This document has not been reviewed and approved by the Democratic Caucus of the Budget Committee and therefore may not necessarily reflect the views of all the members of the caucus.
Budget Effects of Tax Bill (numbers are preliminary)
| 1997 - 2002 | 1997 - 2007 | |
| Net tax cuts 1/ | -$ 95 billion | -$275 billion |
| The May Bipartisan Budget Agreement | -$ 85 billion | -$250 billion |
The New Bill Drops the Following from Prior Bills:
The New Bill Includes the Following that were not in Prior Bills:
Major Tax Cuts Include the Following:
Budget Effects of Tax Bill (numbers are preliminary)
| 1997 - 2002 | 1997 - 2007 | ||
| Tax increases 2/ | $ 56 billion | $126 billion | |
| Gross tax cuts | -$151 billion | -$401 billion | |
| Net tax cuts | -$ 95 billion | -$275 billion | |
| Net tax cuts in the May Bipartisan Budget Agreement | -$ 85 billion | -$250 billion | |
Major Tax Cuts 3/
Note: A number of tax benefits described below (for example, the children's credit, education tax credits, the student loan interest deduction, the D.C. home buyers credit, and the benefits related to tax-preferred savings accounts) are subject to high-income-related phase-outs. That is, when a taxpayer's income exceeds a specified amount, the benefits are either reduced or disallowed. For these phase-outs, income is measured by modified versions of adjusted gross income. Details vary among the provisions.
Children's credit goes to more low-income families than under the House or Senate bill.
The credit is for each child age 16 and under. The credit is $400 for 1998 and $500 thereafter.
The high-income-related phase-out starts at the same thresholds as prior Republican proposals: $110,000 for a joint return and $75,000 for other returns. Credits for a family are phased out at a rate of -$50 per $1,000 of income (i.e., -$500 per $10,000 of income). The size of the phase-out range varies with the total amount of credits; that is, it is larger for a higher number of children. For example, for a couple with two children, the phase-out range is $110,00 to $130,000. For a couple with four children, the range is $110,000 to $150,000.
Because of changes incorporated into the new bill, the Administration estimates that 9.5 million more children from families with income below $30,000 will benefit than under the House bill. Married couples with incomes as low as $18,000 and heads of households with less income will now be able to participate.
Families that pay net taxes, counting payroll taxes, will typically now be eligible for the children's credit. Republican proposals were replaced with a credit that will be "stacked" prior to the Earned Income Tax Credit (EITC) and will, for families with three or more children, be refundable to the extent that their income and employee payroll taxes exceed the size of the EITC. Until the "stacking" was changed, families getting the EITC were typically disqualified because they owed no net income tax after subtracting the EITC. This disqualification took place even though these families typically pay substantial payroll taxes.
Neither the credit amount nor the phase-out thresholds are indexed for inflation.
Unlike the House bill, the new bill does not reduce the children's credit for families that use the Dependent Care Tax Credit.
Includes the President's major education initiatives, unlike the House or Senate bills.
HOPE Scholarship credit for first two years of post-secondary education:
For the first two years of post-secondary education there is the following credit per student: 100% of up to $1,000 of expenses and 50% of additional expenses of up to another $1,000. For example, when expenses are $2,000, the credit is $1,500. As in the President's proposal, this credit is non-refundable. An eligible student must be at least a half-time student. The credit is for the education expenses of either the taxpayer, spouse, or dependent. Expenses include tuition and required fees, but not books nor room and board.
There is an income-related phase-out of the credit similar to the phase-out in the President's original plan. The phase-out occurs between $80,000 and $100,000 for joint returns, and between $40,000 and $50,000 for heads of households.
There is no Pell grant offset, under which the potential HOPE credit might have been reduced dollar-for-dollar (or a portion thereof) for each dollar of Pell grant.
If a taxpayer chooses instead to use the tax benefits described below (a 20% credit or Education Savings Account withdrawals) for a student's expenses, he cannot claim the HOPE credit for the same student's expenses.
