The 1997 Tax Act: Introduction

Introduction
Promises Made,
Promises Kept
A Tax News & Views Special Report:
Promises Kept: The 1997 Tax Law

Guide to
Promises Kept

Tax Cuts for Individuals

Principal Tax Increases

Other Key Provisions

Table of Contents

resident Clinton and Congress have agreed to the details of
The Taxpayer Relief Act of 1997. This report describes the new law and asks the measure of its real significance. By many measures, the Act must be scored as one of major significance. It provides the first real tax cuts since 1981 while fulfilling campaign promises made by both parties. It reduces or eliminates taxes related to individual savings and investment. It introduces a number of new targeted tax incentives. The result includes substantial new complexities, uncertainties, and opportunities.

By other measures the Act falls far short of labels such as "historic" that politicians want to use. Compared to the 1981 Economic Recovery Tax Act, this legislation is only a modest effort. The 1981 Act cut taxes by $750 billion over a five-year period. In 1997 dollars, this cut would equal about $1.2 trillion. The 1997 tax cut, net of tax increases, amounts to only $95.2 billion for a comparable period. This $95 billion tax cut represents 1.1% of all the revenues that the federal government otherwise would expect to receive over the five-year period. On balance, we believe the "historic" aspect of this legislation is in the message sent regarding our economic priorities. Congress and the President have joined together in saying that the era of massive budget deficits is over and that the tax system should reward private savings and investment in both human and financial capital.

n the details of its provisions, the Act profoundly fails to keep the easy-to-make, hard-to-deliver promise of a simpler system. Although it contains several packages of simplifications, on balance it presents enormous new complexity for rank and file taxpayers. Lower-income working taxpayers are asked to make a multi-step, multi-factor computation to determine their child credit and earned income credit. Middle-class taxpayers are confronted with possible capital gains tax rates of 8%, 10%, 18%, 20%, 25% and 28%. Would-be savers now must analyze and make wise choices between traditional IRAs, new Roth IRA accounts, and educational IRAs. Real estate investors must deal with a special 25% recapture tax. Taxpayers who benefit from the new tax incentives probably will not complain about this new complexity.

Since 1981, Congress has enacted over 5,000 pages of tax legislation including the Tax Reform Act of 1986, initiated by President Reagan, which dramatically lowered tax rates, eliminated special treatment for capital gains, and broadened the tax base for both individuals and businesses. Now, after nearly two decades of essentially constant change to the tax system, Congress has sent to President Clinton a piece of legislation that the commentators and politicians have labeled "the most significant since 1981," and "a major tax cut for families."

he Taxpayer Relief Act of 1997 provides tax cuts of approximately $151.6 billion over five years and imposes roughly $56.4 billion of tax increases. Nearly all of the tax cuts affect the individual income tax or the estate and gift tax. These include five major tax cuts, which we describe in Part 1:

A $500 per child tax credit.
Substantial new education incentives.
Lower capital gains rates.
Enhanced IRAs.
Lower estate and gift taxes.

Adoption of these tax cuts fulfills a variety of campaign promises made by the President and Republican congressional leaders over the past six years. In his 1992 presidential campaign, President Clinton called for income tax relief for families through a child credit. In the 1996 campaign, he renewed this promise of a middle-class tax cut and called for substantial tax incentives for education.

In their successful 1994 drive to win control of Congress, Republican leaders articulated a "Contract with America." That contract contained the following promises, which the Act fulfills to various degrees:

A $500 per child tax credit for families with up to $200,000 of income.
New after-tax IRAs.
A top capital gains rate of 20%.
Repeal of the corporate AMT.
Estate tax relief.

espite all of this promise keeping, the reality of trying to balance the federal budget led Congress to ignore or break some of the more expensive of its campaign promises. A number of Contract with America provisions were abandoned, such as indexing capital gains for inflation, repeal of the 1993 increase in the amount of Social Security benefits subject to taxation, and enhanced depreciation allowances.

More than one-third of the tax cuts are paid for with tax increases.

The most dramatic of the lost promises must be the Republican Congress' abandonment of the party's oft-repeated pledge to raise no new taxes. More than one-third of the tax cuts provided in the new legislation are paid for with tax increases. The major increases include the airport and airways ticket tax, a 15 cent increase in the tobacco tax, and attacks on a number of financial products and corporate transactions. We describe these tax increases in Part 2.

The Act contains hundreds of miscellaneous tax cuts and simplifications together with a number of smaller tax increases. This is the largest collection of miscellaneous cuts since the 1981 Act. These provisions reflect the fact that the 1986 struggle over tax reform, and the ensuing efforts to curtail the deficit, effectively blocked most miscellaneous tax legislation for the last decade. These other tax changes are described in Part 3.

This report describes the Act as reported by the House-Senate Conference Committee on July 30, 1997. At the time the report was being written, only the statutory language approved by the committee had been released. The explanatory report of the conferees was not available. We have exercised our editorial judgment in choosing to omit some changes that we felt were of less interest to our readers. Other provisions we have described so that the reader can gain some appreciation of the complexity and detail Congress must deal with when it comes to taxes. As required by the line-item veto legislation, the Act contains a listing of 79 items that could be subject to line-item veto. These are provisions that for various reasons apply to only a limited number of taxpayers. The arcane rules by which this determination is made result in such items as the research tax credit being classified as affecting fewer than 100 taxpayers because of the relationship between its effective dates and termination dates and fiscal year taxpayers. We do not describe or identify line-item veto provisions because we do not expect the President to exercise this authority. The Act represents an agreement between the Congress and the President. He will hesitate to be seen as reneging on the deal. Further, the President probably will want the first challenge of his line-item veto authority to come on spending issues.

s the ink dries on the 1997 Act, taxpayers may ask two more questions. What happened to fundamental tax reform and how long will this version of the tax law last? Interest in fundamental tax reform is driven by two goals: tax exemption for savings and investment income and simplification. By reducing taxes on investment income through liberalizations of IRAs and reduced tax rates on capital gains, the Act accomplishes a substantial portion of the first goal. The intensity of this year's struggle over whether the wealthiest taxpayers were receiving too much benefit under the Act suggests that any future effort to further reduce taxes on investment income would meet stiff opposition. If the Act moves the country closer to radically simplified tax administration, it does so only by increasing the demand for simplification by increasing the level of complexity in the current system.

As to the second question, perhaps it is enough to note that in the last two decades, Congress has passed nine major pieces of tax legislation and half a dozen lesser bills including three last year. The bold new world of lower rates and fewer deductions created by the 1986 Act lasted just four years. We expect that the House Ways and Means and Senate Finance Committees will find many more changes to make in our tax system.

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Tax News & Views is produced by the Financial Counseling Specialists and the Legislative & Regulatory Services Group at Deloitte & Touche LLP.