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Budget Review - Obama's Election Budget


By Tax-News.com Editorial
February 21, 2012


United States President Barack Obama has announced his proposed budget for the next fiscal year beginning on October 1, which, with over USD1.5bn in net new revenue from taxes on the wealthy and more spending on job creation and education, will provide his platform for re-election. However, it will also set up another protracted fight with Congressional Republicans adamant that any deficit reduction package should not contain one dime in tax increases.

Overall, President Obama’s 2013 Budget proposes USD3.8 trillion in spending, or 24.3% of gross domestic product (GDP), and USD2.5 trillion in revenues, or 15.8% of GDP, resulting in a still substantial deficit of USD1.3 trillion (8.5% of GDP). However, it is foreseen that the deficit would fall to 3.0% of GDP by 2017, which, according to the Administration should be sufficient to stabilize US public debt at 76% of GDP by the end of this decade.

The Budget blueprint, which is non-binding on Congress, recycles many of the tax measures originally proposed by President Obama in the 2008 election campaign, but which he has failed to get onto the statute book in all his subsequent budget plans. These include his pledge to let the Bush-era temporary tax cuts expire for those making over USD250,000 per year and his determination to punish US companies ‘shipping jobs overseas’ with higher taxes. However, with the economy certain to be the key battle ground in this year’s elections, Obama has placed much more emphasis on stimulus measures, proposing a battery of new or expanded tax credits and other incentives designed to encourage firms to ‘insource’ investment to America and generally get US companies hiring again. These pledges are paid for in large part by higher taxes on the wealthy and will obviously appeal to Obama’s core Democratic support. However, critics point out that the proposals contradict the Budget’s tax simplification goals while achieving little in the way of deficit and debt reduction.

A summary of the 2013 Budget’s tax measures follows below:

Growth Orientated Measures

• Extend 100% first-year depreciation deduction for certain property. As part of the compromise tax package passed at the end of 2010, additional first-year depreciation was increased to 100% for qualified property through the end of 2011. The Budget proposes to extend this incentive for businesses to invest for an additional year. 

• Provide a temporary 10% tax credit for new jobs and wage increases. The Budget proposes to provide a new income tax credit for employers who increase their payroll, whether through job creation, increased wages, or both. The maximum amount of the increase in eligible wages would be USD5m per employer, targeting the 98% of firms that have a payroll below that threshold, for a maximum credit of USD500,000. The credit would be available for wage increases in 2012 and would provide USD18bin in benefits over the next 10 years. 

• Providing temporary tax credits for domestic clean energy manufacturing. The President is proposing to extend Advanced Energy Manufacturing Tax Credit to drive nearly USD20bn of investment in domestic clean energy manufacturing, ensuring new windmills and solar panels will incorporate parts that are produced and assembled by American workers. It is said that the additional USD5bn in tax credits being proposed will leverage nearly USD20bn in total investment in the United States.

Individual Tax Measures

• Make the American Opportunity Tax Credit (AOTC) permanent. Currently authorized through 2012, the AOTC provides taxpayers a credit of up to USD2,500 per eligible student per year for qualified tuition and related expenses paid for each of the first four years of the student’s post-secondary education. The Budget proposes to make the AOTC permanent, providing up to USD10,000 for a student in their family over four years in college. More than 9 million families with students will receive an average AOTC of nearly USD2,000 in 2012. Making the AOTC permanent would provide USD137bn in additional benefits over the next 10 years. 

• Expand the Earned Income Tax Credit (EITC) to support working families. The EITC is available to low- and moderate-income working families. The Budget proposes to make permanent an expansion of the EITC for families with three or more qualifying children. This provision will increase the credit for larger families by up to 12.5%, or nearly USD675 in 2013. More than 2 million families will receive an average increase in EITC of nearly USD600 as a result of this provision in 2012. This proposal would provide USD14bn in benefits over the next 10 years.

• Provide for automatic enrollment in individual retirement accounts (IRAs). With only about half of American employees today are covered by a pension plan at work, the proposal includes a credit to help small employers set up auto-IRA arrangements, and it doubles the existing start-up credit for small employers who offer a retirement plan, such as a traditional pension or 401(k). This proposal would provide USD15bn in benefits over the next 10 years.

