Making the individual tax cuts permanent is the cornerstone of a new effort by House Republicans to craft Tax Reform 2.0. House Ways and Means Committee Chairman Kevin Brady (R-Texas) has indicated that the White House and House Republicans are planning a second phase of tax cuts that may be in two or three new pieces of legislation. The first order of business will be to permanently extend tax cuts for individuals that are set to expire after 2025 under the Tax Cuts and Jobs Act. “The focus here is going to be on making sure those middle class tax cuts and those small business tax cuts are made permanent,” Chairman Brady told FOX News in early July.
The Committee pointed to a study by the nonpartisan Tax Foundation of the positive economic effects of making the cuts to individual rates permanent. That study found:
- An additional 1.5 million full-time jobs would be added over the long-term.
- Permanent cuts would generate an additional 2.2 percent increase in long-run GDP.
- Long-run wages would be boosted by 0.9 percent.
Expensing, Retirement and Education Incentives
Making the TCJA’s expensing incentives permanent is one of Brady’s goals, along with extending the higher AMT exemption, the increased child tax credits and the doubled standard deduction. New areas of change identified by Brady are retirement and education incentives. “We think the timing is right to help families save more and earlier in life,” Brady says on the Committee website. What kind of incentives? The Ways and Means Committee has assured taxpayers that it will not abolish the pretax benefit for retirement savings. “Rothification” was floated during the first round of tax cuts, but did not make it into the final bill; Brady, however, has yet to identify the new types of savings incentives. On education, the Committee is looking to streamline the many existing education tax benefits and combine them into a package of middle class benefits covering both college and vocational education. Charitable contribution deductions are another area slated for change under the next phase of tax reform.
The Big If: Capital Gains Indexing
Capital gains indexing could be a part of a second tax reform bill, although Chairman Brady has been hesitant to definitively state that it is part of the plan. Instead, Brady said Republicans are open to the idea of indexing, as reported by Politico. Conservative groups, such as Americans for Tax Reform, have called on President Trump and Treasury Secretary Steve Mnuchin to implement capital gains indexing by executive order, but the Treasury Secretary has been cool to the idea due to the legal uncertainty about changing the tax code through executive order.
The best indicator that Congress is serious about capital gains indexing is the release of a June 2018 report by the Congressional Research Service (CRS) entitled, Indexing Capital Gains for Inflation. CRS prepares reports in response to Congressional inquiries and identifies upcoming issues while explaining legislative options. This 25-page report does just that.
How Indexing Would Work
Indexing capital gains would eliminate the part of capital gains resulting from inflation. The mechanism is an increase in the basis of a capital asset by the inflation factor occurring since the asset was acquired.
CRS offers the following example: If the inflation rate is 2% and the real rate of return is 7%, an asset purchased for $100 would sell for $109.14 a year later if interest is compounded annually. Without indexing, the gain if the asset was sold would be $9.14. With indexing, the basis would be increased from $100 to $102, and the gain would be $7.14.
One issue that has to be decided is which Consumer Price Index to use. Chained CPI is now used for the tax code, which results in a lower inflation factor than the traditional CPI. Also, Congress will have to address whether corporate capital gains will qualify, whether both short-term and long-term assets will be indexed and what happens when indexing causes a loss. Finally, Congress would need to decide whether indexing would be prospective only or would apply to taxpayers’ existing holdings. No matter how it is done or what benefits flow from indexing capital gains, it would complicate existing capital gains law and would be tricky to implement.
Timetable and Outlook
Although no bill has been introduced or reported out of the Committee so far, the draft of a second tax package is being circulated to House Republicans. A legislative outline could be made public as early as August, with votes in the fall. The biggest roadblock is the Senate. Without putting tax reform in a budget reconciliation bill, it would take 60 votes, which require support from a number of Democrats, to pass tax legislation. Democrats could find themselves in a tough position in the fall if they are forced to vote for or against a permanent extension of the individual tax cuts immediately prior to the midterm elections. If nothing else, it should be a lively fall!