Public: Textile Rental magazine

Ask For Tax Reform Now!

U.S. tax code due for major overhaul

By J. Burton Eller

Presidential hopefuls are feverishly preparing their issues and platforms to roll out before the American public. However, one issue that should be a concern of most Americans—tax reform—will not be at the top of any candidate's list. The economy is too good: most people have jobs, the stock market has been bullish and cash is flowing abundantly and freely among consumers. This is great, but many economists and fiscal planners fear our economy will not be able to sustain its current level. We are experiencing the longest sustained-growth period in the stock market ever. The current federal budget surplus is a direct result of taxes received from gains in stock value and earnings. When this trend slows, and perhaps plateaus, where do we turn for new economic growth? One viable option is major and thorough tax reform—reform that rips the tax code out by the roots.

Current Tax Laws Endanger Small Business and Family Corporations
Massive capital formation in the private sector would follow fundamental, broad-based tax reform. Following are some ideas on how to effect such reform. Taxes present some of the most burdensome obstacles for family businesses to continue from one generation to the next. Small businesses and family corporations don't qualify for many tax breaks afforded to larger corporations and public companies for certain investments, retooling, training, research and development, etc. Some of the tax code provisions effectively eliminate the chance for small business to capitalize at Uncle Sam's expense. Conversely, when it's time to transfer the company assets to another family member or another generation, Uncle Sam wants a huge estate tax payment just for the privilege of keeping the business in the family. Remember, these businesses and assets took from one to many generations to build. Corporate taxes and taxes on income, sales, real estate as well as municipal assessments and more, have been paid on these assets since the businesses' beginning.

Estate and gift taxes should be eliminated
The death tax should be eliminated—it is the leading cause of dissolution for thousands of family-run businesses every year. The estate tax, a "virtue tax" that penalizes work, saving and thrift in favor of large-scale consumption, is an obstacle to entrepreneurship and job creation.

Death taxes raise only about 1% of all federal tax revenues, generating far more ruin than government funds. Those heirs who can't pay the death tax are forced to either sell the business, break it up, liquidate it or secure large loans against assets. Any of these options is devastating to the business, its employees and community and surviving owners. Even if the heirs prepare well in advance for death taxes, the costs are staggering. Most won't be able to expand the business or create new jobs for several years if they first must pull capital from operations to cover legal fees, insurance costs and trustee costs—all in the hope of crafting a plan that will offset the death taxes levied against the heirs. One way or another, death taxes must be paid whether the business is mortgaged up front, leveraged with life insurance and other fees, mortgaged after death, saddled with huge loan payments or liquidated partially or entirely.

Two members of the House Ways and Means Committee (the committee of Congress responsible for initiating all tax and trade legislation), Reps Jennifer Dunn (R-WA) and John Tanner (D-TN), have introduced a tax bill known as the "Death Tax Elimination Act," which would amend the 1986 Internal Revenue Code to phase out estate and gift taxes over a 10-year period. They have considerable support in the committee and the House of Representatives.

The House is expected to pass a package of tax cuts this year. The Senate seems less enthusiastic about major tax reform, but is likely to pass a smaller tax bill containing several additional tax cuts. The president and the White House appear to have absolutely no interest in tax reform this year. However, the dire need for major tax code reform, especially estate tax and capital gains tax elimination, remains paramount.

The death tax and its negative impact on the national economy
More money is spent within our national economy to prevent family businesses from being destroyed by death tax obligations than is collected by the federal government in estate tax revenues.

A recent study by the Heritage Foundation found that a repeal of the death and gift tax would cause dramatic positive effects in the American economy within the next nine years. This is because:

the nation's economy would average as much as $11 billion annually in extra output;

an average of 145,000 new and different jobs would be created;

personal income would rise by an average of $8 billion per year above current projections; and,

the nation's deficit would actually decline due to the growth generated by the abolishment of the death and gift taxes.

The Center for the Study of Taxation used a sophisticated econometric model and assumed that death taxes had been eliminated in 1971. The study found that 262,000 more jobs would have been created by 1991 than actually were created, the stock of capital would have been $398.6 billion higher than it actually was and the gross domestic product (GDP) would have been $46.3 billion higher in 1991 than it actually was. A subsequent assimilation compared simulated data to actual projections regarding the U.S. economy in 2000. That model showed that, compared to current projections, if the death tax had been abolished in 1993, 228,000 more jobs would have been created by 2000 than were predicted.

The death tax—where did it come from?
Here is the history:

Prior to 1916, the U.S. used death taxes solely to fund national emergencies.

In 1916, the federal government instituted the income tax and enacted a permanent death tax. The Act prescribed a rate schedule ranging from 1% on estates valued at less than $50,000 to 10% on estates valued at more than $5 million.