• Preserve Middle-Class Tax Relief. The Administration’s Budget also assumes that the 2001 and 2003 tax cuts are made permanent for lower- and middle-class families, saving them about USD1 trillion over the next 10 years.

‘Insourcing’ Tax Measures

• Provide tax incentives for locating jobs and business activity in the United States and prohibit tax deductions for “shipping jobs overseas”. The Budget proposes to create a credit against income tax equal to 20% of the expenses paid or incurred in connection with insourcing a US trade or business. The proposal would disallow deductions for expenses paid or incurred in connection with outsourcing a US trade or business to reduce incentives for US companies to move jobs overseas. 

• Provide a new “Manufacturing Communities” tax credit. The Budget proposes to create a new tax credit to encourage investments in communities affected by military base closures, plant closures, and mass layoffs. This proposal would provide about USD2bn in credits for qualified investments approved in each of three years, 2012 through 2014. 

• Target the domestic activities production deduction to domestic manufacturing activities and provide a larger deduction for advanced manufacturing activities. The Budget proposes to disallow the deduction for domestic production activities (commonly referred to as the manufacturing deduction) for oil and other fossil fuel production, as well as for certain other non-manufacturing activities. The revenue resulting from this limitation would be used to increase the general deduction percentage and double the deduction rate for activities involving the manufacture of certain advanced technology property. This proposal is approximately revenue neutral. 

 Enhance the research and experimentation (R&E) credit and make it permanent. The Budget proposes to enhance the R&E tax credit by increasing the credit rate for the alternative simplified credit from 14% to 17% and making it permanent to encourage innovation and reward businesses that continue to invest in research projects. This proposal would provide USD109bn in benefits over 10 years.

Small Business Tax Measures

• Permanently eliminate capital gains tax on investments in qualified small business stock. The Budget would make permanent the President’s proposal to completely eliminate the capital gains tax for investors in certain qualified small businesses. This provision was enacted as part of the Small Business Jobs Act and was extended through 2011 as part of the December tax compromise. Making this provision permanent - and also making it easier to use by giving investors a longer time to roll over qualified investments and making sure that the income is not subject to the Alternative Minimum Tax—would save small business owners USD8bn over the next 10 years. 

• Double the amount of currently deductible start-up expenditures. Under current law, a taxpayer generally is allowed to elect to deduct up to USD5,000 of start-up expenditures in the year a business begins and to amortize any remaining costs. For 2010 only, the immediately deductible amount was doubled, from USD5,000 to USD10,000 (reduced by the amount by which the cumulative cost of start-up expenditures exceeds USD60,000). The Budget proposes to permanently increase the immediate deduction amount to USD10,000. This would save entrepreneurs about USD3bn over the next 10 years. 

• Expand and simplify the small business health care tax credit. The Affordable Care Act created a new tax credit, effective beginning in 2010, that covers up to 35% (rising to 50 % in 2014) of an eligible employer’s premium contributions towards their employees’ health insurance. The Budget proposes to expand the tax credit to additional employers (including by increasing the eligibility cut-off from 25 to 50 workers), change the phase-out formula so firms that appear eligible will qualify for some credit, and simplify the calculation of the credit (by removing a requirement that an eligible employer pay a uniform percentage of the premium for each employee and also eliminating a cap on the credit based on the average health insurance premium in the employer’s state). This would provide an additional USD14bn in tax relief to small business owners over the next 10 years.

Offsets

• Allow the 2001 and 2003 income tax cuts to expire (including the low tax rate on dividends) for households making more than USD250,000 per year and restore the estate tax to 2009 levels. The President’s Budget allow income tax rates that benefit upper-income households to return to the levels they were at throughout most of the 1990s; tax dividends (currently taxed at a maximum of 15%) as ordinary income for married tax¬payers with income more than USD250,000 and single taxpayers with income more than USD200,000; and restore the tax on large estates to 2009 levels. The Administration claims that allowing these temporary tax cuts to expire as scheduled at the end of 2012 will avoid increasing the deficit by nearly USD1 trillion over the next 10 years. 

 Limit certain tax expenditures for the most affluent by capping itemized deductions at 28%. The Budget proposes to limit the tax subsidy for itemized deductions for high-income families to 28% – the same level that was in place at the end of the Reagan Administration. This year’s proposal builds on the legislative language in the American Jobs Act and expands the limitation to other deductions and income exclusions claimed by high income taxpayers such as tax-exempt state and local bond interest, contributions to retirement accounts, employer-sponsored health insurance, and deductions for income attributable to domestic production activities. It would raise more than USD580bn over the next 10 years. 

