When I first read the title of the Act I thought immediately of Jonathan Swift’s satirical essay, “A Modest Proposal for Preventing the Children of Poor People From Being a Burden to Their Parents or Country, and for Making Them Beneficial to the Public. The following parody lyric expresses the perceived tongue-and-cheek humor in the title (posted to www.taxfoolery.com on 1/17/13):
(To the tune of “Learning the Blues,” by Delores Vicki Silvers, made popular by Frank Sinatra in 1950s)
Some thought it was good news
Tax rates aren’t rising
But not so the well-off
Who are now realizing
They’ll pay the piper
And the pain won’t be brief
And that’s what they’re calling
But even the workers
Will notice their net-pay
Decline from a tax-hike
From the party they’d let play
Mean fiscal war-games
‘Gainst the Dems and the chief
Who’ve passed what they’re calling
The AMT should never touch
The middle class no-how
So when they pass a patch we shouldn’t’ need
How dare they take a bow
To add to the insult
You’ll lose your exemptions
And all those deductions
Will phase-out, need I mention
On your investments
A new tax pours on grief
And this they are calling
And tax reform’s a word we’ve heard
That always seems to vex
For every time they say reform
The Code grows more complex
And now they’re preparing
To forge the next battle
On spending and budgets
Loudly sabers will rattle
Same old crime like a thief
Till congress reforms though
We’ll get no relief
Irony aside, this issue deals with the Act’s impact on individuals and the economy, both good and bad, and points out some rather ugly or unpleasant aspects of what our fine congress, called by some the worst ever, did and what it did not do.
The Act is basically a laundry list of expired or expiring Internal Revenue Code sections that the Act retroactively reinstates, extends temporarily or extends permanently. What does “permanently mean?” It does not mean that provisions labeled as “permanently extended” are a forever gift. Rather, permanently here means that the provisions in the Act so labeled are extended with no definite sunset or expiration date. Recall that the Bush-era tax cuts initially had a sunset occurring ten years following enactment (See Steinberg Talks Tax™ “Fiscal Déjà Vu, 11-29-12, also posted on www.thetaxwars.net, 12/26/12). In fact, if congress ever seriously takes up real tax reform, many of the so-called permanent provisions will likely be amended or dropped from the reformed Internal Revenue Code.
There are some things to like, albeit with reservations, in this so-called “Relief Act,” namely:
- Provisions made permanent:
- AMT Patch and future AMT indexing: The Act retroactively and permanently patches the Alternative Minimum Tax (a parallel tax system to the regular income tax) to raise the AMT income threshold’s (exemption amount) at which the AMT kicks-in and retroactively allow non-refundable credits against the AMT. Thus, for 2012 the AMT exemption will be $78,750 for Married Filling Joint returns. The exemption amount will now be adjusted for inflation each year without the need for congress to enact a last-minute inflation patch. This provision seems good, however, only if one ignores that the AMT was never intended to reach middle class taxpayers. The inflation adjustment will knock many out of the AMT grasp. But, common, everyday middle class tax-deductions for state and local taxes, medical expenses and home mortgage interest will continue to ensnare middle-income filers while tax breaks for dividends and capital gains, larger for the wealthy, remain not subject to the AMT at all. For 2011, the TaxPolicyCenter found that only one-third of taxpayers earning more than $1 million paid AMT. Many, including the National Taxpayer Advocate have sought AMT repeal, but that has not happened because the AMT has become as cash cow for revenue that would be difficult to replace.
- Marriage Penalty relief permanently extended: The Act extends permanently the higher standard deduction for married couples and earned income credit phase-out to partially offset the “marriage penalty” that otherwise causes married couples to pay more tax on their combined taxable income than they would pay as single filers. For the same reason, the Act also permanently extends the doubled 15% tax bracket for married couples. These provisions are good because they ameliorate discrimination in our tax system against married filers versus single filers. The Act did not address the even greater discrimination against married persons who file separately.
