Whether the new Bush administration surprises skeptics and manages to forge a sufficient bipartisan coalition to pass its legislative agenda or gets sidetracked in Beltway gridlock remains to be seen. What is clear is that the time finally seems ripe for the most sweeping tax reform since 1986, the kind that could impact just about every American's wallet and every financial advisor's clients. Congress and the White House's shared vision?
Increase Americans' savings in IRAs, retirement plans and college savings vehicles, while easing estate taxes. Clarity regarding how many clients an advisor could have in any state before having to register there.
There's a new optimism among the lobbyists who fought so hard for reforms, especially tax changes, last year. "The tactical approach to tax reform may be a bit unsettled," says Duane Thompson, director of government relations in the Financial Planning Association's Washington office. "Clearly one of the new administration's primary aims is to work toward major tax reform, and the fact that you have one party controlling the White House and both houses of Congress should make that easier."
The fact that there isn't a Clinton veto hanging over Republicans' heads this year should help speed things along, Thompson adds. How hot an issue does the FPA think tax reform is this year? Thompson says the FPA plans to hire its own tax attorney in the Washington office who will devote all his or her time to monitoring and shaping tax policy in Congress and at the Treasury Department and Internal Revenue Service. It's a first for the FPA and a sign that the winds of tax reform are indeed blowing for real.
Of course, how reform is achieved will undoubtedly cause some heated debate across party lines. Last year, tax reform and investment-incentive bills, most notably the Comprehensive Retirement Security and Pension Reform Act (H.R 1102), cleared major hurdles only to be stalled at the last minute by political grandstanding and controversial, unrelated amendments.
What's different this year? How close Congress came to passage in 2000 is giving even jaded financial-services analysts and lobbyists hope that lawmakers will put politics aside to enact real cuts. There also are indications from Democratic leaders like House Minority Leader Richard Gephardt (D-Mo.) that Democrats have the will to see tax reform through.
But there's more reason for tax-cut proponents to be positive. Sagging economic indicators have prompted President Bush and Vice President Dick Cheney to embark on a whirlwind of high-profile appearances, arguing that tax cuts are the only remedy for the economic slowdown.
How this strategy plays with fence-sitting Democrats isn't clear. For those lawmakers who see former President Clinton and current Federal Reserve Board Chairman Alan Greenspan as fiscal role models, the inclination is still to earmark the surplus to pay off the federal debt. However, there are cold, hard numbers that indicate the budget surplus is far greater than the Congressional Budget Office had projected. If there is validity in recent leaks, the overage estimate is slated to be $1 trillion higher than the CBO's current 10-year projection. And that's a lot of money for lawmakers to play with. So while no one in Washington expects the Bush administration to get the full $1.7 trillion tax cut it is requesting, many think the odds of a significant tax cut are rising.
The probability of strong future surpluses also gives lobbyists hope that meaningful changes will be enacted to allow Americans to build and preserve more wealth. "We made heroic progress last year on tax reform," says Liz Liess, vice president and director of retirement policy at the Securities Industry Association. "We engaged the leadership early and had them fighting for us down to the end and we're looking to build on that success early this year."
Juicier IRA and other retirement-plan contribution provisions are likely to be first out of the gate, analysts forecast. In fact, congressional leaders are planning to make retirement security one of the first 10 bills introduced in 2001, one House Ways and Means Committee staffer says.
What will changes look like? A good deal like what lawmakers of the 106th Congress produced but failed to pass last year. Lobbyists say this year's legislation is likely to:
Increase IRA contributions to $5,000 annually.
Increase maximum qualified retirement-plan contributions to $15,000 annually.
Institute catch-up provisions for individuals without substantial retirement savings.
Ease 401(k) nondiscrimination requirements for small businesses, so more employers adopt plans.
While last year's versions of H.R. 1102 would have increased the income caps for IRA contributions, making more people eligible to sock away funds, the inclusion of such a provision in final legislation is doubtful, lobbyists say. "Everyone will push for higher income-limit increases, but that's usually one of the first things to go because it's so revenue intensive," one lobbyist says.
Tom Ochsenschlager, a tax partner and analyst for Grant Thornton's Washington office, agrees tax cuts benefiting retirement savings and investments are highly likely this year, although he predicts that the increase in maximum contributions to IRAs and qualified retirement plans may be phased in over a number of years.
Ochsenschlager is one of a number of lobbyists who is also predicting that the Bush administration will push for increases in the current $500-a-year college IRA contribution cap. Last year, lawmakers attempted to ratchet annual contributions up to $2,000. Such a push "will look like a compromise to Democrats, who believe education incentives are their bailiwick," he says.
Associations such as the FPA and the National Association of Personal Financial Advisors have been supporting such increases since the college IRA was enacted. "Right now, the limits make it a bit of a joke, so we would wholly support a step in the right direction on this," says the FPA's Thompson. "College costs are accelerating faster than salaries, so it's important to have meaningful tools investors can use."
Estate taxes are also likely to get slashed, if not eliminated, by this Congress, many Beltway observers believe. While actual budget bills aren't expected until the end of this month, relief from the death-tax penalty seems well within reach. "We're very interested in this," says NAPFA's government-affairs liaison Susan John. "It impacts so many planners' clients, we're watching this issue carefully."
