The Tax Sunsets (Mostly) Sunset

Thursday, January 3, 2013 at 3pm
By John Friedman

We can, I suspect, all agree that taxes impact behavior.

To see that this is so, one need only look to Vancouver, Washington, a Portland suburb adjacent to the Oregon/Washington border, where many Vancouverites go out of their way to do most of their shopping across the river in Portland, Oregon, where there is no sales tax, but live and work in Vancouver, Washington, where there is no income tax and where property tax rates are low.

And clearly our federal income tax system is chock full of provisions intended to impact behavior, whether it’s the mortgage interest deduction designed to help people afford home purchases, or the R&D tax credit designed to incentivize businesses to invest in research and development, or the tax break for many government-issued IOUs — muni bonds and the like — which help various public entities raise funds more cheaply than otherwise would be the case.

And how about the tax-goading our very own Internal Revenue Code exerts on many of us to do good? Ari Fleischer, George W. Bush’s former press secretary, said earlier this week that, with the new, higher income tax rates for high earners, coupled with some other twists and turns in the inner workings of the new income tax laws, he would surely give less to charity because the tax benefit just wasn’t there the way it had been.

And the list goes on and on and on and on.

So our tax system impacts behavior: we see how the system works and learn about how it can provide us with some somewhat-free free lunch, and then we act and plan accordingly.

For taxes to impact behavior in a way that really takes hold, though, the tax system must offer up some predictability. If the system changes frequently, or, worse yet, if the system has built into it changes that are designed to be short-lived, its impact on behavior will be muted or even discombobulating. After all, how can you plan within a system that is a zany bouncing ball of contradiction that’s hard to follow, let alone predict?

*  *  *

Within our political system, what was once a rare occurrence has now become standard operating procedure. Signing statements went from seldom-seen oddity to often-used rule, as George W. Bush followed his apparently deeply-embedded instinct to push the limits of virtually everything he touched (maybe that was the MBA in him). So too with filibusters, now an everyday part of Senate skirmishing rather than Mr. Smith’s noble last stand in The District.

So, too, with sunset provisions, which became de rigueur for folks trying to cram great-big tax cuts into not-so-big ten-year budgetary pigeonholes emanating from something known as the Byrd Rule.

The term sunset provision is tax-ese for a part of a new tax law that says the new tax law will last for a limited amount of time, after which the new tax law will simply vanish and any other provision which the new tax law overrode will spring immediately back into existence. The lingo also verbs, as in, the lower tax rates sunset at the end of 2012.

*  *  *

The phrase sunset provision came into consciousness for most folks, if ever, when George W. Bush was president, because Georege W. Bush’s crowning tax achievement — across the board reductions in marginal tax rates passed into law in July of 2001 (notice that this is prior to 9/11/01, and before he wielded considerable power due to the body blow the country took on that date) — veritably oozed sunset provisions out of its every pore, all so that the new tax rates could fit within the ten-year budgetary Byrd Rule pigeonhole mentioned above.

As a result, those lower rates had a shelf life that lasted through 2010, after which it was, pre-2001 tax rates here we come, and those pre-2001 tax rates were higher across the board.

Fortunately for lovers of those lower across the board tax rates, in late 2010, when Congress and Obama shindigged over the lapsing of those lower tax rates coupled with the simultaneous lapsing of various stimulus programs Obama very much wanted to see extended, the result was an agreement to extend all of George W. Bush’s tax rates — all of ’em — for two years. That came to us via the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, which flies off the tongue, quickly, as The TRUIRJCA, doesn’tit?

Wouldn’t’ch’ya know it, though, but that extension of the lower rates in turn had a shelf life that only lasted two years — through 2012. They, too, sunsetted.

That’s where things stood until, alas, earlier this week the lower rates really did vanish, if only momentarily, when the ball dropped in Times Square on New Year’s Eve.

Then yesterday the lower rates were mostly revived when Congress passed and Obama signed the American Taxpayer Relief Act. The ATRA retained all those lowered tax rates we’d been living with over the past decade except for folks with taxable income greater than $400k per year ($450k per couple), who saw a boost in the tax rate applied to income over those amounts, from 35% to 39.6%.

Call that a grand a day (weekends included): make less than a grand a day (weekends included) and none of it touches you at all. It’s the same as it ever was if that’s you.

*  *  *

T’was a bruising battle, all fought over 4.6% — over the addition of a 39.6% tax rate serving as the maximum marginal tax rate rather than the now-second-from-the-top 35% tax rate, and then only hitting folks making more than a grand a day (weekends included), and then only hitting the amount they make in excess of a grand a day (weekends included).

Importantly, the new tax rates do not sunset. They are with us until a congress passes a bill changing them and a president then signs that bill into law. For the first time in nearly twelve years, then, income tax rates are apt to not change any time soon (though perhaps we will we read this later and see that it was hopelessly wrong, especially given all the distant rumblings of massive income tax reform).

Did the lack of certainty about future income tax rates change anyone’s behavior? I’d suspect it did not; people kept on keeping on regardless of what the rates were. Millionaires and billionaires kept on trying to make money, da mo’ da betta’, and so too did working stiffs.

Income tax rates of, say, 90% might change people’s behavior — they could, for instance, change a Frenchman into a Russian — but my hunch is that going from 39.6% to 35% did not change people’s behavior towards making money (e.g., I’m going to really go out there and make a lot of money now that rates are 4.6% lower than they were!) and that going from 35% to 39.6% will not either (e.g., I’m not going to work so hard now that rates are 4.6% higher than they were!).

