have come to a conclusion that one useless man is a shame, two is a law firm, and three or more is a congress.”

So here we are ten years out from the 2001 and 2003 Bush Tax-Rate Cuts and the battle lines are unchanged. Grover Norquist (Americans for Tax Reform) insists that Republicans will hold the line on the “Tax Protection Pledge” exacted in November that demands “no new taxes” (The Repbulcan controlled House last week refused to consider its Speaker’s own bill to raise taxes on only those earning $1 million or more); and President Obama insists that any agreement include higher taxes for wealthy (defined as couples earning over $250,000 or single filers earning over $200,000 {more recently, the President offered to raise the threshold to $400,000}, although I have always thought a rich person as one who does not have to work to support a luxurious lifestyle). Each side has recently spoken in conciliatory tones but belying this seemingly more cooperative spirit is a deep rooted philosophical breach about the size and role of government. Republicans have been accused of employing obstructionism as a strategy for shrinking government by attrition and germinating negative popular attitudes towards the resultant inefficacy of governmental action. The desire to control government sprawl, however, is not necessarily bad for, as Will Rogers quipped, “It is good thing that we do not get a much government as we pay for.” And, Milton Friedman, “if you put the federal government in charge of the Sahara desert, in five years there’d be a shortage of sand.” Republicans should counterbalance Democratic enthusiasm for governmental intervention, but with more emphasis on cogent arguments and less on belligerent ideology. Democrats in turn should respect Republican concern for overreaching government (a concern of our founders) but promote governmental programs that do things the private sector cannot accomplish such as building the interstate highway system that fostered an auto industry’s growth; or, ending child labor and unsafe working conditions that would exist today and do in other countries that do not provide governmental supervision to moderate capitalism’s greed. The two sides don’t have to play a win-lose game Google co-founder Sergey Brin called a “bonfire of partisanship”. The game can be win-win. Perhaps Roger Fisher and William Ury’s book on negotiation, “Getting to Yes,” (1981) should be mandatory reading for Republicans and Democrats. Ultimately it is a question of finding the right balance between the public and private sectors.

The GOP’s bitter election pill is that what some have called a scotched earth strategy failed to change the political dynamics in Washington and, after two years of insufferable campaigning and name calling, we are right back where we started from (Democrats in the White House and even more strongly controlling the Senate and Republicans still controlling the House, although by a somewhat lesser number of seats) as parodied in my song lyric on http://www.taxfoolery.com (posted after election on 11/7/12) a portion of which follows:

RIGHT BACK WHERE WE STARTED FROM(To tune of, “Right Back Where we Started From,” by Pierre Tubbs and J. Vincent Edwards (1975))

Chorus
After all the beating of all the drums
We end up right back here where we started from
All that spent, those tidy sums
And we are right back here where we started from

Verse
Another great divide
The House and Senate will collide
Just like they did before and naught gets done
Politics impedes
Any bill the country needs
While on the next campaign they’ve already begun
(Repeat Chorus)

WHY DO WE STAND ON THE EDGE OF A FISCAL CLIFF?
Incredulously, the U.S. government, overseeing the largest world economy, has functioned without a budget since congress last passed a budget in April 2009. Since then spending, authorizations and appropriations have been approved on a piecemeal basis through continuing resolutions. The base for these measures has been the fiscal year 2008 budget adjusted for inflation. The outcome has been deficits (spending over revenues) of $1 trillion in each of the last four years. For October 2012 the U.S. deficit was $120 billion. Failure to reach agreement on the last round of spending and debt resolutions led to the passage of a law imposing automatic spending cuts of $1.2 trillion over ten years(called sequestration) that are to take effect on January 1, 2013 unless agreement is reached. These spending cuts are across the board and include cuts of $54.67 billion to defense and a like amount to non-defense spending in 2013. These cuts will come as a large portion of the tax code expires on December 31, 2012. The details of the tax code implosion and tax-reform issues are discussed at depth in Steinberg Talks Tax™ Vol. 4, No. 10, “The Lost Art of Compromise,” (December 13, 2010), Vol. 5, No. 6, “Is Tax Reform on the Horizon?” (July 27, 2011), Vol. 5, No. 9, “Year-end Tax Worrying! (December 1, 2011), and, Vol. 6, No. 4 (May 7, 2012), “The Last Good Year.”