In 1924, Congress enacted the first gift tax to curb the trend of citizens who gave their estates away as gifts to avoid paying the death tax.

In 1926, the gift tax was repealed and the death tax rates were lowered.

In 1932, Congress re-instituted the gift tax and raised death tax rates. The federal gift tax has been in effect since then.

From 1932 to 1941, the financing demands of World War II caused a high-water mark for federal transfer receipts. During this time, rates were raised and revenue from death taxes accounted for as much as 9.7% of the federal tax receipts.

From 1942 to 1976, there was very little change in the tax law. The top tax rates remained at their relatively high wartime levels and exemption amounts were unchanged.

sIn 1976, the Tax Reform Act resulted in a major overhaul of the death tax system. The death and gift tax systems were basically united, and the separate exemptions were replaced with a unified credit. This credit gradually increased in value from $120,667 in 1977 to $175,625 in 1981. Both gift and death taxes became subject to the same progressive rate schedule. Marginal rates ranged from 18% on estates valued less than $10,000 to 70% on estates valued at more than $5 million. For estates comprised largely of interests in small business or family farms, real estate holdings were valued at their current use rather than at the highest or best use. This provision reduced the value of some estates by as much as $500,000 for death tax purposes. sIn 1981, the Economic Recovery Tax Act built on the provisions of the 1976 Tax Reform Act. It did this by raising the unified credit, lowering the top rate and providing additional relief to small businesses and family farms with a 15-year extension on payment of death taxes and by rule changes regarding marital exclusion.

Although the 1981 Economic Recovery Tax Act planned to lower the top tax rate from 70% to 50% in 5% increments from 1981 until 1985, new legislation halted this tax relief. The Deficit Reduction Act of 1984 froze the maximum rate at 55% until 1988, when the rate was set to fall to 50%.

The Omnibus Reconciliation Act of 1987 made additional changes to the 1981 law. The two top marginal rates -the 53% tax on estates valued between $2.5 and $3 million, and the 55% on estates valued at more than $3 million-were extended for five years. In addition, by enacting an additional 5% on estates valued between $10 and $21 million, the act also phased out the benefit of the unified credit and graduated rate schedule over this range.

The Omnibus Reconciliation Act of 1993 retroactively reinstated the 53% and 55% rates and reinstated the additional 5% on estates valued between $10 million and $21 million.

Currently, federal death tax rates are assessed as follows:

Estates valued up to $10 million pay taxes on a graduated rate system that ranges between 18% and 55%. An exemption is allowed for the first $600,000 of an estate's value. Unfortunately, this exemption is fixed and not indexed for inflation.

Estates valued between $10 and $21 million are taxed at a rate of 55%. But an additional 5% surcharge is levied, which has the effect of phasing out the $600,000 exemption completely as the value of the estate approaches $21 million.

Estates valued at more than $21 million face a tax rate of 55% and no exemption is allowed.

Congress Crafts the Lifetime Tax Relief Act
Far-reaching tax relief for individuals and small business has been introduced by Ways and Means Committee members Dunn and Weller (R-IL), known as the "Lifetime Tax Relief Act." The Dunn-Weller bill is touted as providing tax simplification from marriage to death. The bill has three cornerstones: 1) Restoring fairness to job creation. 2) Restoring fairness to savings and investment. 3) Restoring fairness to families.

Restoring Fairness to Job Creation
Eliminating the Death Tax Against Family Business According to Dunn and Weller, the death tax prevents 70% of family-owned businesses from surviving into the second generation, and 87% do not make it to the third generation. Dunn and Weller would reduce the death tax rate by 5% each year until it reaches zero in 2010.

Restoring Health Care Fairness to Small Business Owners
The tax code actually gives preferential tax treatment to corporations over the self-employed-who, to a large extent, include women, independent operators, family-owned businesses and family farmers. The self-employed need health care but often find it unaffordable. Dunn and Weller would allow 100% deduction for health insurance premiums for the self-employed by January 1, 2000.

Simplifying the Transition from Welfare to Work

Dunn and Weller would permanently extend the Welfare Opportunities Tax Credit, thereby insuring the private sector's continued commitment to welfare reform.Few firms are participating in the current Welfare to Work Program because the government refuses to make the Work Opportunities Tax Credit permanent, creating financial uncertainty for the companies wanting to help more Americans gain independence and control for their own future.

Simplifying and Encouraging Research and Development
Our current tax code enables companies to receive a temporary tax credit against wages paid for jobs associated with research and development. Dunn and Weller would make this research and development tax credit permanent.

Encouraging Investment in Future Jobs
Dunn and Weller would ensure that new capital-intensive small businesses would have access to the money they need by raising the threshold from $50 million to $300 million for defining a small business, and eliminating all capital gains taxes from individual and corporate investment in businesses at this level.