So in income-tax-land, minorly bouncing balls are perhaps not such a terrible thing.

But how about elsewhere?

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The worst example of sunsetting getting in the way of people making plans is the estate tax, which, of all taxes over the past decade, has been the bounciest ball of all.

The estate tax is foreign and complicated to most folks. It is also among the most politicized, with Republicans, always the better of the two major parties at linguistic frames, using the Lutzian how-could-you-like-it-when-it-has-a-name-like-that? thoroughly creepy name of The Death Tax (derivative, I’ve always though, of The Death Star from Star Wars).

To simplify the estate tax, for our purposes here all you really need to know is that, in the estate tax system, there is always a Magic Number, below which no tax is due and above which a hefty tax (north of 30% typically, and sometimes an even-steven half-for-me/half-for-you 50% or more) is due.

Way back when, in the 80’s, the estate tax Magic Number was $250k, so the estate of a person dying with a dollar more than $250k of net assets would pay estate tax on that dollar, equal to, say, thirty cents or maybe even 50 cents, while the $250k that came in below the Magic Number would pass tax-free to the heirs (there’s that marginal tax bracket thing again).

When George W. Bush arrived on the scene, the estate tax Magic Number was $675,000. Even before 9/11/01, though, and even before he started wielding the increased power he derived from that calamity, George W. Bush quickly moved to increase the estate tax Magic Number, getting a law passed in July of 2001 to increase it by leaps and bounds every two or three years and to ultimately reach, in 2009, $3.5 million per person, after which the Magic Number was slated to go up up to infinity — i.e., during 2010 there was, in most senses, no estate tax (but there was something else which took its place, kinda, for which the estate of the late George Steinbrenner, who did in fact die in 2010, serves as Exhibit A).

Then, in late 2010 Congress and Obama reached a series of compromises, set out in the above-mentioned TRUIRJCA (I’m known for using gnarly abbreviations, and even I wouldn’t have let that one out of its cave), which, among other things, increased, to many people’s utter surprise, the estate tax Magic Number all the way up to $5 million for 2011 and 2012, but also called for that new and very scrumptious-for-rich-folk Magic Number to sunset after two years, bringing the number for 2013 all the way back down to $1 million.

And revert it indeed did, as George W. Bush signature low tax rates, including both income tax rates and estate tax rates, sunsetted for a single day — New Year’s Day 2013 — only to be retroactively reinstated the following day to cover, with respect to income tax, all but the over-400-in-income crowd and, with respect to the estate tax, to cover everyone, as the the $5 million estate tax Magic Number returned lock stock ‘n barrel and applicable to all people dying from now on . . . which means applicable to all of us.

So now the Magic Number for the estate tax is back to $5 million — period and sans a sunset provision — which means that, until a congress and a president act together again to pass a bill into law, $5 million, with inflation adjustments, the estate tax Magic Number it shall be.

That’s some wicked bouncing ball, eh?

And the laws were written that way.

Right from the start.

*  *  *

By definition, estate planning is the most long-term planning most people do; an estate plan survives your own death, your own departure from this mortal plane, your own date with destiny, your own getting run over by a bus (this latter phrase being, believe it or not, language very often used in estate planning discussions), at which time the plan specifies who gets what of your stuff and how they will get it.

Having the estate tax system as unpredictable as it’s been over the past decade — with the Magic Number bouncing around all over the place and even going to infinity in 2010 — was, plain and simple, a travesty. It was good for estate planning professionals because it assured that they would have plenty of work responding to all the uncertainty, and because it’s professionally rewarding to have to figure out clever ways to write an estate plan that could expand and contract and contort and shape-shift into an an appropriate estate plan, regardless of whatever sort of weird, illogical law Congress might have just passed. At the same time, though, my sense is that a good many estate planning professionals found it annoying, or worse, to be working within a tax system that was so obviously jerry-rigged and makeshift, so very much a political football, and just plain ol’ stupid and nonsensical.

And since the gift tax system mostly parallels the estate tax system (though for awhile under George W. Bush the gift tax and the estate tax were not at all parallel . . . ), estate planning professionals also suffered through a lot of deadline-driven crunches, as their clients fretted about whether they would ever again have the ability to give $5 million away to their loves ones without incurring any sort of tax on the gift, amid talk of the Magic Number for both gift and estate taxes going away on a moment’s notice, and hurried to do so before it was too late (which we now know it never was). And doing, say, a bunch of $20 million gifting transactions (assuming a bunch of married couples each giving the max to, say, their two children) subject to very unforgiving calendar-based deadlines, all crammed into the final weeks of the year, can be a very stressful way to make a living. Spouses grow angy. Children crave attention. And estate planning professionals carry on.

*  *  *

I leave it to you to decide whether these new tax rates and these new Magic Numbers are good ideas or bad ideas or some of both. That is a Rorschach Test for you to understand via your own perceptual apparatus.

More firmly, though, and with no attempted even-handedness, I say, Thank you, Congress, for at long last bringing a bit more predictability back into the tax system. The unpredictability we’ve all been living and working within has been an absolute travesty; it’s an unqualified good thing to have greater predictability.

So can we please make a law that outlaws sunset provisions — an anti-sunset law?

Or, at the very least, can we take a break from these sunsets? Yes: can we please have an anti-sunset law that lasts, say, a couple’a years?

 

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