I will not here repeat the dreary details, but suffice it to say, come January 1, 2013, many income tax benefits will fall off the tax map, marginal tax rates will go up steeply (Total tax increase said to be $532 billion), and the AMT will severely impact middle class taxpayers in 2012, absent a retroactive patch extender. IRS has announced that should that occur tax filings and refunds will be delayed until late March while its systems are re-programmed. New taxes imposed on unearned income and wages under Obamacare will also kick-in. Unemployment benefits expire for millions of those out of work. The Mortgage Forgiveness Debt Relief Act will expire just as foreclosures, modifications and short sales are accelerating. The payroll tax holiday ends for those still working. The economy, improving but more fragile than robust, may not be able to absorb the bludgeoning of these new economic hammers without falling into another recession. The dour global economic situation adds to already great consternation over allowing this fiscal disaster to occur. The stock market totters with uncertainty. Yet no one is certain that congress and the President will reach agreement to prevent going over the fiscal cliff (a moniker used to describe these scary eventualities). A good summary, “The Fiscal Cliff: A Primer,” from the Tax Foundation Special Report No. 204, 11/8/12 is available at: http://taxfoundation.org/article/fiscal-cliff-primer.

IS THERE ENOUGH TIME FOR A DEAL?In a word, yes, there is enough time. The question, Is there enough will?
The debate at hand is not new. All of the components for solving the problem have been on the table and discussed and dissected ad-nauseam for over ten years. These are:

 The taxation side: Where new revenue would come from. In turn this component of the budge has two sub-components:
o Tax rates – higher rates it is argued will bring in more revenue.
o Fewer tax expenditures. These are the tax benefits and loopholes (deductions, credits, exclusions) in the tax law that result in foregone revenues which, but for the tax benefit granted, would be collected. We know how much each major tax benefit costs the government.
o Economic growth – This is the supply-side argument that lower tax rates generate economic growth that, in turn, produces more tax revenue. Warren Buffett and many economists reject this theory as “nonsense,” but the argument persists.
 The spending side: The debate here is about what federal programs will be eliminated or curtailed? The biggest items by far are defense, Social Security, Medicare and Medicaid (While Obamacare was upheld by the Supreme Court, issues still swirl regarding its implementation).These dwarf everything else in the budge if the government had a budget.

Thus, the overall all makeup and components of a deal are already known. The difficulty is that no one wants to give up their tax benefit and strong lobby groups protect each cubby-hole. Also, it is hard to find a solution that does not harshly impact the middle class because that is where the largest tax revenues lie. Even insignificant tax benefits (in relating to total tax expenditures), like partially tax deductible college football tickets (in tax law since 1986 and costing taxpayers 100 million a year according to Bloomberg.com report, “Football Tax Break Helps Colleges Get Millions,” 10/25/12), are fiercely defended. Imagine the struggle to reign in home mortgage interest deductions, state and local taxes, retirement savings or charitable donations. Senate Finance Committee member Charles Schumer says: “The old style (revenue neutral reform in 1986) tax reform is obsolete in a 2012 world.” Reform must raise the top rate, address the nation’s wealth gap and limit deductions for the middle class (because that is where the big dollars reside)

In addition to tax reform, congress must finally address and tweak Social Security, Medicare and Medicaid because fiscal realities and longer work-lives and life-spans make that both necessary and wise. Here again the components are known (e.g., older eligibility age, means testing for Medicare, higher wage base for Social Security Tax). What has been lacking is the political will to go out on a limb for change, however much needed. In light of the election results Medicare vouchers and privatized Social Security accounts are not in the cards. Republicans must join Democrats to fashion a solution within the current structure of these safety-net programs.

WHY IS A DEAL MORE LIKELY NOW?This time around stronger pressures weigh on the actors to reach an agreement, namely:

 The consequences are more severe than when the Super-committee failed to reach agreement.
 No one wants to be blamed for pushing us over the fiscal cliff.
 Political headwinds have shifted against the Republicans who now feel less secure about facing the new-demographics electorate.
 The President is being more assertive this time around.
 Another debt ceiling debate is on the horizon and no one wants our already lowered debt rating further jeopardized. Higher interest costs on our debt would be devastating.

WHAT IS WORRISOME?Both sides are talking about a framework that would include some deficit reduction this year but push off substantive tax reform and dealing with the large spending items such as Social Security, Medicare and Medicaid (so-called entitlements) until 2013 (more can-kicking). Republicans twist logic and posture that they are willing to make large concessions on revenue and ask for significant cuts in entitlements. Democrats have yet to be specific about what spending cuts they will offer. Thus, the sides continue to dance as the clock ticks towards “High Noon.” Yet no sense of urgency is discernable.