- Cancellation of debt income on foreclosures, restructuring and short sales: The Act extends for one year (through 2013) the Mortgage Forgiveness Debt Relief Act of 2007 which had expired at the end of 2012. The Debt Relief Act allows taxpayers to exclude from income cancellation of debt income on principal residence mortgage debt up to $2 million ($1 million for married filing separately taxpayers). This provision is good because foreclosure activity is gearing up in 2013 with the robo-signing scandal now largely resolved. Failure to extend the relief would have imposed heavy tax burdens on families who are losing their homes and are without resources to pay a large tax on phantom income (i.e. income in an economic sense, from being relieved of debt, at least to the extent they remain solvent, but no hard cash to put in their pockets). This provision probably should have been extended through 2014 because it will take longer than one more year for the housing bubble mess to work itself out.
- New 401(k) Roth IRA conversion rule (Intra-plan conversions): This is an entirely new provision which allows employees with a 401(k) plan to convert that plan to a Roth 401(k) plan if the employer’s plan offers such Roth conversions. Under prior law you could only convert if you are eligible to take a distribution from the plan (over 59 ½, deceased, disabled, or separated from service). This rule makes sense but whether conversion makes sense for one depends on specific individual circumstances.
- Child tax credit of up to $1,000 for kids under age 17 (income must be below certain threshold amounts).
- Dependent care credit for 35% of eligible expenses up to $2,400 for one child and $4,800 for two children (no income phase-out but lower dollar limits apply for higher earners).
- Coverdell Education Savings Accounts (Education IRAs) into which annual contributions of up to $2,000 may be made, and used for educational expenses, including expenses for elementary and secondary school (subject to income phase-out).
- Above the line deduction for student loan interest up to $2,500 subject to phase-out at various income levels.
- Temporary extension of other tax breaks :
- 5 years (2013 through 2017): American Opportunity Tax Credit up to $500 for higher education expenses (four years post-secondary, subject to income phase-out), special relief for families with 3 or more kids for the refundable portion of the child tax credit and increased percentage for the earned income tax credit. These provisions had previously been extended through 2012.
- Two years (for 2012 and 2013):
- Above the line deduction for teacher expenses ($250).
- Deduction as interest for home mortgage insurance premiums.
- Election to deduct state and local sales taxes in lieu of state and local income taxes (a no-brainer for Florida residents – no state income tax).
- Above the line deduction for up to $4,000 of qualified education expenses (subject to income phase-out).
- Energy efficient credit for existing homes.
- One year (for 2012): Tax free distributions from IRA accounts of those over age 70 1/2: Direct distributions to charities made in January 2013 can be treated as made in 2012. Distributions made in 2012 to the IRA participant can also be excluded from 2012 income to the extent redirected to charities before the January 31, 2013 deadline. This tax break is good for those who cannot itemize deductions because of income phase-out rules, have limited non-IRA liquid assets, or wish to minimize Adjusted Gross Income; but, personal non-IRA gifts of appreciated assets in lieu of cash may be better for some.
- Permanent estate and gift tax rates, exemption and portability. These changes are good lending, at least for the moment, some sense of certainty to estate planners, and simplifying estate planning for most families:
- Estate, gift and GST lifetime exemption is set at $5 million indexed for inflation. The indexed exemption was $5.12 million in 2012 and will be $5.25 million in 2013.
- Portability of exemption: Surviving spouse can claim unused exemption of deceased spouse but an estate tax return must be filed by the personal representative of the first to die to make the irrevocable election.
- Maximum estate, gift and GST rate set at 40% for taxable estates or cumulative taxable gifts exceeding $1 million (i.e. for 2013 total cumulative gifts of $6.25 million). The rate on transfers of $500,000 to $750,000 is 37% and the tax bracket is 39% for transfers exceeding $750,000 but not over $1 million
Most regard the following permanent provisions as either good or bad, but in reality they are a mixed bag. I list them as bad for the reasons stated:
- Extension of Bush-era tax cuts on ordinary income for all but those described in the next paragraph. I believe this provision is unwise because:
- More tax revenue from the middle class is necessary to close the budget deficit and decrease national debt.
