If Congress Does Not Act, Tax Increases are on the Way

On July 14th, 2010, approximately 30 legislative days before the fall elections and less than six months before significant portions of the tax code expire, the Senate Finance Committee held the first substantive hearing on the implications of allowing the Bush tax cuts to expire.

The tone of the majority of the witnesses and comments by the Chairman suggest this hearing was designed to anticipate higher rates next year. Most of the Bush tax cuts enacted in 2001 and 2003 went to middle- and low-income Americans, not the rich. So the pending tax hike is going to impact regular families in a very real and harmful way. With just 30 days of legislative session left before the elections, even a well intentioned effort to extend those tax policies may fall short.

Also, the hearing demonstrated the lack of a plan for what happens beyond 2010. Even if Congress extends some or all of the 2001 and 2003 tax cuts, something more comprehensive is needed.

Senators Jon Kyl (R-AZ) and Blanche Lincoln (D-AR) yesterday evening introduced an amendment to make permanent changes to the estate tax. The estate tax is not in effect in 2010 but unless action is taken will return in 2011 with a top rate of 55 percent and an exclusion of $1 million (in 2009 the exclusion was $3.5 million). We may go from a system that taxed the sale of assets at low capital gains rates or allowed the carryover of basis on inherited assets to one where the capital gains rates will raise, the exclusion be reduced, and the allowance of a carryover basis restricted. Conceivably this could be one of the largest tax consequences in United States history.

The Lincoln-Kyl proposal is designed to mitigate this harm and uncertainty by making permanent a middle ground on taxing estates. Key provisions in the bill include: reducing the top estate tax rate to 35 percent; increasing the exclusion from $1 million to $3.5 million; and allowing the estates of deceased taxpayers to choose between no estate tax and limited carryover basis or the provisions included in this plan for 2010.

Missing from the proposal are any revenue increases or spending cuts to offset the revenue loss of the lower rates and higher exclusion. The selective pay-go rules adopted by Congress earlier this year would have allowed Congress to extend 2009 estate tax without offsets (which was not done), but any reduction in the estate tax beyond that would have to be offset or face a 60-vote Budget Act point of order. This problem appears to be unresolved.

The question now is whether there is enough time in the legislative calendar for this or any other proposal to be adopted. The most likely outcome is that no proposals will pass. The result will be significant tax increases for business owners.