The HOPE credit is first available for tax year 1998.
"Lifetime Learning" tax credit for post-secondary education
For the years 1998 - 2002, there is a non-refundable 20% credit for post-secondary education expenses of up to $5,000. Thus, the maximum credit is $1,000. Starting in 2003, there is a credit of 20% for expenses of up to $10,000. Thus, the maximum credit becomes $2,000. The maximum creditable expense does not go up with the number of students. Eligible expenses are for tuition and required fees and do not, for example, include room, board, books or activity fees.
Eligible expenses are those incurred by a taxpayer for himself, spouse or dependents. There is no limit on the number of years for which the credit may be claimed, and the credit may be claimed for graduate education. The student must be at least half-time in the case of a degree or certificate granting institution, but can be less than half-time in the case of acquiring or improving job skills.
The same income-related phase-outs apply as for the HOPE credit.
If a taxpayer chooses instead to use the HOPE credit or Education Savings Account withdrawals (see below) for a student's expenses, he cannot claim the 20% credit for the same student's expenses.
The Lifetime Learning credit is first available after June 30, 1998.
Backloaded education savings accounts (ESAs) and state-sponsored education pre-payment plans
Education savings accounts
Like backloaded IRAs described below, the education savings accounts (ESAs) do not provide an up-front deduction for contributions, but instead allow tax-free withdrawals for tuition, fees, books, and room and board for post-secondary education. This effectively makes personal investment earnings tax-free.
In the new bill, ESAs are subject to tighter limitations than in the House and Senate bills. Contributions are limited to $500 per year per intended student beneficiary up to age 18. Money must be withdrawn or rolled over by the time the potential student reaches age 30. If withdrawals are not for eligible education expenses, the accrued investment earnings are subject to the regular income tax plus a 10% penalty tax. Money can be rolled over to ESAs for other family members. Eligibility to make contributions is subject to income-related phase-outs of $150,000 to $165,000 for a couple and $95,000 to $110,000 for single taxpayers.
If a taxpayer chooses instead to use the HOPE credit or the 20% credit for a student's expenses, he cannot use tax-free ESA withdrawals for the same student's expenses.
State sponsored pre-paid tuition and savings programs:
The new bill expands prior law, which concerned programs established and maintained by state governments. According to the new bill, contributions may now be made to cover future room and board expenses, as well as those covered under prior law. This expansion is less than in the House or Senate bills. These pre-payment plans allow tax-free inside build up of investment earnings until a student's expenses are paid, at which time the investment earnings become income to the student rather than the contributor. This treatment creates tax deferral and tax reduction, because a student is normally in a low or zero tax bracket, unlike the contributor at the time he made the contributions.
The bill also includes a new "super deduction" for student loan interest, an extension of the exclusion for employer-paid education expenses, and a tax benefit for elementary and secondary school improvement.
Student loan interest: Taxpayers will be able to take a deduction for up to $2,500 of student loan interest expense, even if they otherwise use the standard deduction rather than itemize deductions. Interest can be deducted for up to 60 months after interest has begun to be due. This benefit is subject to income-related phase-outs of $60,000 to $75,000 for a couple and $40,000 to $55,000 for a single return. The $2,500 maximum for the deduction is phased in over four years.
Employer-paid education: The current benefit, which applies only to undergraduate expenses, is extended for three years for courses beginning prior to June 1, 2000.
Elementary and secondary education: The new bill includes tax benefits for elementary and secondary school construction and other improvements. Local governments in qualified areas can borrow for certain purposes, and lending financial institutions will receive a tax credit that will replace the interest that will otherwise have to be paid by local governments. Qualified areas include empowerment zones or enterprise communities, or schools with 35% or more students from low-income families. To be eligible, a school must form a public-private partnership that includes contributions from businesses. There is a nationwide limit on the amount of eligible borrowing, and this amount will be allocated among the states. The state government will allocate within the state.