- Making the Bush rates permanent releases what leverage the President could exert on Republicans to agree to higher rates. The sunset of Bush-era rates meant automatic higher rates. Now a new law (see discussion below of why new laws are almost impossible to pass in the Senate) will be required to impose higher across the board rates.
- Increase in tax bracket rate to 39.6% for so-called rich, i.e., those joint filers with taxable income over $450,000 and single filers with taxable income over $400,000 (indexed for inflation). These rate increases begin at higher levels of income than the President had demanded ($250,000/ $200,000). While Tea Party GOP diehards criticized the Act, it is really a victory for the GOP not the President. Remember the first $450K of their income will still be taxed at the Bush era rates. The modest rate-increases for higher income combined with the personal exemption (PEP) and “Pease” itemized deduction phase-outs (discussed below), do not seriously impact the income inequality present in our economy and erosion of the living standard faced by many middle class families (stagnant wages, lowered home values, higher education costs). Nor do these provisions dent budget deficits (expected to raise $600 billion over ten years). In fact, the Act, according to a report by the Congressional Research Service will add about $330 billion to the deficit. Amusingly, New York Times Magazine article of January 13, 2013 “A Tax on Annoying Behavior,” annoying things we do that effect others which the market in unable to price. Perhaps such a tax levied on members of congress would alter the shameful behavior of its members.
- Permanent extension of Bush O% and 15% tax rate on long-term capital gains and 15% rate on dividends, except for a 20% rate on capital gains that fall within the 39.6% tax brackets ($450K/ $400K).
- Phase-out of Personal Exemptions (PEP): This provision in and out of the law, returns beginning in 2013. PEP reduces exemptions by 2% for every $2,500 of excess income above a threshold of $300,000 AGI for married couples/ $250,000 for singles (indexed for inflation).
- Phase-out of itemized deductions (called the Pease limitation after its author) also returns for 2013 and reduces deductions by 3% of excess income over the same threshold amounts of AGI as for PEP. The net effect of this rule and the PEP phase-out is that each increases a persons marginal tax rate by about 1% (PEP has a greater impact on larger families who have more exemptions).
- Not affected by the Act are the Affordable Health Care Act new taxes that begin in 2013:
- 3.8% Medicare surtax on net investment income for those with net investment income or modified adjusted gross income above $250,000 (married) and $200,000 (singles).
- 0.9% additional Medicare withholding tax on earned income (wages and self-employment income) above the same thresholds.
- Not extended by the Act is the employee payroll-tax holiday that had reduced Social Security tax withholding by 2 percentage points to 4.2%. The withholding rate returned to 6.2% on January 1, 2013.
Apart from not addressing inequality and revenue needs, the Act’s various phase-out amounts and temporary extensions (tax code changes since 2001 number 5,000), and the 3.8% Affordable Care Act surtax on net investment income (IRS proposed regulations and comments total 159 pages), add to the tax code’s complexity, already approaching a level of obscurity that is almost incomprehensible to all but the most elite of tax lawyers and CPAs. The bickering and in-fighting between the two political parties and within each party make the possibility of real tax reform feel more unlikely.
The ugly most frustrating aspect of The Taxpayer Relief Act lies in what it does not do: provide, “we the people” relief from the endless sniping and fighting in congress; it is not the result of the kind of compromise on difficult issues that would restore confidence in a functional congress. The whole fiscal cliff ruckus was about taming swollen budget deficits. The Act did not seriously address the budget (if we had one) and so we are faced with a potential battle and constitutional crisis (interpretation of Section 4 of the Fourteenth Amendment) over the debt ceiling standoff, i.e., how much the federal government is authorized borrow. The government is at the present borrowing limit. The Treasury can shuffle payments for a while (until mid-February or March) to stave off default. Our national debt credit rating, already dropped one level, is again threatened, S&P claiming that the Act did not accomplish enough to remove the threat of further credit rating reductions. Credit rating reductions would increase our national debt borrowing costs, increase budget deficits and cause inflation. Notwithstanding that additional borrowings are to cover obligations already appropriated by congress and incurred, Republicans have asked for dollar for dollar spending cuts for any increase that must be approved by the GOP controlled House. Once again, the GOP leadership and President play Russian roulette with a deadline for action looming. The President has said he will not negotiate spending cuts over the debt-ceiling. Republications most recently seem inclined to put off the debt-ceiling issue by kicking the can again down the road (see www.taxfoolery.com post of 11/21/11) a few months when the next spending appropriations fight will arise (without a budget the federal government operates by congress passing periodic spending appropriation bills. The Act pushed back the “fiscal cliff” automatic spending cuts to March).
