real tax policy

On September 27th, President Obama signed the Small Business Jobs Act of 2010.  In addition to several other tax breaks described elsewhere in more detail, the bill created a three month window in which any individual or group of investors can purchase the stock of a C corporation (not an S corporation or LLC) with less than $50 million in assets and lock in a zero percent capital gains rate.  The stock must be acquired by the end of 2010 and held for five years.  Certain industries are off-limits and there are anti-abuse rules that must be adhered to.

Payson Peabody, Of Counsel with Dykema’s Washington, DC office and former House, Senate, and PricewaterhouseCoopers tax counsel, has written an article that describes this opportunity in more detail.  Interviewed last month by Emily Maltby in the Wall Street Journal, Mr. Peabody said, “I don’t think this provision will change investors’ behavior significantly,” because of the narrow time window to take advantage of the new provision.  But, he also noted that the Alternative Minimum Tax advantages of the new provision are significant.    If the provision is extended beyond its 12/31/2010 expiration date, it could have a much broader impact on small business investment.

Nevertheless, for those who are in a position to take advantage of the new law – - whether they are outside investors, debt holders with the ability to acquire common stock, or insiders with options that may be exercised – - the benefits could be substantial, given the projected increase in capital gains rates.

According to insiders interviewed by the Wall Street Journal, President Obama’s deficit commission has turned its attention to the entitlement programs that today constitute the lions share of federal spending in its efforts to bend the upward-trending cost curve facing the federal government in the next 20-30 years.

Unwilling to re-open the Medicare cost-curve debate, the panel evidently has been focusing on a range of options relating to Social Security.  Not coincidentally, the annual surplus generated by Social Security that the federal government has been “borrowing” from the Social Security trust fund has begun to dwindle, and it appears that Treasury will have to make good on its IOUs sooner than anticipated in order to pay current beneficiaries.  This will mean more borrowing from overseas, or more cuts elsewhere.

Reportedly, the heavy-weight seniors’ lobby AARP is being courted in secret for its endorsement of a number of politically explosive ideas, including:

1. Raising the Social Security wage base.  Under present law, only the first $106k of wages are subject to the 12.4% levy shared by employee and employer.  Middle class wage earners in the $106k to $250k range would experience a very substantial tax increase.
2. Raising the retirement age.  Former CBO Director Alice Rivlin says the panel is not considering 70 years old.  But, apparently, 68 and 69 are now possibilities.
3. Means-testing benefits.  The “rich” would get less in Social Security benefits or, amounting to the same thing, they would get lower cost of living increases.

The secretive nature of the negotiations between AARP and the White House task force is troubling, particularly in light of the fact that AARP tends to represent current beneficiaries, not those paying into the system and hoping to receive benefits.  If they are to have any credibility, the task force’s recommendations must be endorsed by younger workers as well, but there are no organized groups of younger workers with AARP’s influence.

As a result, the promise of Social Security for younger wage earners is becoming increasingly threadbare.  This reality is likely to sink in when younger workers are asked to pay more for a smaller  benefit that is pushed further into an increasingly uncertain future.

In the past, proposing cuts to Social Security was the third rail of politics, but the White House appears to believe AARP can provide the insulation they need to grasp the rail without harm.   The only question is whether younger workers opposed to wage tax increases and benefit cuts will prove that assumption wrong.

Citing the “most extraordinary financial crisis that I have ever seen or read about,” Former Fed Chairman Alan Greenspan is calling for complete repeal of the 2001 and 2003 individual and business tax rate cuts that he famously endorsed as Fed Chairman. Mr. Greenspan’s endorsement of the 2001 tax bill was critical to its success on Capitol Hill, and he says his position today is consistent with his former position in an era of surpluses. He opposed government surpluses as much as he opposes deficits.

Mr. Greenspan’s position is at odds with the majority of economists who say that raising taxes sharply at the beginning of 2011 would endanger the economy and risk a deeper recession.

To the extent that he retains credibility, Mr. Greenspan’s announcement is likely to bolster the resolve of President Obama to carry out his plan to raise income tax rates on joint filing individuals with more than $250,000 of gross income per year, and it may stifle dissent from economists, Republicans and some Democratic Senators who argue that raising the top rates, alone, would endanger the economy. Mr. Greenspan’s star has faded, however, and his critics say that he did not do enough to prevent the expansion of a dangerous credit bubble that threatened the global economy in 2008.

Even President Obama would extend the massive cuts for individuals earning under that threshold and he would extend his signature “Making Work Pay” tax benefit. These lower income cuts and outlays account for the vast majority of revenue raised, on paper, by the scheduled 2011 expiration of the cuts in Congressional Budget Office projections.

Mr. Greenspan is aware that allowing the 2011 expiration to take place would result in the largest income tax increase in U.S. history. And, it would immediately reduce the take home pay of every employee in America, because the rate changes would be reflected in income tax withholding tables in January.

Nevertheless, Mr. Greenspan says the ability of economists to predict the effect of tax changes on the economy is limited. The models have a “very poor record of forecasting.” He acknowledges that the strategy is “risky,” but he says “the choice of not doing it is far riskier.”