‘Zero plan’ chopped — but tax breaks still on the block

Congress won’t act directly on the recommendations of a presidential deficit commission, but elements of its plan — including the elimination of tax breaks and deferrals for retirement, life insurance and employer-sponsored health care plans — may become part of legislation in coming months.
The 18-member National Commission on Fiscal Responsibility and Reform garnered 11 votes Friday for a plan that would reduce the federal deficit by $3.9 trillion by 2020. Under a presidential executive order creating the body, 14 votes were required to send the proposal to Congress for a vote.
The report recommends more than $2 trillion in federal spending cuts and nearly $1 trillion in tax increases. A large chunk of the tax revenue would come from the elimination of all so-called tax expenditures, such as the tax-favored treatment of retirement and insurance plans. In addition, capital gains and dividends would be taxed as ordinary income.
The outline closely follows the “zero plan” that was put on the table by the commission co-chairmen, Democrat Erskine Bowles and Republican Alan Simpson, in November.
Under that plan, the money saved by scrapping the tax expenditures would allow individual rates to drop to 8%, 14% and 23% from their projected 2011 levels, which range from 15% to 39.6%. The corporate tax rate would fall from the current to 26%, from 35%.
The plan drew the support of six members of Congress — representing both the liberal and conservative ends of the political spectrum — sitting on the commission, which increases the chances that at least parts of it will be a foundation for congressional debate.
“This becomes a starting point for policymakers to discuss budget decisions in 2011 and 2012,” said Brian Gardner, a Washington analyst for Keefe Bruyette & Woods Inc.
The primary theme of the final commission meeting Friday was that the proposal is just the beginning of the dialogue on deficit reduction.
The plan serves to “kick-start an adult conversation,” said Sen. Dick Durbin, D-Ill., who voted in favor. “It is just a step forward in the debate.”
Several of Mr. Durbin’s colleagues, including a couple who will be at the center of tax policy in the Congress, voted against the proposal — Rep. Dave Camp, R-Mich., likely chairman of the House Ways & Means Committee, and Sen. Max Baucus, D-Mont., chairman of the Senate Finance Committee.
Their reluctance to embrace the commission’s work signals that nothing in the plan, including zeroing out the tax expenditures, is imminent.
“For the 112th Congress (which begins in January), it’s going to be a divisive issue,” said David Tittsworth, executive director of the Investment Adviser Association, who nonetheless was surprised that the final report drew 11 votes.
One of the points that likely will come out as the Congress wrestles with tax reform is that the tax expenditures for retirement plans and the buildup of cash value in life insurance products are tax deferrals rather than deductions, according to Mr. Gardner.
Proponents likely will argue that the budget savings from eliminating them are modest and that they’re designed to increase savings and investment.
“If we’re talking about a complete elimination, that’s a bridge too far,” Mr. Gardner said. “If we’re talking about limits on the deferral, it probably has a better chance politically, but it’s still an uphill climb.”
Jettisoning the tax expenditures is one of the signature elements of the proposal.
“The tax earmarks are spending by another name,” Mr. Bowles said.
During a commission meeting last Wednesday, a couple of Republican members praised two of the goals of the tax reform portion of the report — lowering rates and broadening the tax base.
“If we did the zero plan, the explosion of economic activity in this country would be extraordinary,” said Sen. Judd Gregg, R-N.H., a member of the commission.
Other members of Mr. Gregg’s party, however, may resist removing tax exclusions, which they might define as raising taxes on retirement and insurance plans.
“There are a lot of deductions and credits in the tax code that are specifically aimed at achieving a certain objective, like stimulating economic growth in a certain industry,” said Sen. Michael Crapo, R-Idaho, a member of the commission. “In that context, there are going to be a lot of people who are reluctant to see us simplify the tax code. The return for that, though, is that tax rates are brought down so dramatically.”
Many interest groups will be urging both Republicans and Democrats to protect the tax-favored status of retirement and insurance plans.
Brian Graff, executive director and chief executive of the American Society of Pension Professionals and Actuaries, said in a statement that the commission’s recommendations to remove retirement tax preferences “will threaten the stability of the established employer-sponsored retirement system that millions of American workers depend on — setting off a chain reaction that could undermine Americans’ retirement security in a tenuous economy.”
If groups such as ASPPA succeed in protecting their tax-favored status, the loss of revenue will have to be made up elsewhere, Mr. Bowles warned.
“Congress can choose to add back key provisions, recognizing that each add-back raises the rates; they are not free,” Mr. Bowles said.
Organizations on the left reacted angrily to recommendations to raise the Social Security retirement age and cut Medicare.
Last Wednesday, Mr. Simpson, a former senator from Wyoming, urged Congress to withstand pressure from the right and the left to water down deficit reduction efforts.
“They’ve been waiting a long time to chew this one to pieces,” Mr. Simpson said of Washington interest groups. “They’re geared up to destroy this work.”
Even commission members who voted against the proposal praised it as a serious attempt to address a federal deficit, which is currently $1.29 trillion, and a massive federal debt that threaten the U.S. economy if the rest of the world suddenly decides to stop buying American Treasury bonds.
“We have fundamentally changed the debate in America,” Mr. Bowles said. “We have put the debt issue on the map. This is about America being competitive in the world. It is about pulling together, not pulling apart.”
Mr. Crapo, who voted in favor of the report, will urge his congressional colleagues to take the recommendations seriously.
“We should not let this proposal fall idly by the wayside,” Mr. Crapo said. “The option of inaction is unacceptable.”