1998 Tax Guide: The Current Scene (Chapter 1)

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Chapter 1
The Current Scene

1998 Tax Guide

or nearly two decades, Congress and three presidents have fought to bring the federal budget into balance. It now appears they have

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succeeded, although their success is attributable to surpluses in the Social Security system that are offsetting deficits in the remainder of the budget. This balanced budget was accomplished, in part, through significant tax increases in 1982, 1984, 1990, and 1993, and a dramatic tax reform in 1986. Many of these tax increases brought unprecedented complexity. For example, individual taxpayers must now confront such complexities as the passive loss limitations, alternative minimum tax, and investment interest deduction limitations.

In 1995 and 1997, Congress and President Clinton began cutting the tax burden on individuals, investors, and small businesses in tax laws paid for with other tax increases and with spending cuts. At the close of 1998, the compelling tax and budget issue is whether, and to what extent, a projected federal budget surplus will be used to provide more tax relief. Will Congress and the administration have the courage to begin undoing some of the needless complexity that makes our current system so burdensome?

efore our political leaders can answer this seemingly simple question, they will have to address two more difficult questions:

Do they believe a surplus can be sustained?
What should be done about the prospect that the social security system will go into deficit early in the next century?

A few facts will help you understand the difficulties inherent in these questions.

The Congressional Budget Office projects a federal budget surplus of $520 billion over the next five years and $1.6 trillion over the next 10.
If the economy enters a recession in late 1999, the five-year projected surplus effectively would disappear.
Nearly the entire projected surplus is attributable to Social Security surpluses. Over the next five years, non-Social Security expenses of the federal government will exceed non-Social Security receipts by $657 billion.
If Social Security spending were allowed to exceed social security tax receipts at the levels set by current policy, the federal budget would slip back into deficit very rapidly and dramatically.

hairman Bill Archer (R-Texas) of the House Committee on Ways and Means presented a tax cut proposal in September 1998 that offers a model for the resolution of these questions. He proposed spending 10 percent of the projected surplus on tax cuts and saving 90 percent until Social Security reforms are adopted. Such an approach is reminiscent of the early days of deficit reduction when bills were designed around an agreed mix of tax increases and spending cuts.

We believe Congress eventually will have to address Social Security reform and that, in any event, it will begin to spend part of the growing short-term surplus on additional tax relief.

As you consider year end tax planning tasks for 1998, you should ask whether these future tax cuts will come in the form of fundamental changes to our tax system, as further incentives for investment and savings, or as simplifications.

We believe the answer is suggested by the course of recent congressional tax-writing efforts. Tax legislation considered since 1994 has several defining characteristics. The emphasis in tax cuts has been on helping middle-class families, encouraging investment and savings, and lowering estate taxes. Beyond estate tax and capital gains relief, Congress has not been concerned with lowering taxes on high-income taxpayers. Single individuals have benefited only through liberalized savings incentives such as the new Roth individual retirement accounts. These trends probably will continue.

The trend toward complexity probably will be reversed for moderate-income taxpayers. Congress seems to have scared itself with the frightful level of complexity it created around capital gains in 1997. Changes in the IRS restructuring legislation corrected that mistake. More recent proposals, such as one to allow exclusion from income for up to $200 of interest and dividends ($400 for a married couple), would simplify dramatically tax compliance for rank-and-file taxpayers.

Congress can be expected to continue on the path of incremental changes to the tax system as it attempts to find consensus on how to use the surplus, how to reform social security, and whether to start over with a new tax code. These interim measures will lower taxes on the middle class and may bring some simplification with them. For higher-income individuals with complicated financial affairs, the tax law will remain complex and the burdens largely unchanged.

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