Deficit Commission Draft Proposal Released

The co-chairmen of the National Commission on Fiscal Responsibility and Reform released their draft proposal on November 10, 2010.  The Commission was established by Pres. Obama on February 18, 2010 and is to provide recommendations for reducing the national budget deficit by December 1, 2010.  The draft proposal has brought fierce reactions from politicians and others seeking to protect their personal interests in government benefits.  In my opinion, if our politicians are unwilling to responsibly lead, and if the public is unwilling to make sacrifices, the country's financial mess will produce consequences that will be more severe than the steps needed to fix the mess.

The draft proposal suggests a variety of spending cuts and tax increases, organized into three options.  Some of the proposals are:

OPTION 1:  THE ZERO PLAN

• Eliminate income tax deductions worth $1.1 trillion of tax savings.  The Commission terms this as eliminating "tax expenditures," which is political-speak for deductions.  Only a politician can think that legitimate tax deductions are a form of government spending.
• Lower the top individual income tax rate to 23% and the corporate tax rate to 26% once deductions have been eliminated.  This is called "broadening the base."  Then, as certain deductions are deemed desirable, correspondingly increase the tax rates.  We saw this before under Pres. Reagan as part of the Tax Reform Act of 1986.  Deductions were eliminated and the tax rates lowered.  Of course, once more income became taxable, Congress later increased the tax rates.
• Eliminate the alternative minimum tax.

OPTION 2:  WYDEN-GREGG STYLE REFORM (named after proposed legislation)

• Repeal the alternative minimum tax.
• Triple the standard deduction to $30,000 ($15,000 for individuals).
• Repeal the deduction for state income taxes, cafeteria plans, and miscellaneous itemized deductions.
• Disallow mortgage interest deductions for mortgages over $500,000.
• Allow charitable deductions only to the extent the amount exceeds 2% of adjusted gross income.
• Establish three individual tax rates of 15%, 25%, and 35%.
• Eliminate depreciation, LIFO, and oil and gas industry incentives for corporations and lower the tax rate to 26%.
• Permanently extend the research credit.

OPTION 3:  TAX REFORM TRIGGER

• Call upon Congress to enact tax reform by 2012.
• If tax reform is not enacted by 2012, then starting in 2013, all deductions and credits would be reduced across the board by 15% to achieve certain deficit reduction goals.
• Increase the percentage haircut over time until tax reform is enacted.  The Commission thinks Congress will be forced to reform taxes by inflicting more pain on the public.

OTHER ITEMS

• Increase the gasoline excise tax by 15 cents per gallon over time.
• Eliminate or limit the income tax exclusion for employer-sponsored health care coverage.
• Gradually increase the Social Security retirement age to 68 by 2050 and to 69 by 2075.  Increase the amount of wages subject to Social Security tax.  The unfortunate fact about Social Security is that the past decades of surplus taxes, which were supposed to constitute a "trust fund," have been spent and have masked the size of previous budget deficits.  Now that the program needs to tap into the "trust fund," nothing is there.  Excess Social Security benefits now have to be funded with additional budget deficits, higher taxes, reduced benefits, or a combination of all three.
• Reduce "discretionary spending" in the budget, including defense and farm subsidies.

Selected 2011 Inflation-Adjusted Tax Figures

Each year new tax rate bracket amounts, deduction limitations, exemptions and other items are adjusted to reflect inflationary increases.  The Tax Code now requires over 50 inflation-driven computations to determine deduction, exemption and exclusion amounts.  In addition, many items have built-in statutory changes enacted under previous tax legislation.  Due to nominal inflation during the 12-month measuring period, most of the amounts have not changed from 2010.  Some of the more important 2011 tax figures announced by the Federal Government or estimated by the Research Institute of America (RIA) are the following.

• The Social Security wage base is $106,800 (the same as 2010)
• The personal exemption is $3,700 (up from $3,650 in 2010)
• The IRA contribution limit is $5,000 with a $1,000 "catch-up" for those age 50 or older (the same as 2010)
• The Roth IRA contribution phases out for modified adjusted gross income between $169,000 and $179,000 (up from $167,000 to $177,000 in 2010) for joint tax returns, and between $107,000 and $122,000 (up from $105,000 and $120,000) for single and head of household filers
• Note that the Roth IRA conversion income limit does not apply any more after 2009
• The 401(k) plan deferral limit is $16,500 with a $5,500 "catch-up" for those age 50 or older (the same as 2010)
• The annual limit on additions to defined contribution plan accounts is $49,000 (the same as 2010)
• The annual gift tax exclusion is $13,000 (same as 2010)

Information regarding 2011 tax figures for the following items remain uncertain.  These are items that could change depending upon whether or what portions of the Bush tax cuts of 2001 and 2003 that expire on 12/31/2010 are extended into 2011 and/or what portions of the Obama budget proposals are adopted.

• Income tax rate brackets
• Overall limitation on itemized deductions
• Phase-out limitation on personal exemptions
• Estate tax exemption amount and tax rate
• Alternative minimum tax exemption amount