CRS Updates Report on Taxes and Budget Reconciliation

A large number of extended provisions were common to both the House and Senate bills; in most (but not all) cases, the extensions carried through the end of 2006. Some of the more prominent extensions in both bills were:

• the alternative deduction for state and local sales taxes (extended through 2006 in both measures); the research and experimentation tax credit (extended through 2006 in both measures);

• the deduction for higher-education expenses (extended through 2006 in the House proposal and 2009 in the Senate plan); the 15-year depreciation recovery period for leasehold improvements and restaurants (extended through 2006 in both proposals);

• the work opportunity and welfare-to-work tax credits (extended through 2006 in both plans); application of non-refundable tax credits against the AMT (extended through 2006 in both proposals); and

• the increased ($100,000) "expensing" tax benefit for small business investment (extended by both measures through 2009).

Due to the prominence of these two items, some background information is useful. The temporary tax cut for capital gains and dividends was enacted by the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA; P.L. 108-27). JGTRRA reduced the tax rate on both capital gains and dividends to 15% (5% for income in the 15% and 10% regular-income brackets, with complete elimination in 2008). However, the reductions are temporary and are scheduled to expire on January 1, 2009. Absent congressional action, the capital gains rate will revert to prior law's 20% rate (10% for income in the lowest brackets). Dividends will be taxed under the tax rates applicable to regular income, which range from 10% to 35%, but which are also scheduled to revert to a 15% to 39.6% range in 2011. According to JCT estimates, a two-year extension of the reduced rates for capital gains and dividends will reduce revenue by an estimated $20.4 billion over five years and $50.8 billion over 10 years.¹

The context of the AMT exemption's extension is this: individuals generally pay either their AMT or regular tax, whichever is higher; a taxpayer's tentative AMT is partly dependent on a flat exemption amount specified by law. The value of the exemption is subject to erosion due to inflation and the growth of real income. Partly for this reason, an increasing number of taxpayers are faced with the possibility of paying the AMT rather than the regular tax. Beginning in 2001, Congress enacted a series of temporary increases in the exemption. The most recent increase was provided by the Working Families Tax Relief Act of 2004 (P.L. 108-121). Under its terms the exemption is $58,000 for couples and $40,250 for individuals. However, the increase expires at the end of 2005, and -- absent congressional action -- in 2006 the exemption will revert to prior law's level of $45,000 and $33,750 for couples and individuals respectively.

Aside from the extenders, the Senate bill contained a number of additional items not in the House bill. These included a number of tax cuts for areas affected by the recent hurricanes, a set of provisions applying to charitable contributions, and a number of revenue-raising provisions. The disaster-related provisions were generally more in the nature of development incentives for stricken areas than were the provisions of the Katrina Emergency Tax Relief Act (P.L. 109-73) that Congress enacted in September. The earlier measure generally focused more on providing direct tax relief to individuals affected by the hurricanes, providing, for example, more generous rules for deducting casualty losses and a set of tax benefits for charitable giving. The Senate bill would generally have extended KETRA's scope to include victims of Hurricanes Rita and Wilma. In addition, it contained a package of tax benefits for development in the affected areas, and included provisions such as bonus depreciation for investment in the Gulf area and increased low- income housing tax credits. On December 7, the House passed a standalone bill (H.R. 4440) containing a set of disaster-related tax benefits similar to those in the Senate reconciliation package. The disaster-related bill was approved by the Senate and signed by the President, becoming P.L. 109-135.

The charity-related items in the Senate bill included both tax benefits and revenue-raising measures. The tax cuts included a proposal that would have allowed tax-free withdrawals from IRAs if used for charitable purposes and a provision to allow nonitemizers to deduct charitable contributions in certain circumstances. (The proposal, however, would also have instituted a minimum "floor" amount below which a deduction is not permitted for itemizers.) Revenue-raising items in the charitable area included provisions intended to curtail the involvement of tax-exempt organizations in tax shelters and the doubling of certain fines and penalties applicable to charitable organizations.

In terms of revenue impact, the largest of the revenue-raising items was codification of the "economic substance" doctrine that is aimed at suppressing corporate tax shelters. Other revenue-raisers were additional measures designed to suppress the movement of U.S.- chartered parent corporations to low-tax countries (corporate "inversions" or "expatriation") and a requirement that large oil companies that use the Last In First Out (LIFO) method of inventory accounting revalue their inventories.

