The 2012 election is over. The market (and the economy) has one less uncertainty to worry about. In response, the market dropped 2.2% from its close on Nov. 6, 2012 (as measured by SPY). The media claims this drop is due to the fiscal cliff and weakening economy in Europe, neither of which is new information. Everyone agrees we need to fix the fiscal cliff; our country needs real tax reform, which Congress needs time to figure-out, like a year. What to do about the fiscal cliff in the meantime? I think the revenue/tax side should be the easiest to get an agreement on.
Kicking the can down the road is an option. I believe neither side of the aisle is willing to hold their noses and pass the status quo or only a tax increase on the wealthy. The first sign of leadership from Washington has come from Speaker of the House Representative John A. Boehner (R - OH), who agreed to accept some additional revenues for a cleaner tax code (link). Since I believe the true solution is complex and requires significant time to iron out the proper details, I would like to propose an interim fix to bridge the gap between the cliff and the solution.
The win-win interim fix needs to have a little for everyone, including a stimulating aspect. In order to get revenue to the levels everyone would like, we need a growing economy. Tax increases and spending cuts will not stimulate economy. The Federal Reserve cannot be expected to do all of the heavy lifting.
- Extend the Corporate R&D tax credit for two years (CY2013 and CY2014).
- Extend Bonus Depreciation and 100 Percent Expensing (CY2013 and CY2014).
Both will encourage companies to use money sitting on the balance sheet. If put in effect for two years, it will reduce some uncertainty in regard to what the final fiscal resolution may be.
Stimulus and Revenue
- Reduce the Repatriation tax to 5% for four years (CY2013, CY2014, CY2015 and CY2016).
Currently, that money is sitting overseas and produces no revenue for the federal government. Any increase in repatriation would be an increase in revenue (link, link). It is estimated U.S. companies have $1-trillion overseas. If 60% comes back home at 5%, that would $60-Billion increase in revenue. Some would say this would "cost" the government money because of the lower rate. This is not true. Currently, there is no revenue at the higher rate. If there is $60-Billion at a lower rate, this costs the government nothing. Bringing that money back home will allow corporations to reinvest here. An interesting compromise may be the Foreign Earnings Reinvestment Act introduced in 2011 (link). Combining the repatriation with the bonus depreciation and 100% expensing could give this economy the kick in the pants it needs.
I will use the married, filing jointly tax brackets for this discussion.
Step 1: Let the individual payroll tax holiday expire. Reducing the revenue for entitlements is not a wise idea. Replace it with a marginal tax rate cut of two percentage points for the $16,500-$65,500 bracket (15% to 13%). Granted, a good number of the tax payers in this bracket don't pay federal income taxes.
Step 2: Keep all rates the same (including dividends, short-term and long-term capital gains) for all tax brackets below $385,000.
Step 3: Add two new brackets: (1) $385,000 to $1,000,000 and (2) $1,000,000+.
Step 4: For the $385,000 to $1,000,000 bracket, eliminate the mortgage deduction tax credit. Increase the dividend and short-term capital gain rate to 20%. Keep all other tax rates the same. This should help the revenue side of the equation without hurting small business owners too much.
Step 5: For the $1,000,000 bracket, keep the marginal earned income tax rate the same, but eliminate pre-tax payment of medical insurance and eliminate these popular deductions: mortgage interest, residence interest, passive interest, business interest, income taxes paid, real estate taxes paid, rental expense, gambling lost, childcare tax credit, medical and dental expenses. Finally, for the $1,000,00 bracket, keep long-term capital gain tax low (15%) and increase short-term capital and dividend/interest income to 25%. These changes may actually result in a higher tax payment for this bracket than just increasing the rate back to 39.5%. Since taxes are a form of penalty, this tax bracket will be penalized for earned income and rewarded for dividend and capital gains income, which, in theory, should encourage investment and CEO/CFO level compensation in the form of dividends.
The above deductions alone could raise as much as $30-Billion in one year according to U.S. Tom Coburn, M.D. (R-OK) report, "Subsidies of the Rich and Famous, Nov. 2011" (link). During the 2011 debt-ceiling talks, President Obama wanted approx. $800-billion in new revenue (link) over 10 years. This $30-billion from deduction elimination is 37.5% of the way there.
Per U.S. Senator Tom Coburn, M.D. (R-OK) oversight report, "Wastebook 2012" (link), eliminate the non-profit loophole used by the NFL, NHL and the PGA (estimated at $91-million in revenue).
Spending cuts, like it or not, would also hurt this economy. Ideally, spending cut would occur during rapid growth period and spending would be controlled from that point forward.
We are just finishing the first quarter of FY13 for the federal government. Congress should include a rough budget that caps the remaining FY13 spending at FY11 levels or less (excluding Health, Medicare, Income Security, Social Security, Veteran benefits and Net Interest).
In FY2011, the federal government spent $1,144,928,000,000 (excluding Health, Medicare, Income Security, Social Security). In FY2013, the federal government is "budgeted" to spend $1,158,244,000,000 (excluding Health, Medicare, Income Security, Social Security). If we remove Veteran benefits, reducing the FY2013 budget to FY2011 will reduce spending by $13,315,987,072, a small drop in the hat compared to the $190 Billion/year that is currently scheduled.
I would challenge Congress to complete only two tasks between January-2013 and September-2013; (1) Comprehensive, Pro-growth, Internationally Competitive Tax Reform and (2) Balance Budget for FY14, FY15 and FY16.
In conclusion, I believe the above plan is a reasonable bridge between the fiscal cliff and a true long-term solution. The republicans can keep the marginal rate essentially the same. President Obama can "get revenge" on the wealthy with an even more progressive tax code. Also, with a reduction in deductions and an increase in the dividend tax rate, Mr. Buffet should be paying more in taxes also, which should make him happy (link).
This solution, accompanied by reasonable spending cuts (like any of the items in the various "pork reports" available), could go a long way in restoring some trust and leadership in Washington.
Personally, I do not believe in the progressive tax system; it is, by nature, the opposite of fair and just. Unfortunately, I do not see Washington's feeling on a flat tax changing any time soon.
Review of current federal income tax situation. Who got what tax cuts? http://seekingalpha.com/instablog/620714-zach-tripp/1399361-the-truth-about-president-bush-s-tax-cuts