WHAT SHOULD YOU DO AND NOT DO?DO NOT – Order your broker and to sell your entire portfolio to lock in gains at 15%. The decision to sell should not be based solely on tax rates. If you already had planned to sell soon (whether stock, real estate or business) try to sell before December 31, but otherwise evaluate your after tax return in the present investment versus available alternatives. The capital gains rate is likely to go up because there is no sound solution to budget deficits without narrowing the gap between the regular top tax rate (presently 35%) and rate on long-term capital gains (presently 15%, or less than ½ of the regular rate). There is simply too much tax revenue invested in this tax break.
 Give away substantial assets to take advantage of the $5.12 million gift tax exemption without considering the wisdom of lifetime gifts that deplete your ability to support your own lifestyle. For example, gifts to grantor trusts require the grantor to pay tax on trust income while others may receive the income.
DO CONSIDER SOME ACTION, FOR EXAMPLE
 Make larger charitable donations in 2012 (perhaps to donor advised funds or of appreciated stock) because donations may be limited after 2012 (most likely for higher income taxpayers by deduction cap or return of phase-out of itemized deductions).
 Wait to take required distributions from your IRA if you want to gift to charity in lieu of taking minimum distribution in case congress reinstates the provision allowing tax free gifts up to $100,000 from your IRA.
 Make individual gifts of $13,000 to as many individuals as you want.
 Buy depreciable assets in your closely held business since bonus and expensing deductions drop precipitously in 2013, unless reinstated (likely due to economy but perhaps not as generous as before).
 Make an extra mortgage payment (you’re allowed to prepay one month’s interest) because home mortgage interest deductions may be limited in 2013 (most likely for higher income taxpayers and on second homes).
 Maximize contributions to retirement plans (401(k) limit is $17,000($22,500 if you’re over 50).(Will survive in some form due to need to encourage retirement savings). This is always a good idea.
 Prepay next semester’s college tuition or contribute to a Sec. 529 education savings account.
 Pay medical bills outstanding since after 2013 no deduction is allowed until expenses exceed 10% of Adjusted Gross Income (although the rule is not effective until 2016 for those over 65).
 If you own stock options, seek expert advice in evaluating what to do, if anything, before year-end as any decision about the benefits of early exercise is complex.
 Prepay state income and real estate taxes if doing so does not trigger the AMT (likely to be limited for higher earners).
 Convert a regular IRA into Roth IRA although weigh the up-front tax cost against the uncertain future tax benefit. Remember regular IRA distributions will not be subject to the 3.8% tax on investment income but can push adjusted gross income over the investment tax threshold of $250,000 for married couples and $200,000 for single filers.
 Take capital losses up the capital gains plus $3,000 but watch the wash-sale rules.

Above all remember that tax law is complicated and each taxpayer will be uniquely impacted by these changes and uncertainties depending on their particular situation. Thus, generalizations are dangerous. Seek advice before you take action. Unfortunately, those hit hardest, low income households, can do little to minimize the impact of losing the expanded earned-income credit, child credit or college tuition breaks that will expire if congress fails to act.

CONCLUSIONSome last words of wisdom:

The eloquent Israeli statesman Abba Eban: “History teaches us that men and nations behave wisely once they have exhausted all other alternatives.”

Albert Einstein, as much a philosopher as genius physicist: “Imagination is more important than knowledge.”

The reluctance to give up one’s tax benefits is parodied in another of my song lyrics, this one as published by the American Bar Association Tax Section in Tax News Quarterly, Tax Bites. If it seems familiar, you’re not experiencing déjà vu. This lyric appeared in an earlier Steinberg Talks Tax™ sing-along newsletter.

YOU CAN’T TAKE THAT AWAY FROM ME(To tune of “They Can’t Take that Away” by George and Ira Gershwin)

Intro
There’ve been many goodies added to the tax code as it grew
Here are some that we’ve become addicted to

Verses
The 401 sub (k)
The corporate R&D
You want to take away?
No, no, you can’t take that away from me.

Home mortgage interest prized
By every family
Think of that home downsized
No, no, you can’t take that away from me

Bridge
We can’t solve the budgetary crisis
We’ve grown wary of
Lest we all give up some tax breaks dearly loved

Verses
My contributions for
The art of Johns or Klee
Allowed not any more?
No, no, you can’t take that away from me.

The rate on long term gains
Health benefits tax free
The lobbyist complains
No, no, you can’t take that away from me

You can’t take that away
More campaign cash I’ll pay
You can’t take that away from me.

Lyric © 2011 by Robert S. Steinberg, Esquire
All rights reserved

Let us hope that congress has learned to be more useful than John Adams thought, that delaying tactics have been exhausted and that it can at last combine wisdom with imagination to put aside differences and restore government to a fiscally sound footing without subverting our ideals and humanity.

*Orignally published on November 26, 2012 in my client newsletter Steinberg Talks Tax.™

©2012 by Robert S. Steinberg, Esquire
All rights reserved

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