Restoring Fairness to Savings and Investment
Restoring Investment Fairness Dunn and Weller would provide equitable tax relief by allowing individuals to exclude their first $1,000 in capital gains and the first $2,000 for a married couple.

Restoring Fairness to Higher Education Savings The Dunn-Weller legislation would enable parents to begin purchasing their children's college tuition at today's tuition prices. This prepaid tuition plan explicitly encourages both public and private colleges to offer prepaid tuition plans and grants.

Restoring Fairness to Families
Eliminating the Marriage Penalty When two working, single people marry, their combined income generally pushes them into higher tax brackets. The Dunn-Weller bill doubles the standard deduction for married couples filing their taxes jointly. In addition, the proposal broadens the 15% tax bracket providing an additional $1,000 in marriage tax penalty relief.

Restoring Fairness to Single Taxpayers The legislation provides tax relief for singles by raising the personal exemption from $2,750 to $3,500. It expands the 15% bracket to include another 45 million working Americans.

Encouraging Savings for the Future The retirement savings portion of the legislation would allow all workers over the age of 45 to set aside an additional $3,000 in their IRAs annually. Also, couples who have access to only one employer-sponsored retirement savings plan could put away up to twice the normal contribution deferred by an individual. Eliminating the Earnings Limit on Seniors Who Want to Work This bill would eliminate the Social Security earnings limit, or "Means Test," giving seniors the freedom and incentive to work as they choose, enabling seniors to work without fear of losing Social Security. Our present tax code actually forces many older Americans into retirement on fixed income before they are ready.

Better Yet, "Rip The Old Tax Code Out By The Roots"
Americans are caught in a tax trap: "The harder we work, the more we save, the more we are taxed." Americans hate the IRS and the current tax system. It is complicated, burdensome and unfair. The average individual works a substantial portion of every day just to meet the payroll deductions skimmed right off the top of every paycheck. In addition, most Americans live in fear of the consequences of filing an incorrect return. One survey found more people would prefer a root canal than an IRS audit. According to another survey, the most feared phone message in the nation is, "This is the IRS calling." When the federal income tax was established in 1913, the new law was a mere 16 pages long. Today, the tax code takes up 17,000 pages. The eight million pages of forms the IRS sends out every year is enough paper to circle the planet 28 times.

There are several tax reform plans floating around, and some still on the drawing board, that would essentially abolish the current tax code and rebuild our tax structure from scratch. They all have merit. Some are perceived to be more fair and balanced than others. One especially equitable plan is the consumption tax plan supported by House Ways and Means Committee Chairman Bill Archer (R-TX). The consumption-tax proposal would endeavor to create a new tax code that achieves six basic principles:

1—Promote fairness. All Americans would bring their paychecks home without losing a cent to income tax withholding. Those spending more would be taxed more—a Geo Metro would have a smaller tax than a Rolls Royce. Tax loopholes would be abolished and protections for low-income Americans would be added.

2—Simplify the tax code. Under a consumption tax, no individual would ever have to file an income tax return with the IRS again. The income tax would no longer be withheld from a worker's paycheck. This tax would reduce the number of collection points from the current 170 million to less than 2 million under the new code.

3—Attack the underground economy. The consumption tax broadens the tax base by taxing the underground economy. It is estimated that tax evasion costs U.S. taxpayers at least $200 billion a year in lost revenues. Honest taxpayers are estimated to be paying an additional 10% to 15% in taxes to make up for those who cheat the income tax system.

4—Encourage savings and investment. The current system punishes anyone who saves and invests by taxing them twice—once on income taxes and again on interest, dividends and the profits of saving. Under a consumption tax, there would be no tax on savings. Every country that has increased its national savings rate has seen a corresponding increase in its standard of living.

5—Improve our balance of trade. No product made in the U.S. and exported to other markets around the world would be subject to the consumption tax. All imports would be subject to the consumption tax, however, just like any other product sold in the U.S. This border-adjustability, which is completely legal under World Trade Organization rules, would give the U.S. a fair advantage in the global marketplace.

6—Stimulate Economic Growth. Dale Jorgenson, Chairman of the Economics Department at Harvard University, testified before the House Ways and Means Committee that a consumption tax could increase the projected overall size of the U.S. economy immediately by 13% and then remain at 9% above current economic forecasts.

If you could reduce your current tax burden for the next ten years, which tax cuts would help you the most? Would you support major overall tax code reform that would lower taxes and increase fairness? Please write your answers to your representatives and senators in Washington, D.C., and be sure to copy TRSA.

J. Burton Eller is the executive director of TRSA.

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