The new bill does not terminate the exclusion for tuition remissions given to children of college employees or to graduate students.
This provision from the House bill is not included.
Tax-preferred savings accounts
Frontloaded IRAs (i.e., IRAs for which up-front deductions are given)
The new bill includes a phase-in of higher income-related limits. The thresholds for starting the phase-out of eligibility will be doubled eventually. (The thresholds have been $40,000 for a couple and $25,000 for a single person.) The thresholds rise by $10,000 for couples and $5,000 for singles in 1998 and then $1,000 per year through 2002. In 2003, they increase to $60,000/$40,000 and by $5,000 per year thereafter until the thresholds are $80,000/$50,000, which are double the prior amounts. (The size of the phase-out interval - the difference between the threshold and the income cut off - is ultimately doubled for a couple from $10,000 to $20,000; for singles, the interval remains $10,000.)
IRA contributions will no longer be disallowed for a spouse if the other spouse has a company-sponsored pension plan, except that the allowable spousal contribution is phased out over an income range of $150,000 to $160,000.
New backloaded IRAs: The new bill also includes new backloaded accounts for retirement, higher education expenses, or first-time home purchases. Under the backloaded arrangement, there is no up-front deduction for contributions. Instead, when funds are withdrawn, there is no tax whatsoever on the investment earnings (nor on the original contributions). For the backloaded accounts, there are high-income related phase-outs of $150,000 to $160,000 for a couple and $95,000 to $110,000 for a single person.
Tax-free eligible withdrawals are those made at least five years after an account was started and after age 59½, or for first-time home purchases or for higher education.
By rolling over amounts from old-style IRAs, a taxpayer can purchase future tax-exempt status for withdrawals from his account by paying tax now on the roll-over amount. However, rollovers are not allowed for taxpayers with incomes of $100,000 or more.
The proposal was designed to lose little or no revenue for the first five years, because rollovers generate temporary revenues. However, the accounts generate growing revenue losses after the year 2001.
Consolidated contribution limit: There is a combined contribution limit that applies to both front- and backloaded IRAs. Contributions to both accounts are limited to $2,000 per spouse. A taxpayer can decide how to divide the allowable contribution among the possible accounts.
Penalty-free IRA withdrawals for higher education and first-time home purchase: In general, for either a front- or backloaded IRA, penalty-free withdrawals will be allowed for higher education spending and first-time home purchase.
Capital gains tax cuts
General provisions
For all assets held more than 18 months but less than five years, the new capital gains tax rate is 20%. However, the capital gains rate is 10% for taxpayers who are in the bottom, 15%, regular tax bracket. 4/ For assets held less than 12 months, the tax rate that applies to other income applies to capital gains as well. For assets held more than 12 months but less than 18 months, the tax rate on capital gains is the lesser of the regular income tax rate or a 28% maximum. (See below for effective date and transition rule considerations.)
For salaries, dividends, interest and all other income besides capital gains, the top statutory rate continues to be 39.6%, while under this bill, capital gains are taxed at 20%, about half as much. For a taxpayer with ordinary income in the 15% bracket, capital gains are taxed at 10%, about two-thirds as much.
Starting in the year 2001, capital gains rates of 18% (or 8% for bottom-bracket taxpayers) will be available for assets held at least five years. These rates are available for assets purchased after the start of this year, or for assets held at that time only if a taxpayer effectively purchases the tax benefit by deeming these assets to have been sold and paying tax on the capital gains accrued up to that time. This is called "marking to market."
The same capital gains preferences are allowed under the alternative minimum tax as under the regular tax. The package has depreciation recapture at 25%, a compromise between the House and Senate bills.
Effective date and transition rules: The effective date is essentially retroactive to May 7, 1997, unless stated otherwise above. Because the tax chairmen announced a retroactive effective date prior to passage of the bill, the bill provides that assets sold between May 7 and July 28 that were held between 12 and 18 months, are subject to a maximum capital gains tax rate of 20% rather than 28%.