Although Republicans have pushed for a total repeal of estate taxes, and President Bush has echoed those sentiments, it's more likely the tax will be amended to allow taxpayers to exclude between $2 million and $4 million from their estates for tax purposes, lobbyists say. Such a change would bump up the current $675,000 limit considerably, even after 2006, when the amount a taxpayer can exclude rises to $1 million. In addition, the Bush Administration and lawmakers are poised to push for a reduction in the top marginal estate tax rate of 55%, Ochsenschlager and others predict.
Last year, estate-tax repeal was passed by two-thirds of the House. There was a surprising degree of support from Democrats, who, after years of dubbing estate-tax relief the tax cut for millionaires' kids, began to see the cut as a good thing for constituents. They even offered an alternative bill that would have brought the top rate down and doubled the lifetime exclusion from estate taxes to $2 million per person. In effect, a married couple would have been able to pass on $4 million to the next generation, free of tax. "We couldn't understand why the Republicans rejected this bill," Ochsenschlager says. "We wondered: Why not take a half loaf now, which is better than nothing, and go after the other half next year?"
Lawmakers didn't quite see it that way in 2000, but there's still hope for 2001. The large federal budget surplus should aid this cause considerably.
Which doesn't mean that estate-tax repeal won't be without its detractors. States that depend on the federal government to collect their estate taxes will be less thrilled than advisors and their clients over cuts and may seek to augment their revenues from this source.
Many states don't have an outright inheritance tax. Instead, they have a "sponge tax," allowing them to collect a portion of what the federal government takes in. "If estate taxes are lowered or repealed, the states are not going to want to do away with their take," says NAPFA's John.
In New Hampshire, where John has her advisory practice, more than 7% of state revenues come from a sponge tax. "My fear is that instead of having one national estate tax, we'll end up with 50 experimental state laboratories where different estate-tax formulas are applied. That would be especially fun for those investors who have residences in several states," John says.
A reduction or elimination of the so-called marriage tax penalty is also likely, sources say. Senate Majority Leader Trent Lott has been a major proponent of the legislation and has said he will continue his support. The bill he shepherded through the Senate last year would have cut taxes on married couples by $248 billion over 10 years.
Financial-planning lobbyists are also positive about the changes congressional leaders made to commitee structures, especially in the House, where insurance and securities issues have been taken away from the House Commerce Committee and given to the newly created Financial Services Committee. The new committee replaces the House Banking Committee. "This is good for planners and gives us one place in the House to look to for jurisdiction over most of our issues," Thompson says.
The change is in keeping with the new financial-services industry lawmakers began to craft when they lifted the legal and regulatory fire walls separating different types of institutions with the Gramm-Leach-Bliley Act. The Federal Reserve Board and the Treasury Department are starting to craft power-sharing arrangements that delineate their authority over the mammoth financial-services holding companies that are emerging. Other tax relief in sight, lobbyists say, includes a package that would ease the burden on self-employed individuals. "Republicans believe that the future economic growth of the country relies on small businesses, so they want to encourage a whole litany of things that we think will pass," Grant Thornton's Ochsenschlager says.
Tax relief for the self-employed is slated to include:
Bigger retirement-plan contributions.
A 100% deduction for medical insurance premiums.
A bigger deduction for meals and entertainment (60% or greater).
A larger deduction for depreciable assets ($25,000 or higher).
Other issues near and dear to advisors' hearts, like a national clarification of the de minimus rule exempting planners from state registration, are also likely to be revisited in this Congress, John and Thompson predict. "We need this cleaned up so that planners have a clear understanding that if they have five or fewer clients in a state other than in the state where they have their place of business, they won't have to pay a fee or register," Thompson says. Right now, there are a handful of states, including Texas, that don't recognize a de minimus rule, he adds. The last thing planners want is to have one or more clients move to a state and find themselves out of compliance because that state has different registration rules than their own. Last year, the bill that would have instituted a national de minimus rule, the Competitive Market Supervision Act, was sidetracked when unrelated privacy amendments were attached.
One of the other issues important to planners resides at the SEC. It's the agency's proposal to exempt broker-dealer advisor representatives from having to register as investment advisors, a proposition that planning groups and their constituents see as dangerous for consumers and competitively unfair to independent planners and advisors. The problem with the proposal is that it exempts wirehouse advisors from living up to the law and spirit of fiduciary standards. Arthur Levitt Jr. has stepped down as chairman of the SEC, and Laura Unger has been named acting chairman, but that hasn't derailed the proposal, analysts say. "Right now, our understanding is they're considering requiring exempted advisors to make additional disclosures (regarding the fact that they work for a broker-dealer), but we don't think that goes far enough," says Thompson. "At this point, we're skeptical the SEC will do the right thing, which is abandon the rule."
Both the FPA and NAPFA say they will continue to press this issue in an effort to reach an accord that does not disadvantage registered advisors or investors. But frankly, both groups admit they're a lot more hopeful on the tax-cut front.