All eyes on Washington

Normally, Sen. Jon Kyl is one of the more loquacious members of Congress. The Arizona Republican was a font of quotes, for instance, last summer when reporters were trying to gauge the progress of the bipartisan debt-ceiling negotiations between lawmakers and Vice President Joseph Biden. But as a member of the Joint Select Deficit Reduction Committee, Mr. Kyl is circumspect. “You know that I won't comment on that,” Mr. Kyl responded recently to a question from InvestmentNews while talking to a group of reporters just off the Senate floor. The panel, known as the “supercommittee,” was established in August as part of the legislation that raised the nation's debt ceiling. It is supposed to come up with $2 trillion or more in budget savings over the next 10 years. A bipartisan, bicameral 12-member panel, the supercommittee may be the best chance for any kind of substantial tax changes before next year's election. It has free rein to design legislation that cuts spending and reforms entitlements. It also can undertake major tax reform. It might suggest a fundamental tax overhaul that would produce revenue for deficit reduction, which Democrats want, while lowering individual rates, which Republicans seek. Or it might punt the issue back to the relevant tax committees in the House and Senate. Trial balloon proposals have been floated by staff, but no one — not even Mr. Kyl — is providing any hints about the committee's direction as it nears its Nov. 23 deadline.

KEEPING THE LID ON

The lack of leaks is an indication that the panel has decided to refrain from fighting in the media and actually come to the table. “I can't remember the last time I've seen a congressional body doing something in private, but they've been able to pull it off,” Brian Graff, executive director and chief executive of the American Society of Pension Professionals and Actuaries, said at his organization's annual conference Oct. 23. Both houses must vote on the supercommittee proposal by Dec. 23 to avoid automatic across-the-board spending cuts of $1.2 trillion. With the clock ticking, expectations are low. “They're not really coming together,” said Dean Zerbe, national managing director of alliantgroup, a firm that advises small businesses on tax matters. “The soufflé isn't rising in terms of significant tax reform.” The supercommittee is not in a position to accomplish the kind of fundamental tax reform achieved in 1986 by a Democratic Congress and Republican President Ronald Reagan, according to one expert. “Now Congress has weaker committees, a deeper partisan divide, weaker approval [ratings] and worse relationships with the White House,” Clint Stretch, managing principal for tax policy at the Deloitte Tax Policy Group, said recently on Twitter.

SHORT TIME FRAME

Another big difference between now and 1986 is that the reforms that took place 25 years ago occurred over the course of about two years. The supercommittee was given a little more than three months. “No one can do tax reform in several weeks,” Mr. Graff said. What the panel can do, according to Mr. Graff, is give the House Ways and Means Committee and the Senate Finance Committee instructions to come up with tax reform plans next year and suggest an expedited time frame for voting on them. Such a fast-track process would threaten to put so-called tax expenditures, such as tax deferrals for retirement savings and mortgage interest, on the block to pay for a reduction in rate on personal income. If congressional committees come up with tax reform proposals that include raising revenue, they will likely run into a wall of opposition from Republicans, who have vowed to oppose tax increases. “The House Republicans would vote it down,” said Andrew Friedman, principal at The Washington Update, an online newsletter. “They are determined to stand by their pledge.” Some ideas apparently have already been taken off the table. For instance, in his original jobs package, President Barack Obama proposed a series of tax increases for individuals who make more than $200,000 and families that make more than $250,000 — ranging from capping the municipal bond interest exemption at 28% to taxing hedge fund managers' income at individual rates rather than capital gains rates. But Mr. Obama's ideas were replaced in the Senate version of his jobs bill by a 5.6% surcharge on earnings above $1 million. The Senate Democratic majority thought that the $1 million level for higher taxes provided a clearer delineation between the wealthy and the middle class. Senate Republicans and a couple of Democrats filibustered Mr. Obama's jobs package, and Senate Democrats so far have failed to push through pieces of the plan funded by a smaller surcharge on the wealthy. Republicans have argued that such a levy would undercut job creation. “From here to the election, nothing's going to happen on a millionaires' tax,” Mr. Zerbe predicted. But that doesn't mean that it won't stay on the legislative agenda. “It will be introduced over and over again,” said Alan Viard, a resident scholar at the American Enterprise Institute for Public Policy Research. “The Senate Democrats will force Republicans to vote against it many, many times.” An issue that is likely to lie dormant until after the election is the Bush administration tax cuts, which are set to expire Dec. 31, 2012.

LAME DUCKS

Depending on the outcome of the election, a lame-duck Congress may not have the political motivation to extend the tax breaks. The one part of tax policy that is certain is that the expiration of the Bush cuts guarantees higher taxes. For instance, the estate tax will zoom to 55% with a $1 million exemption, from 35% with a $5 million exemption. If they were allowed to expire, the top tax rate would rise to nearly 44%, from 35%, according to Mr. Friedman, if you include the 3.8% tax on investible income that will go into effect in 2013, thanks to the health care reform law. The capital gains rate would rise from 15% to nearly 24%, and dividends would be taxed at nearly 44%, up from 15%. “I think it's quite possible that nothing happens, and [taxes] go up across the board,” Mr. Friedman said. “If Congress is tied up and can't do anything, we will have a 55% death tax,” said Dick Patten, president of the American Family Business Institute. “That's the legislative reality that's out there.” Mr. Patten's organization is confident that it can move a bill that would eliminate the estate tax through the House and gain significant Senate support. But like other rifle-shot tax legislation, the prospects of its being signed into law before the end of 2012 are dim. Meanwhile, congressional leaders of both parties are backing the general idea of tax reform. “Our tax system is broken and needs to be fixed,” Senate Majority Leader Harry Reid, D-Nev., said recently. But no one knows when Congress will get around to the task. Email Mark Schoeff Jr. at mschoeff@investmentnews.com