Home sales
A 100% exclusion is allowed for up to $500,000 (joint return) of capital gain on the sale of a principal residence. (The amount is $250,000 for single taxpayers.) This exclusion cannot be used more frequently than once every two years. The effective date is retroactive to May 7, 1997. This new benefit replaces the prior "roll-over" and over-age-55 exclusion provisions. For property sold after May 6 and before the date of enactment, a taxpayer may choose instead to apply prior law.
No exploding revenue loss from capital gains inflation indexing.
Unlike the House bill, the new bill does not add inflation indexing for capital gains to the cuts in the tax rates applicable to capital gains.
The House bill included a double-barreled capital gains tax cut: not only cuts in the effective tax rates on capital gains, but also inflation indexing as well.
Capital gains inflation indexing loses a great deal of revenue, once it has been in place long enough to cover the holding period of most assets. According to the Congressional Research Service, the tax cut from indexing is as large as from excluding about 45% of capital gains (assuming a 2.6% rate of inflation). The revenue losses explode because indexing is not retroactive for past inflation. Over the first few years of indexing, only a few years' worth of inflation is covered. As time passes, more and more years of inflation are covered.
In the House bill, the large revenue losses from capital gains indexing were further masked by delaying the start of indexing to account only for inflation after the year 2001, and by requiring a subsequent three-year holding period for eligible assets. Thus, the provision had little or no effect until after 2003, and at that time, reflected only three-years worth of inflation. Revenue losses were also masked by selling the tax-reduction benefits of indexing to taxpayers in tax year 2001. Taxpayers would have had to "buy" inflation indexing for assets already in their portfolio in the year 2001. They would have done this by paying tax on accrued capital gains as though they were selling the assets.
Inflation indexing -- in addition to tax rate cuts -- would have further skewed overall tax cut benefits toward the affluent. Even when taxpayer incomes and capital gains are averaged -- to wash out the effect of infrequent large gains -- it is clear that gains are concentrated in the hands of the very affluent. For example, by examining a 10-year "panel" of taxpayers, Congressional Budget Office researchers calculated that 73% of capital gains were realized by the 3% of taxpayers with incomes over $100,000 (1993 dollars). Furthermore, taxpayers at this level of income realized their gains frequently.
No cut in capital gains rate for corporations.
Unlike the House bill, the new bill does not cut capital gains taxes for corporations.
Estate tax cuts
General effective exclusion:5/ The general effective exclusion is raised from $600,000 in year-by-year steps to $1 million in the year 2006 and thereafter. For 1998, for example, the effective exemption is $625,000.
Family-owned businesses: An estate that includes significant family-owned business interests, including farms, is eligible for a special effective exclusion of as much as $1.3 million, rather than $1 million. This special exclusion is also available sooner, starting fully for 1998.
The difference between the $1.3 million and the effective general exclusion for a given year applies only to the value of the qualified family-owned business interests (FOBI) and not to other assets such as bonds or publically-traded corporate stock.6/
For an estate to qualify for the higher special exemption, more than 50% of its value must be qualified family-owned business interests which pass to qualified heirs. A business interest qualifies as family-owned if certain ownership thresholds are met, depending on the numbers of families involved in a business. For example, if one family is involved in a business, that family can own as little as 50% of a business and that business interest is qualified. If there are more families involved, then the percent owned by the families together has to be higher, but the percent owned by the family of the decedent must be at least 30%.
There are other qualifying standards that apply. For example, the FOBI bequest must pass to a certain class of heirs including family members. The decedent must have owned and "materially participated" in the family-owned business. A business interest does not qualify if the business's stock has been publicly traded. There are also rules for recapture of the special estate tax benefit, if, within a certain time, the heirs cease material participation in the business, sell it or move it abroad.