According to estimates by the Joint Committee on Taxation (JCT), the version of H.R. 4297 approved by the full Senate on February 2 would have reduced revenue by $69.4 billion over five years, by $49.5 billion over 10 years, and $983 million in FY2006.² (The bill approved by the full Senate differed slightly from the Finance Committee proposal.) The House bill was estimated to reduce revenue by $55.6 billion over five years, $80.1 billion over 10 years, and by $4.9 billion in FY2006.³

Debate over reconciliation legislation focused, in part, on its specific provisions, their fairness, and their likely economic impact. Supporters of the tax cuts in general, however, in some cases cited philosophical reasons: a belief in low tax burdens. In addition, supporters linked the economy's recovery from the 2001 recession to the tax cuts enacted in EGTRRA, JGTRRA, and elsewhere, arguing that the stimulus from the tax cuts helped make the slump shorter and less severe than it otherwise would have been. It was argued that continuation of those cuts -- many of which will expire without congressional action -- is important to sustain economic growth.⁴ Opponents of the tax cuts generally questioned the prudence of enacting tax cuts in a time of budget deficits, and also tend to be skeptical of the tax cuts' beneficial economic effects.⁵

The Conference Agreement

On May 9, a conference committee approved a budget reconciliation tax bill. (H.R. 4297, the Tax Increase Prevention and Reconciliation Act of 2005. The President signed the bill on May 17; it became P.L. 109-222.) The measure extends both the dividend and capital gains reduction (for two years) and AMT relief (for one year), and also extends the increased business expensing allowance. The conference agreement, however, does not include most other extensions contained in the House and Senate bills. (According to press reports, the extensions not contained in H.R. 4297 will likely be addressed by subsequent legislation not included in the budget reconciliation process.⁶) In addition, the conference agreement does not contain the bulk of the revenue-raising items contained in the Senate bill. It does not include, for example, either modifications to the economic substance doctrine or accounting changes for oil companies. Joint Committee on Taxation estimates indicate the conference agreement will reduce revenue by a net amount of $70 billion over five years and by $10.8 billion in FY2006.⁷

The conference agreement's one-year extension of AMT provisions applies to 2006, and includes both the applicability of personal tax credits against the AMT that was contained in both the House and Senate bills (though for different periods) and the increased exemption amount. The increased exemption is higher than those applicable to 2005, reflecting indexation for inflation. The exemption amount is $62,550 for joint returns and $42,500 for single returns.

The extended dividend/capital gains tax cut applies to 2008 and 2009. The increased expensing provision is extended for two years, for 2008 and 2009.

² Ibid., p. 7.

³ U.S. Congress, Joint Committee on Taxation, Estimated Revenue Effects of H.R. 4297, the "Tax Relief Extension Reconciliation Act of 2005," as Reported by the Committee on Ways and Means, JCX-81-05, Nov. 18, 2005, 3 pp. Available on the Joint Committee's website at [http://www.house.gov/jct/x-81-05.pdf].

⁴ See, for example, the statement of Sen. Gregg, Chairman of the Senate Budget Committee, remarks in the Senate, Congressional Record, daily edition, vol. 151, Mar. 14, 2005, pp. S2588-S2591, and the introductory language in the report of the House budget committee, U.S. Congress, House, Committee on the Budget, Concurrent Resolution on the Budget -- Fiscal Year 2006, report to accompany H.Con.Res. 95, 109th Cong., 1st sess., H.Rept. 109-17 (Washington: GPO, 2005), p. 7.

⁵ See Sen. Kent Conrad, remarks in the Senate, Congressional Record, daily edition, vol. 151, Mar. 14, 2005, pp. S2591-S2596.

⁶ Kurt Ritterpusch, "Conferees Reach Reconciliation Accord, Strip Some FSC Benefits to Offset Cost," BNA Daily Tax Report, May 10, 2006, p. GG-1.

⁷ U.S. Congress, Joint Committee on Taxation, Estimated Revenue Effects of the Conference Agreement for the "Tax Increase Prevention and Reconciliation Act of 2005," JCX-18 -- 06, May 9, 2006, p. 3. Available on the committee's website, at [http://www.house.gov/jct/x-18-06.pdf].