Will Rogers said, “Even if you’re on the right track, you’ll get run over if you just sit there.” A sign of hope: both GOP House and Democratic Senate leadership have stated most recently that they may attempt to pass comprehensive budgets that would then go to committee to iron out differences. In the Senate budgets are not subject to the GOP abused supermajority filibuster rule (386 GOP lead filibusters in the past six years) and could lead to a reconciliation process for deficit reduction also free of the filibuster bottleneck. Although Senate reconciliation bill would invariably focus on revenue while the house bill would attack spending restarting the budget process would be a first step towards a more orderly, less frenetic congressional climate.
What also distresses about the Act is how it was passed at all and what that tells about how congress works. Benjamin Franklin said, “If you would persuade, you must appeal to interest rather than intellect.” Well, to line up the votes for this Act numerous pork or goodies had to be dealt out to members: For example, sneaky benefits for Amgen, a drug maker, generous gifts to NASCAR track owners and, rum and movie makers. All of these beneficiaries of congressional largess employ armies of lobbyists who effectively buy votes to improve someone’s bottom line at our expense.
In “The Optimism Bias,” researcher Tali Sharot reports that our brains are wired for optimism, “A belief that the future will probably be much better than the past and present.” Hope springs eternal, even hope not based on experience, that congress will get its act together and begin to govern. How will this happen? In the end, we hold the answer in our own hands. Another lyric from www.taxfoolery.com:
HOW DO YOU MAKE A CONGRESS GOVERN?
(To tune of “How Do you Keep the Music Playing,” by Michel Legrand and Alan and Marilyn Bergman)
How do you make a congress govern?
How do you make it work?
How do get them to do the job they shirk?
How do you keep your optimism?
When it’s a cynic’s town
How do you right a system turned upside down?
I thought they’d surely have to bend with sequestration
They’ve played with fire and now I’m so afraid
They’ll put the party line above a nation
God help the nation!
If we would choose the best of people
Who’d work for us not gain
Then we might see real compromises there,
Not self-made crises, when,
Our voice is heard again.
Perhaps, in the last analysis, Bertrand Russell was correct: “The whole problem with the world is that fools and fanatics are always so certain of themselves, and the wiser people so full of doubts.” I don’t know if I am any wiser than the next person or more or less optimistic than most, but I do have my doubts about congress straightening out and starting to fly in the right direction.
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 Nobel Laureate economist Joseph Stiglitz in a New York Times article, “The Great Divide,” (1/20/2013) argues that inequality is holding back our recovery from recession predominantly by leaving the middle class too weak to contribute sufficient consumer spending to reinvigorate growth and tax revenues. Re. rising income inequality, the Congressional Budget Office reports that after-tax income, including government benefits like Social Security, of the top 1 percent of households between 1979 and 2009 rose more than 150% and only 44% for the average household in the middle fifth of the income scale.
 “(t)he validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned.”
It is no longer necessary to hold the floor with long-winded speeches to filibuster (like James Stewart did in the Frank Capra film, “Mr. Smith Goes to Washington.”). Merely announcing an intention to filibuster essentially stifles Senate action unless 60 votes overcome the tactic. The Senate majority is considering rule changes but there is controversy about whether a supermajority vote is required and whether rule changes would make things better or worse in the Senate.