Tax policy decisions ahead: President-elect Obama's call for change, prepared by the Tax Policy Group of Deloitte Tax LLP in Washington, D.C., predicts that with Barack Obama in the White House and a strengthened Democratic Congress facing huge budget and tax issues, the outlook is for changes in tax policy in the next two years that could determine the size and shape of our income tax systems for the foreseeable future.
Tax policy decisions focuses on the likely tax agenda for 2009 and 2010, and suggests that decisions will unfold in two pieces. The first set of policy decisions will address the current economic crisis and would likely include focused tax cuts as part of an economic stimulus package. The second would consist of decisions that address long-term issues raised in the campaign in the context of significant, projected budget shortfalls.
The new president will need to make his priorities clear to Congress early in his tenure, the authors say, since Congress will develop its own agenda.
Business Tax Policy
Detail is sparse in Obama's business tax proposals, which combine incentives and revenue raisers. The President-elect has said he is open to a cut in corporate tax rates and in the tax rates for start-ups, but has also called for targeted tax increases through measures affecting business that could result in an overall increase in business tax revenue of $770 billion over 10 years, according to Tax Policy Center estimates.
In the absence of specific information about these proposed measures, the Deloitte study looks to four broad themes struck by the campaign that could impact business taxes:
- Protecting and growing U.S. jobs;
- Changing how we produce and use energy;
- Restoring "fairness" to the tax code; and
- Providing quality health care.
Economic stimulus proposals to grow U.S. jobs
Obama's approach to protecting and growing jobs in the U.S. will likely combine incentives for U.S. companies including:
- Reducing the corporate tax rate and
- Eliminating the capital gains taxes on small business and for investments in start-ups
- Permanent extension of the research and experimentation tax credit
- Loan and tax incentives for community broadband.
Other policy changes that were discussed include a New American Jobs Tax Credit during 2009 and 2010 that would provide existing businesses that make net additions to their U.S. workforce a $3,000 refundable tax credit for each additional full-time employee hired. Obama would extend the temporary increase in the small business expensing allowance to $250,000 through 2009.
Tax on U.S. companies that operate abroad
Obama has promised to raise taxes on U.S. companies that operate abroad. He is not likely to propose complete repeal of deferral of foreign income but will impose some form of indirect limit. Among measures that could affect income from international sources:
- Indirectly limiting deferral, possibly limiting the deduction of expenses allocable to foreign income until that income is repatriated
- Limit foreign tax credit benefits
- Limit specific international tax planning strategies — for example, the Obama campaign suggested establishing an international "tax havens watch list."
Obama did not discuss international tax policy in detail during the campaign and the Deloitte study suggests that may indicate that his advisers have not held substantive discussions about international tax policy.
Obama's energy policy is similarly a combination of carrots and sticks. His tax proposals would affect domestic production and consumption of energy. Various bills presented in Congress during the past year that would have repealed or modified the amortization of geological and geophysical costs, extended recovery periods for gas distribution or gathering lines, and imposed an excise tax on oil or gas extracted from leases on the Outer Continental Shelf could all become part of his energy policy.
Obama has proposed a windfall profits tax on oil, incentives to investment in renewable fuels, and credits for electricity produced from renewable resources.
The president-elect's plan to restore fairness to the tax systems is based primarily in changes to individual and corporate tax rates but he has also called for taxes on certain private equity and hedge fund entities and closing loopholes in the corporate tax deductibility of CEO pay. He also supports legislation to codify the economic substance doctrines and penalize non-economic substance transactions.
Health care reform
Large employers that do not provide heath care or pay a substantial part of their employees' health care insurance would be required to contribute a percentage of payroll to the costs of a National Health Insurance Exchange under the Obama health plan. Small businesses would be exempt and would receive a new small business health tax credit.
Business needs to be aware of and prepare for the effect of changes in tax laws on their financial statements, the study says. The business community should remain vigilant, because while specific provisions relating to corporate tax revenue raisers have not been made clear, revenue raisers do not have to wait for a major tax bill and could be included in other legislation in early 2009.
Individual Tax Policy
Obama campaigned on promises to keep some tax cuts for married couples earning less than $250,000 and singles earning less than $200,000 which under the present law are set to expire at the end of 2010.
He has said he will:
- Reinstate the top two individual income tax rates (currently 33 and 35 percent) to their pre-2001 levels of 36 and 39.6 percent while maintaining the existing 10, 15, 25, and 28 percent tax brackets;
- Increase the capital gains rate to 20 percent for taxpayers in the top two tax brackets;
- Continue to apply the same tax rates to qualified dividends as capital gains; and
- Reinstate for high-income taxpayers the personal exemption phase-out and itemized deduction limitation, which are scheduled to be fully phased out starting in 2010.
In effect, the Obama plan would raise the top income tax rate, considering these phase-outs, to 40.79 percent from its 2008 level of 35.35 percent.
President-elect Obama has proposed extending and indexing the temporary increase in the AMT exemption amount enacted for 2008. This would prevent a dramatic increase in the number of AMT taxpayers. His increases in ordinary tax rates also would remove some high-income taxpayers from AMT by increasing the amount of their regular tax liability.
The estate tax, which is set to drop to zero for 2010 only, will be reinstated in 2011 at the significantly higher rates and significantly lower exemption amounts that were in effect in 2000. This will mean an increase in the exemption level to $3.5 million per person ($7 million per couple) and will increase the top rate to 45 percent.
Other individual tax proposals
Many of Obama's individual income tax proposals already exist in draft form in legislation that has been vetted by Congress. But new proposals would:
- Eliminate all income taxes for seniors (age 65 and over) earning under $50,000 a year.
- Create a refundable Making Work Pay Credit equal to 6.2 percent of up to $8,100 in earnings for those making less than $75,000 a year (maximum $500 credit per spouse).
- Create a refundable 10 percent Universal Mortgage Credit for nonitemizers (up to a maximum of $800).
- Replace existing Hope credit with a refundable American Opportunity Tax Credit, providing up to $4,000 per year for qualifying higher education expenses.
- Expand the earned income tax credit program.
- Mandate automatic employee enrollment in 401(k) plans where employers offer retirement plans. Require employers that don't offer retirement plans to provide employees with access to automatic IRAs.
- Expand Savers Credit and make it refundable. For working families earning under $75,000, government would match $500 of first $1,000 saved and deposit into account.
- Increase child care dependent maximum credit rate to 50 percent and increase phase-out threshold to $30,000.
Long term payroll tax increase
To address long-term problems with Social Security and Medicare, Obama has said that he would propose an additional payroll tax to take effect 10 years or more in the future. This tax would be at a rate of between 2 and 4 percent (split between employer and employee) and would apply to income above $250,000.
Economic recovery and timing of tax legislation
The authors of Tax policy decisions ahead say that they expect the new administration will adopt new tax policies as events unfold:
- First, some tax relief will be proposed early in the new administration as part of economic recovery legislation.
- Second, later in the year as Congress and the White House confront the need to extend a variety of expiring individual and business tax provisions as well as another year of AMT relief, the ballooning deficit projections that have accompanied the current economic crisis and recovery efforts will make Obama and Democratic lawmakers much less sympathetic to pleas that these provisions be extended without offsetting tax increases.
- Third, by 2011, Obama and the Democratic Congress are very likely to have succeeded in their desire to raise ordinary income tax rates, as well as capital gains and dividend rates on the highest income individuals.
Taxpayers will have some time to prepare for changes, because the introduction of new tax rates on both business and individuals will be affected both by the economic situation and the President-elect's strategy for governing.