#ObamaBudget: Tax and Spend and Tax

The 2013 Federal budget has been released by the Administration. Given the state of politics and conflict, it is more akin to a political wish list than a serious proposal that can be molded by Congress into an adopted Budget. It does, however, reveal the thinking of the President about his view of the role of Federal Government, the state of the economy and the direction he intends for the country.

The Budget calls for Federal spending to top $3.8 trillion dollars next fiscal year by adding new and expanding existing programs in areas of renewable energy subsidies, education, school construction, payments to protect local government worker and infrastructure. One thing for sure, it is not a deficit reduction blueprint. It shatters his promise to cut the deficit in half when campaigning for office. This will be the fourth consecutive year the deficit is more than $1 trillion and more, bold red ink for years to come.

.:                            Deficits Under President Obama

Fiscal Year	Deficit
2009	$1.413 trillion
2010	$1.293 trillion
2011	$1.296 trillion
2012	$1.327 trillion (projected)

The purpose here is to look at the revenue side---taxes. The President has been consistently against the Bush tax cuts (except, of course, when he signed a bill to extend them for 2 more years.) The cuts made in 2001 and 2003 are set to lapse at the end of this year. Their fate is the election issue of the year, will drastically impact the economy and influence the type of government we all endure no matter who is the next President.

The Department of Treasury and the Office of Management and Budget released copious material containing the Obama plan on taxes. Reams of pages, charts, and analysis. It was hard to get through the volume but fortunately since most it has been proposed before it was manageable.

There are hundreds of proposals.

Here a two of the good ones that have considerable support:

• Extend Temporary Reduction in the Social Security Payroll until the end of 2012.
• Extend 100 Percent First-Year Depreciation Deduction for One Additional Year.

Here are the most important ones to watch affecting higher income taxpayers and the biggest of the tax increases:

• Eliminate Bush Tax Cuts for Income over $250,000
• Reinstate the Limitation on Itemized Deductions
• Reinstate the Personal Exemption Phase-out
• Reinstate the 36-Percent and 39.6-Percent Tax Rates
• Tax Dividends as Ordinary Income
• Tax Net Long-Term Capital Gains at 20-Percent
• Reduce the Value of Certain Tax Expenditures

 These proposals taken in isolation are bad tax policy, add complication to the tax system and will have unknown macro economic effects. That does not mean higher income taxpayers should not pay more taxes. It means that an ad hoc approach outside of overall tax reform is ill advised and risky. 

The Budget proposal contains considerable discussion about “tax reform”. As far as I can discern, tax reform is defined as rising taxes on high incomes “so that wealthiest Americans cannot avoid their responsibilities by gaming the system…”

Fair enough. That is a view.  Not my view of tax reform. However, the document goes on to say:

“…the tax system has been loaded up with revenue-side spending such as special deductions, credits, and other tax expenditures that help well-connected special interests… we cannot afford a tax code burdened with special interest tax breaks.”

Interesting notion. It would seem this criterion does not apply to activities and groups favored by the Administration. The following are a small sample would not seem to fall under the guise of tax reform: 

• Expand the Earned Income Tax Credit (EITC)
• Expand the Child and Dependent Care Tax
• Provide Exclusion from Income for Student Loan Forgiveness
• Provide Tax Incentives for Locating Jobs and in the United States
• Remove Tax Deductions for Shipping Jobs Overseas
• Provide New Manufacturing Communities Tax Credit
• Target the Domestic Production Deduction to Domestic Manufacturing Activities
• Extend and Modify Certain Energy Incentives

There are a few more specific items worth a comment, noteworthy because they keep coming up again and again.

The first is corporate jet depreciation, one of my favorites. The Administration calls for the elimination of special depreciation rules for corporate jets by changing the amortization back to seven years from 5 years. What makes this so interesting is the attention the President seems to pay to it and the fact he signed the bill in 2009, which granted it special treatment in the first place.

The second are the “carried interest” rules. This is also a favorite highlighted over and over again by the Administration, the changes to which have failed to pass a Democrat-controlled Congress multiple times. In short, the carried interest rule is used by partnerships in real estate, extraction industries, financial funds and other businesses to allow partners to treat as capital gains certain gains in the underlying assets of the partnership upon disposition. It is a complicated area, one that bears examination but it keeps cropping up because Mitt Romney used the technique while he worked at Bain Capital.

The third is taxation of "fossil fuels", another almost obsession by the Administration. For the umpteenth time the Administration is proposing to drastically change the long standing tax treatment of oil, gas and coal extraction by, among other things, repeal expensing of Intangible Drilling Costs (IDCs) and percentage depletion. Congress has rejected theses changes many times. Suggesting them again demonstrates either the desire to make the oil and gas industry a political punching bag, a lack of understanding how these industries work or perhaps both.

Finally, let’s look at two other important areas, which the Administration makes reference but is short on details.

The Alternative Minimum Tax (AMT) has inadvertently grown in scope that unless the base exemption is temporarily raised every year, millions of taxpayers would be snared by it.  This was not the intention of the tax when it was first enacted in 1969. It is no secret the AMT needs changed. The Administration cryptically outlines its possible elimination by substituting some sort of minimum tax on millionaires. The AMT was designed to ensure that those with too many tax preferences pay something, that is not what the Administration is proposing but they do identify the problem. It is worth pursuing but in a slightly different direction.

The last item is the corporate tax. It needs an overhaul.  Republican House Ways and Means Chairman Dave Camp has floated a draft of corporate tax reform. The Administration is working on one that may be released soon. Good idea.

In summary, the Budget reflects the view of Mr. Obama that the national economy and fiscal woes of the Government can only be fixed with much higher taxes on some taxpayers, breaks for others, more spending and further deficits. It is not a remedy prescribed by all but the voters will have the ultimate say. Do not expect much movement on taxes by Congress until the verdict is rendered. 

Jack. O. Nutter is a partner in the Washington DC firm of Nutter & Harris. Mr. Nutter is former tax counsel to the U.S. Senate Finance Committee. His further comments on tax, economic and political issues can be found at jacknutter.com and can be reached by e-mail at jack.o.nutter@gmail.com

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