1999 Tax Guide: The Current Scene (Chapter 1)

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Chapter 1
The Current Scene

1999 Tax Guide

he final year of the millennium will be remembered for many things, not the least of which is the first significant budget surplus in 30 years. A year ago, we made the following prediction: Congress eventually will have to address Social Security reform and, in any event, it will begin to spend part of the growing short-term surplus on additional tax relief.

Social Security reform received little attention this year except from politicians yearning to claim credit for its rescue. President Clinton early on declared he would not consider any tax cuts until Congress acted on Social Security and Medicare reform. His budget called for using the budget surplus to retire a substantial part of the more than $3.7 trillion of federal debt held by the public. Any new spending would be paid for with new tax increases, such as his proposed hike in the tobacco excise tax.

Republicans face the new century united behind one battle cry: Cut taxes! They began the legislative year pressing for a 10-percent across-the-board tax cut, marriage penalty relief, and at long last corporate relief from the alternative minimum tax. The GOP also pledged to protect the 62 percent of the surplus attributable to excess Social Security receipts. As of this writing, the two sides have fought to a standoff.

Congress was not about to raise taxes. President Clinton was not going to permit tax cuts to erode future surpluses he wanted earmarked for reforming Social Security and Medicare. The winter, spring, and summer were devoted to reaching this obvious result. In mid-September, Clinton vetoed a $792 billion, 10-year tax cut. Congressional leaders abandoned work on significant tax cuts until next year.

t the heart of these political gunfights are three factors. First, neither party trusts the other, nor itself, to save projected surpluses to pay down the debt. Republicans want to stop Democrats, and at times fellow Republicans, from spending the surplus on domestic and military programs. Democrats want to block Republicans from spending the money on tax cuts. Next, the projected surpluses may not occur. They are based on assumptions of little growth in spending and no emergencies that will require large sums of money. Beyond the amounts collected to fund the Social Security trust fund, the remaining surpluses assume as-yet-unidentified cuts in future spending. Lastly, congressional leaders exhibit little interest in forging compromises with the president. In the fall of 1999, they still see an advantage in promising large tax cuts over delivering small ones.

It is too early to mourn the loss of the tax cuts Congress promised this year. To ensure that the cuts were financed only from the part of the surplus not derived from the payroll taxes used to bankroll the Social Security trust fund, Congress delayed the implementation of many of the cuts they tried to pass. Instead of the 10-percent rate cut they wanted, Congress passed a 1-percentage point reduction in each rate bracket and delayed their full effect until 2005. Rate table changes approved to ease the marriage penalty also would have gone into effect in 2005. Some of the cuts were scheduled to stay in effect only until 2009 or 2010. So while the Republican tax measures did not survive the president’s veto, there is plenty of time for Congress and the White House to contemplate how, when, and how much taxes ought to be cut.

s you consider year-end planning tasks for 1999, you will want to consider whether and how these future tax cuts might affect you. Will they come in the form of fundamental changes to our tax system, as rate relief, or as further incentives for investment and savings?

The priorities established in the 1999 tax-cutting effort are instructive. The tax-cut packages designed by House and Senate Republicans clearly focused on lowering individual tax rates, easing the inflation-induced sting of the alternative minimum tax, and reducing the marriage penalty. Together these cuts accounted for about 70 percent of the total. The other major pieces of the legislative plans were estate tax relief, higher limits on contributions to qualified savings and retirement plans, and health-insurance initiatives. Democrats targeted the marriage penalty, education, and health care in their alternative tax plans, but their packages were less ambitious and aimed at lower-income taxpayers.

As Congress continues its march down the path of incremental changes to our tax system, you may ask whatever happened to fundamental tax reform. Congress seems to have lost interest -- at least momentarily -- in flat taxes and consumption taxes.

We observe, however, that the last 25 years have brought substantial reform in small steps. In 1975, the top individual tax rate was 70 percent. Capital gains were taxable at rates up to 35 percent. Individuals enjoyed an array of itemized deductions for casualty losses, sales tax, miscellaneous expenses, and consumer interest. Losses from tax shelter activities could shelter earned income. No limits were placed on passive losses. Congress since then has chipped away at the tax code, leaving a statute in 2000 that is dramatically different from the one we knew 25 years ago. Fundamental reform may not be in our near future, but future incremental changes will continue to bring cumulative changes to the system that are significant.

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