YOUR TAXES: A SPECIAL REPORT : HEADING HIGHER? : Experts Agree Taxes Will Creep Up Again; the Only Question Is How
Enjoy it while you can. Taxes may never again be as low as they are right now.
“It’s immaterial whether we have a Republican or Democratic administration after Reagan,” argues Gerald Padwe, national director of tax practice for Touche Ross & Co., a major accounting firm. “We are going to see rates starting to creep back up. Within five years, I expect the top tax rate to be back up to 40%.”
Not everybody agrees with Padwe that income tax rates will move sharply higher, but nearly all tax advisers are warning their clients that, one way or another, most people will be paying more in taxes in the years ahead. That suggests trying to figure out ways to report as much income as possible in 1988, while postponing for future years substantial tax deductions, such as major gifts to charities.
Despite the campaign rhetoric, any effort to reduce the federal budget deficit in 1989 and 1990 will add to the current tax burden, analysts and congressional insiders agree. That probably means tax writers will concentrate on narrowing a handful of leftover tax loopholes that escaped their attention during the tax revision battles of 1986 and boosting the current top income tax rate of 28% to 30%--or perhaps even as high as 35% on families with incomes above roughly $150,000--while modifying or eliminating the phantom 33% rate that applies to some affluent taxpayers.
At the same time, expect to see efforts to impose higher taxes on consumption in the form of additional gasoline taxes, other energy and excise taxes, or--possibly--the eventual establishment of a broader national sales tax similar to the value-added tax (VAT) system widely used in Europe.
“The hidden political battle over the next tax revision has already begun,” says Rep. Robert T. Matsui (D-Sacramento), a veteran member of the House Ways and Means Committee, which initiates all tax legislation. “The venture capital folks, the excise tax guys--they’re all over the Hill. We’re getting it from all directions.”
It used to be so simple. From the early 1960s to near the end of the 1970s, the income tax code was modified only infrequently, usually in response to a specific presidential initiative. And, except for 1968, when President Lyndon B. Johnson belatedly proposed a 10% surcharge to pay for the Vietnam War, income tax changes invariably meant politically popular tax reductions.
All that has been turned upside down over the past decade. Beginning with the first rescue effort of the Social Security system in 1978 and a separate reduction in the capital gains rate that was originally opposed by then-President Jimmy Carter, barely a year has gone by without a major change in the federal tax system.
Under President Reagan, taxes have been substantially overhauled on practically a nonstop basis, with the original massive 1981 tax reduction act followed by a series of tax hikes--generally as part of broader deficit reduction moves--in 1982, 1983, 1984 and 1987. And that doesn’t even include the revolutionary, “revenue-neutral” income tax changes that Congress agreed upon in 1986, which shifted a portion of the income tax burden away from individuals and back toward corporations, while rewriting hundreds of separate provisions that taxpayers are only beginning to grapple with as they prepare their 1987 tax returns.
There doesn’t seem to be any end in sight. Not only does the 1988 tax system vary significantly from last year’s transition to the new tax code, but most analysts are also convinced that lawmakers will continue to tinker avidly in the years ahead.
“Even the smallest tax bill of the 1980s was a lot bigger than anything Congress did in the 1970s,” said Stephen R. Corrick of Arthur Andersen & Co.’s office of federal tax services in Washington. “And we don’t see it getting much better. The one constant you can count on now in the tax system is constant change.”
What’s next on the agenda? Given the present political and economic instability, it is impossible to forecast accurately the shape a tax bill will take under the next administration. Certain changes, however, seem more likely than others, tax experts agree. At the same time, some major unknowns loom on the horizon as lobbyists for every interest group begin to gear up for the impending tug of war that is certain to break out as soon as Reagan leaves office.
Perhaps the biggest question mark is whether Congress will respond to the lobbying campaign for a major new tax on consumer spending, either in the form of a national sales tax or a value-added tax that hides the additional cost by imposing the tax on goods at each stage of their production.
“Right now, there’s no consensus for a consumption tax,” Matsui said. “But there will be a lot of pressure not to tamper much with the individual tax rates, and, as we get closer to the crunch, I could see a consumption tax emerging as the most desirable of the undesirable options.”
Backers of a broad consumption tax--which would have to be at least 5% and raise a minimum of $100 billion a year to justify its administrative and start-up costs--contend that it would benefit the nation by encouraging Americans to save rather than spend, while providing a huge new revenue source to help close the federal budget gap and restore such favored business tax breaks as the investment tax credit. Opponents contend that any such tax would not make much difference in boosting overall savings and investment, while unfairly favoring the wealthy at the expense of average Americans, who spend rather than save nearly all their income.
Regardless of the arguments pro and con, such a massive new tax may not be necessary. A relatively modest 10-cent-a-gallon gasoline tax, for instance, plus further efforts to broaden the income tax base, could more easily accomplish the likely goal of boosting taxes $20 billion to $40 billion a year.
Another major fight is expected over capital gains, which lawmakers--in the key political compromise that made the 1986 tax reform law possible--agreed to tax just like ordinary income. Vice President George Bush has already proposed cutting the capital gains rate to 15%, which would be no help at all to the vast majority of taxpayers who are already in the 15% tax bracket, while providing an estimated three-quarters of its benefit to those with incomes higher than $200,000.
“Any effort to raise the top income tax rate above 30% would reopen all the old wounds,” says a legislative aide to a key Democratic member of the Senate Finance Committee. “It would create tremendous pressure to restore a capital gains differential, destroying the glue that made it possible for both liberals and conservatives to support tax reform.”
One tax area that is no longer sacrosanct is the home mortgage deduction. Last year, Congress capped the maximum tax deduction on mortgage interest by limiting it to a total of $1 million in outstanding loans on a taxpayer’s first and second homes, with a separate limit of $100,000 on home equity loans. Now that the precedent has been set, Arthur Andersen’s Corrick expects lawmakers to whittle down the maximum deduction over the next few years.
Some tax advisers foresee Congress eventually converting the loan cap to an annual limit on interest deductions that might end up as low as $20,000 a year--or roughly the equivalent of a $200,000 mortgage at a 10% interest rate.
Changes in the taxation of Social Security are also a possibility, tax aides note.
The current approach of taxing half of the Social Security benefits of couples with more than $32,000 in income ($25,000 for an individual) could be widened to tax all of an elderly taxpayer’s Social Security benefit above certain thresholds.
At the same time, some lawmakers want to require upper-income individuals to pay more in Social Security taxes. Annual earnings up to $45,000--which will continue to be adjusted for inflation in future years--are currently subject to a Social Security tax rate of 15.02% (split equally between employer and employee).
A battle is already brewing over removing the earnings cap on the 2.9% Medicare portion of the tax, with some in Congress wanting to use the additional revenue of $5 billion to $6 billion a year to finance nursing home care for the elderly, while others suggest applying the gain to deficit reduction.
Whatever changes lawmakers agree upon in future years, don’t expect the tax code to become any easier to understand.
“Every time Congress considers rewriting the tax code, they have to juggle between fairness, efficiency and simplicity,” says Jeffrey Levey, director of federal tax information at Arthur Andersen. “It’s an impossible balancing act. You have to count on them dropping the ball on simplicity.”