In addition, the new bill includes a reduced-interest installment plan for paying the tax on up to $1 million of the taxable value of a closely-held business. There is no change in the fourteen-year maximum for the installment payment period.
Alternative minimum taxes (AMT) -- business and corporate
The new bill is a compromise between the House bill, which would have eliminated accelerated depreciation as an item of tax preference, and the Senate bill, which did not have this change. The bill changes the AMT so that AMT depreciation is no longer based on longer asset lives than for the regular income tax. The new bill eliminates the AMT for "small businesses," those with gross receipts of less than $5 million. In addition, installment sales by farmers will no longer be treated as a tax preference.
The new bill does not include cuts in the alternative minimum tax (AMT) for individuals.
In both the House and Senate bills, the AMT for individuals was reduced.
Expiring tax benefits
The Research and Experimentation credit is extended from June 1, 1997, through June 30, 1998.
The exclusion for capital gains on donations of appreciated stock to foundations is extended from June 1, 1997, through June 30, 1998.
The Work Opportunity Credit is extended for work starting after September 30, 1997, and before July 1, 1998.
The Orphan drug tax credit is permanently extended.
Employer-paid education has been mentioned above.
District of Columbia tax benefits
Certain parts of D.C. will be designated as the D.C. Enterprise Zone. The package of tax breaks includes those now available to "empowerment zones" such as wage credit and added business "expensing." New tax breaks include a zero tax rate for capital gains on the sale of certain qualified zone assets and a tax credit of $5,000 for first-time home buyers, subject to an income-related phase out. The income phase-out ranges are $110,000 to $130,000 for joint filers and $70,000 to $90,000 for individual taxpayers. The credit is effective on the date of enactment and sunsets after December 31, 2000.
Across-the-board independent contractor liberalization is not included.
The new bill does not include a House provision that would have allowed many more employees to be classified as "independent contractors." Under this provision they would not have been subject to tax withholding and would not share in employee benefits.
Other
Welfare to work: There will be a new welfare-to-work credit for wages paid to a person beginning work after January 1, 1998, and before May 1, 1999. The credit follows the pattern of the work opportunity credit, but is larger for the target group, former welfare recipients.
Brownfields: The President's "brownfield" clean-up incentive is included, subject to sunset after three years.
Empowerment zones: There will be two additional "old-style" zones, plus 15 new urban and five new rural zones with liberalized eligibility criteria.
Trade: The Generalized System of Preferences -- tariff preferences for poor countries -- is extended through June 30, 1998. The Carribean Basis Initiative -- lower tariffs and quotas on apparel imports -- is not included.
Self-employed health insurance Prior law phased in an increase to 80% in the percentage of health insurance expenses that may be deducted by the self-employed. In this bill, that phase-in is accelerated and increased. The percentage becomes 45% for 1998 and 1999, 50% for 2000 and 2001, 60% for 2002, 80% for 2003 - 2005, 90% in 2006, and 100% in the year 2007 and thereafter.
Income earned by Americans abroad: The foreign tax simplification package includes a ten-year revenue loss of $1 billion from raising the individual income exemption for income earned by U.S. citizens abroad. That exemption will be raised slowly from $70,000 to $80,000 in the year 2002, and will then be indexed for inflation.
Amtrak: The Senate bill transferred a portion of general fund excise tax revenue to a special fund for spending on Amtrak and other rail programs. The new bill does not transfer funds but rather creates a $2 billion tax benefit over the years 1998 and 1999 for Amtrak, based on a "refund" to Amtrak of taxes paid by railroads that were the precursors to Amtrak.
The plan includes numerous smaller revenue-losing measures suggested by Members and groups. For example, the home office deduction is liberalized, as is the business meals deduction for truckers and airline pilots.
Tax transfer to transportation fund: The new bill includes a transfer of the 4.3 cent motor fuels tax previously dedicated to the general fund for the purpose of deficit reduction. A similar provision was in the Senate, but not House, bill.