• Eliminate the carried interest ‘loophole’ for hedge fund managers and other similar investment service providers. The 2013 Budget proposes to change the tax treatment of carried interests in investment partnerships, are currently taxed as capital gains up to a maximum of 15%, raising and estimated USD13 n over the next 10 years. 

• Eliminate special depreciation rules for purchases of corporate jets and other general aviation passenger aircraft. Under current law, airplanes used in commercial and contract carrying of passengers and freight generally are depreciated over seven years. Airplanes not used in commercial or contract carrying of passengers or freight, such as corporate jets, generally are depreciated over five years. The Budget proposes to increase the depreciation recovery period for general aviation airplanes that carry passengers to seven years, raising USD2bn over 10 years.

• Combating transfer pricing abuses. Under the Budget proposal, excessive profits related to the offshore use of transferred intangibles would be taxable in the United States, thus restricting the tax incentive to engage in transfer pricing abuses. This proposal, along with a related proposal to clarify the definition of intangible assets, would raise more than USD23bn over the next 10 years. 

• Other reforms to reduce incentives to shift income and assets overseas. In addition to transfer pricing reform, the Budget includes a broader package of international tax reforms that has been designed to reduce incentives to shift income and assets overseas. For example, US businesses that borrow money and invest it overseas can claim the interest they pay as a business expense and take an immediate deduction to reduce their US taxes under current law, even if they pay little or no US taxes on their overseas investment. The Budget would eliminate this tax advantage for overseas investment by requiring that the deduction for the interest expense attributable to overseas investment be delayed, saving some USD37bn over the next 10 years. It is claimed that, overall, the Budget’s proposals to reform international tax rules will raise USD148bn over the next 10 years.

During a speech in Virginia introducing his budget, President Obama drew attention in particular to the proposals for tax increases on the wealthiest taxpayers: “a quarter of all millionaires pay lower tax rates than millions of middle-class households. You’ve heard me say it - Warren Buffett pays a lower tax rate than his secretary. That’s not fair.” To those who have said that he is engaging in “class warfare”, he replied that all his policies are merely “common sense”.

However, as expected, comments from the Republican Party were immediately disparaging. House Ways and Means Committee Chairman Dave Camp remarked that the Budget not only involves “the biggest tax increase in history” but also “the biggest budget deficit ever proposed”.

“The President’s USD2 trillion tax increase will destroy jobs and further weaken our economy,” Camp said. “Furthermore, the President is filling the tax code with even more special interest lobbyist loopholes, instead of joining Republicans in job-creating tax reform. The President has decided to play the age-old Washington game of picking winners and losers and handing out favors to industries he thinks will help him politically, making the code less fair and more complex for average Americans.”

“It is time for the tax code to treat American workers and employers fairly,” Camp argued. “The tax code should not favor one company or industry over another. The tax code should treat auto manufacturers no differently than those making solar panels, and it should treat those making wind turbines no better and no worse than those innovators making new cancer treatment drugs. “

“On the individual side of the tax code, the President’s proposals would push federal tax rates close to 45%,” Camp added. “No matter how much money someone makes, the federal government should not be taking almost half of everything they earn, especially not on top of all the other state, local and gas taxes Americans already pay.”

The stage then, is set for another Congressional battle, with the Republicans expected to use their majority in the House of Representatives to block any legislative proposals that will increases taxes or spending. The fact is, however, another compromise will have to be reached in some form or another because many of the proposals in Obama’s budget involves tax laws which expire at the end of this year, and therefore will entail an automatic increase in taxation on many taxpayers if not dealt with. But even if some of the President’s more imaginative proposals are left by the wayside, to a certain extent he has already done his job by announcing a fiscal plan designed to woo the middle class vote. Or, as Orrin Hatch (R - Utah), Ranking Member of the Senate Finance Committee, cynically quipped: “the President’s budget blueprint is better suited to an episode of the Twilight Zone – an alternate reality of more stimulus spending, more taxes, and more debt designed to satisfy his left-wing base during an election year.”

The prospects for quick action on most of the president’s proposals before the election would therefore appear slim, raising the prospect of a busy ‘lame duck’ session in November and December.


 

 

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