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Calling the Shots for Economic Recovery and Deficit Reform

Look out for tax increases and a limit on deductions

After a volatile summer, things in Washington are heating up again. President Obama has proposed some changes to jump-start the economy and avoid a double-dip recession. Some of these changes will affect high-net-worth individuals, as the President considers limiting certain tax deductions and increasing taxes for the wealthy.

The Jobs Bill
Last week, the President unveiled the American Jobs Act (the jobs bill) to Congress, a $447 billion bill that includes a mixture of spending initiatives and tax cuts. The goal was to prove to the American people that he’s serious about getting the economy back on its feet and to challenge Congress to stop the political brinkmanship that has blocked progress on these important issues.

The President’s jobs bill calls for tax cuts for both workers and employers. It extends a Social Security payroll tax holiday created by the 2010 Tax Act and provides a 3.1 percent payroll tax cut in 2012. Normally, workers are levied a Social Security tax of 6.2 percent on about $106,800 of their income. In 2011, that tax was reduced to 4.1 percent and under the President’s most recent proposal, it would be reduced to 3.1 percent in 2012.

As an incentive for employers to start hiring again, the jobs bill includes a 3.1 percent tax break for employers on the first $5 million of wages and a potential tax holiday for new hires and raises of existing salaries up to $50 million in wages.

The jobs bill also extends through 2012 a prior provision that allows businesses 100 percent expensing of new equipment.

The bill also includes an allocation of about $200 billion in additional spending, with about $140 billion for new infrastructure projects. The last $60 billion or so is allocated to extend unemployment insurance for the long-term jobless.

Paying Up
After spending the first part of the year debating the importance of deficit reduction, the President was also sure to include, along with the jobs bill, a plan to pay for it. Essentially, the major funders of the bill would be “the wealthy” and the oil and gas industries. As he has suggested in the past, the President wants to limit certain itemized deductions for the “wealthy” (that is, single people and families who earn $200,000 and $250,000 or more respectively).

Deductions would be limited to 28 percent on mortgage interest, state and local taxes and charitable contributions as well as on municipal bond interest and health care payments. In addition, investment managers and hedge fund managers would be taxed on their gains or “carried interest,” at ordinary income tax rates rather than the present capital gains tax rate.

Certain incentives and tax loopholes for the oil and gas industries would be eliminated as well.
Not surprisingly, Republicans immediately rejected the President’s bill based on the proposed tax increases and new spending.

Deficit Reduction Plan
Only a week after the President presented his jobs bill and funding plan, he was back with another proposal. This time, he submitted a deficit reduction plan to the Super Committee, the bipartisan deficit reduction panel of 12 lawmakers from both houses of Congress assigned the challenging job of finding $1.2-1.5 trillion in deficit reductions over the next decade. The Super Committee is required to submit its deficit reduction proposals by Thanksgiving.

President Obama’s plan would reduce the federal deficit by more than $3 trillion over the next 10 years. He includes the spending cuts and tax increases that he proposed in his jobs bill and calls for $1.5 trillion in tax increases for the “wealthy,” with $800 billion in revenue generated from expiration of the Bush tax cuts for the wealthy. He also proposes adjustments to health and entitlement programs, including reducing payments to doctors and hospitals.

Another $1.1 trillion in savings would come from the drawdown of troops from Afghanistan beginning next year. Finally, he includes an additional income tax to be levied on certain individuals who make over $1 million, the so-called “Buffet Rule,” named after Warren Buffett who argued in a recent Op-Ed piece that many wealthy people pay less tax than middle-class people and should pay more.

The Shakedown
Republicans and some Democrats have criticized the President’s deficit reduction plan, complaining that it’s just “more of the same.” They insist that raising taxes on anyone now would be detrimental to economic recovery and limiting certain deductions could also hurt certain industries, such as the housing, non-profits and the muni-bond industries. The President, however, remains adamant (at least for now) that bringing the deficit under control will require raising taxes on certain individuals and industries. He has promised to veto any bill that calls for entitlement reform without additional taxes on the wealthy.

In the midst of the continued deficit reduction debate, there is some consensus on both sides. Most agree that before any meaningful changes can be made to the deficit, there must be entitlement and tax reform.

Entitlement Reform
Although it’s been widely noted that entitlements aren’t part of the deficit, entitlements comprise a huge part of non-discretionary spending. The government spends over $3 trillion per year on all aspects of the budget with over 60 percent spending on entitlement programs and benefits. Most lawmakers agree that entitlement reform must be tackled sooner rather than later. Some Republicans recommend limiting benefits or raising the retirement age that would qualify an individual for Medicare or Social Security benefits. Democrats want to limit or reduce Medicare payments to doctors and hospitals.

Tax Reform
One of the major takeaways that came out of the Simpson-Bowles Deficit Reduction Panel last year was that the tax code is unnecessarily complicated, includes arbitrary loopholes and has become an inefficient and convoluted mechanism for raising revenue.

Throughout the deficit debate and up until the present, lawmakers from both parties have insisted that the tax code creates a burden on businesses and corporations as well as onerous complications for individuals. While it would certainly take longer than a few months to overhaul the tax code, many are insisting that certain aspects of the code, such as income, investment and corporate taxation rules, should be reviewed before the November deadline.

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