"Limited" Tax cuts subject to line-item veto by the President: The Conference Agreement on H.R. 2014 includes a list of tax benefits, each of which is estimated to benefit less than 100 taxpayers or meets other criteria specified in the Line Item Veto Act, according to the Joint Committee on Taxation. Seventy-nine provisions are listed. The President may choose to veto any one of the provisions. The Administration had this list under consideration as of August 7.
Revenue raisers
Aviation trust fund taxes: The taxes due to expire in several months are extended and restructured to shift more of the burden of financing to short-hop airlines, and the international flight tax is increased and applied to arrivals as well as departures. The extension and modification of the aviation-related taxes account for $33 billion through the year 2002, and $47 billion for the next five years, 2003 through 2007.
At the end of a phase-in, the ad valorem ticket tax will have decreased from 10% to 7.5%. The new "per segment" tax will have risen to $3.00 per passenger per segment in 2002. The per passenger international tax will have gone from $6 to $12 and will be applied to arrivals as well as departures. There are special rules for travel involving Alaska, Hawaii, and U.S. possessions.
Cigarette tax: Although technically in the spending reconciliation bill, rather than the tax bill, the changes deserve explanation here. The current tax is now 24 cents per pack. The new bill includes a 10-cent increase effective for the year 2000, plus another 5 cents effective for the year 2002 and thereafter. That is, for 2002 and thereafter the tax will be 39 cents per pack. The changes raise $5 billion through 2002 and $11.5 billion in the second five years.
Language was inserted into a "technical corrections" section of the tax conference agreement stating that these increases in tobacco excise taxes "shall be credited against the total payments made by parties pursuant to Federal legislation implementing the tobacco industry settlement agreement of June 20, 1997." The intent is to shield tobacco companies from the higher tobacco taxes by reducing what they will pay under a possible settlement initially negotiated by the states' attorneys general. However, the Congress has not yet acted on the proposed settlement. The Congress could choose to increase settlement funds the companies will have to pay - thereby undoing the effect of any credit for higher taxes - or override the language in the tax bill.
Earned income tax credit: The new bill includes changes in the Earned Income Tax Credit that were not in either the House or Senate bill. These include the counting of additional sources of income toward the income-related phase-out of the credit, changes in the treatment of welfare-to-work clients, and additional compliance provisions. These changes raise about $1 billion over ten years.
"Lobbying" reporting requirement affecting labor unions: Not included.
TIAA-CREF: The new bill raises $1 billion over ten years by removing the 1980 "grandfather" tax exemption for the pension business of Mutual of American and the Teachers Insurance Annuity Association -- College Retirement Equities Fund.
The new bill includes a revenue-raising response to a new manifestation -- created by FannieMae -- of the corporate-owned life-insurance loophole that was phased out last year.
Many of the other provisions come from the President's budget, including some financial reforms (e.g., Seagrams, Morris trust, short sales against the box, accounting for credit card receivables) and a restriction on the use of net operating losses.
ENDNOTES _______________________________________________
1/ Net amount reflects cigarette tax increase, which is in spending bill.
2/ Reflects cigarette tax increase, which is in spending bill.
3/ Provisions are generally first effective for tax year 1998, unless otherwise noted.
4/ Technically, the capital gains tax rate is 10% only for the portion of net long-term capital gains that would fit within the remaining room in the 15% tax bracket, after counting all other income.
5/ Technically, there is a unified estate and gift tax credit rather an exclusion. In this discussion, the effect of the credit is expressed in terms of the dollars of an estate that are effectively shielded from tax by the credit.
6/ For example, in 1998, the effective general exemption will be $625,000. The difference between it and $1.3 million is $675,000. If FOBI value is greater than $675,000, $675,000 of FOBI value is excluded. If FOBI value is less than $675,000, the entire FOBI value is excluded and no extra exemption is available for the other assets. After applying this procedure to FOBI, the remaining value of the estate receives the effective general exemption for that year.
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