The 2006 elections saw the Democrats taking control of both the House and the Senate for the first time in 12 years. The shift in the House is probably the most significant.In the House, the majority party controls the agenda: what hearings are held, what legislation gets taken up by committees. The Democratic majority is a narrow one, just as the Republican majority had been a narrow one. Many of the newly elected Democrats were chosen to appeal to moderate voters, so it is far from clear that there has been a major shift in the view of House members on tax issues. Still, control of the agenda will tend to mean that Democratic proposals, rather than Republican proposals, will emerge from the House Ways and Means Committee.
A Democratic majority would obviously be better able to control the agenda in the Senate as well. However, as we have seen over the last few years with narrow Republican majorities in the Senate, the minority party can fairly successfully keep legislation bottled up unless their views are taken into account at the committee level.
The Senate Finance Committee has worked in a more bipartisan fashion to craft legislation than has been the case with the Ways and Means Committee. This need for the Senate Finance Committee to compromise to advance legislation in the Senate is likely to continue with either a narrow Democratic or Republican majority.
What does this mean for tax law changes in the short term and the longer term?
The short term
Even before the 2006 elections, there was a lot of discussion about the need to address the package of tax break extenders that had expired at the end of 2005. These include the research credit, the sales tax deduction, the above-the-line deduction for higher education expenses, the above-the-line deduction for out-of-pocket teacher's expenses, the welfare-to-work and work opportunity
tax credits, the 15-year amortization of leasehold improvements, and more than a dozen other tax breaks.
Extension of these breaks is largely non-controversial. Attempts to pass the extenders failed prior to the election primarily because they were tied to more controversial provisions, such as estate tax reform and a minimum wage increase. The elections are likely to create an atmosphere in which the package can pass in a lame duck session before year-end.
The Republicans want the tax cuts extended, and probably will give up on further efforts to get it packaged with estate tax reform. The Democrats probably will want to demonstrate a willingness to work in a bipartisan manner to get popular legislation enacted.
The longer term
Many of the tax breaks enacted by the Bush administration and Congress are only temporary. The provisions of the 2001 tax act generally expire in 2011. A number of the pension-related provisions of that 2001 tax act were permanently extended by the Pension Protection Act of 2006, but hopes for making all of the 2001 tax breaks permanent now appear doomed, at least until the 2008 elections.
Given that Congress is still closely divided, the Democrats may not see much merit in a fight to repeal something that will expire in a few years anyway. There are many of the Bush tax cuts focused on lower- to middle-income taxpayers that the Democrats would like to permanently preserve. A few tax breaks probably will warrant special attention.
* Lower marginal rates. The reduced marginal rates currently expire in 2011. Many Democrats in Congress might like to extend the reduced marginal rates at the low end, but let them expire for the top brackets. The start of the Clinton administration saw an increase in only the top marginal rate bracket. Given the current deficits and current make-up of the new Congress, taxpayers should probably assume that at least the top marginal rate bracket might be rising in 2011.
* Lower dividend and capital gain rates. These reduced rates were just extended by Congress through 2010 this year. The Democrats will probably allow these reduced rates to expire, but may also push for an earlier termination as a way to help pay for other tax cut proposals. The 0 percent rate in effect for 2008 through 2010 for taxpayers in the bottom two brackets is not viewed by Democrats as a tax break for lower-income taxpayers, but as a tax break for the children of high-income taxpayers.
* Roth IRA conversions. The elimination of the income limits on Roth IRA conversions starting in 2010 is probably also on the Democrats' radar screen. It might be easier to attack this tax break, since it has not yet come into effect. Enacted as a short-term revenue raiser to help pay for other tax breaks, it is a long-term revenue loser that many Democrats feel primarily benefits the wealthy.
* Education. The Democrats seem to be concerned about the growing cost of higher education, and are looking for some additional tax incentives to help out with higher education costs. These would expand on the provisions already in the tax code, including tax credits, Coverdell Education Savings Accounts and 529 plans. There may be some attempt to limit the access of the wealthy to 529 plans, which currently have no income eligibility limits. Now that the 529 plan tax breaks have been made permanent by the Pension Protection Act, however, any existing 529 plan assets would probably be protected under grandfather-type provisions.
* AMT. Hopes for an early repeal of the alternative minimum tax probably died with this election, although there might not have been much life in such hopes in any event. Even Democrats, however, will be interested in avoiding huge increases in the number of people caught by the AMT. The current temporary fixes are likely to continue until a funding source can be identified to pay for a permanent inflation indexing of the exemption amount.
*Estate tax repeal. Both Democrats and Republicans probably want to avoid current law playing out with the estate tax being repealed only in 2010 and then returning in 2011 with pre-2001 tax rates and exclusions. Reform legislation was considered in 2006, and look for even stronger efforts being made in 2007, with rates perhaps not as low as in the 2006 proposed legislation.
As you read this, Congress may have already enacted an extenders package. Both parties seem to want to get it done, and the interest in tying the effort to other tax initiatives seems to be waning.
The longer-term impact of the elections is less certain. There is greater potential for gridlock, but a lot of people thought there was already considerable gridlock with the Democrats' ability over the last few years to tie legislation up in the Senate.
Both parties will immediately be looking at the impact of their actions on the presidential and congressional races in 2008. That will probably mean at least greater lip service being paid to working in a bipartisan manner over the next couple of years to try to show that they were able to get things done leading up to 2008. What is unclear is whether giving lip service to bipartisanship can be translated into real compromise on the widely differing tax agendas each party is pushing.
George G. Jones, JD, LL.M, is managing editor, and Mark A. Luscombe, JD, LL.M, CPA, is principal analyst, at CCH, a WoltersKluwer company.
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