The Next Budget Fights

Since last Friday night's budget deal, much of the reporting on the budget assumes that even bigger fights lie in the future.

Maybe and maybe not.

The agreement reached on Friday pretty much establishes a bottom line for the next few fiscal years, with a possible adjustment to increase the amount so that the current level of spending is annualized. That should not be controversial.

It is likely that the Tea Party will want its riders considered again, however this will likley occur in the regular order of business, with the House passing them, the Senatte stripping them and the House accepting the Senate's amendments or sending it to Conference Committee. Hardly a Battle Royale.

The debt limit legislation may be a stiking point - however two ways out are likely.

The first is the appointment of a renewed Fiscal Commission with the Senate Gang of Six, with six House members to balance and Vice Presidential leadership - this time with adequate staffing. The task would be to consider the Fiscal Commission plan, the Ryan Roadmap, the soon to be released Obama plan and possibly the Bipartisan Policy Center plan and to come up with legislative language to be voted up or down by each house.

The second is to simply deny that debt limitation legislation is unconstitutional under the 14th Amendment, which says that all debts must be paid. The language is fairly plain and, if relied upon, could be the basis for an executive order directing the Bureau of the Public Debt to disregard further limits.

I don't see either house having a majority with the stomach to default on the debt and before it happens, I suspect the second option will get serious discussion.

Much has been made about the urgency of entitlement reform. That is all talk and no reality. Entitlement reform is never urgent as long as the credit markets don't make it urgent and so far they have not. No one is in danger of not getting paid just yet. Indeed, the time for Medicare and Medicaid reform has not come. There are still too many questions about how consumers will respond to the health care reform and how the markets will respond to these questions.

Right now, opponents of reform are hanging onto the hope that mandates will be ruled unconstitutional or that the House Republicans will succeed in repealing the ACA. So far, the market, in a fit of wishful thinking, is still open to these possibilities - if only because if the economy tanks again a Republican may be elected who will repeal the Act, however bad the GOP field looks now.

Once these possibilities are gone, the world will take a look at how pre-existing condition reforms will shake out. Unless current mandate levels are perceived as adquate to keep people insured (it is doubtful that the current climate would allow them to be strengthened), the financial markets could push the health insurance market into bankruptcy or send them to the Treasury in hopes of a bailout. Either scenario means defacto and probably dejure single-payer. I suspect that before that happens, however, AHIP will suddenly begin supporting a public option for anyone who can't get insurance, subsidized by a broad based tax increase on the condition that mandates and pre-existing condition reforms be repealed.

The broad based tax increase will likely take the form of a payroll tax, a Value Added Tax or a business receipts tax (which would preserve exclusions for providing coverage for employees and possibly even retirees). The same kind of tax would undoubtedly include a fix for Medicare and Medicaid funding as well. Enacting such fixes before this question is settled is pretty far fetched, considering most health care analysts know that this storm is coming. Any such tax fix will likely be part of comprehensive tax reform, including reform of the Corporate and Individual Income Taxes.

Much is being made of the coming fight over tax policy. There need not be such a fight.

No one has seemed to notice that, even though 23 of the Senate seats up for election are currently held by Democrats, the prospect of Tea Party nominees makes taking the 13 seats required a slim prosect. Indeed, of the Republican Senate seats up for grabs, half could result in a Tea Party nominee, including Arizona. If Gabby Giffords can hold a press conference and speak a coherent sentence, the GOP will lose John Kyl's open seat to the Democrats. Meanwhile in Maine, Senator Snowe is almost assuredly to be challenged and the smart money should be on her switch in parties, possibly taking Senators Collins and Murkowski with her into the Democratic caucus.

If the GOP can't pick up the White House or 13 Senate seats (net), they have no leverage on tax policy, provided President Obama plays it smart.

In 2010, the ongoing depression tied his hands on playing hard ball on taxes. The GOP successfully leveraged the economy to hold him to his promise to not let tax cuts expire for any family making under $250,000 per year. A strong economy, which he needs for reelection anyway, means he can safely disregard this promise. When this promise was made, the economy had not crashed and we were not facing the prospects of trillion dollar deficits. The voters will understand, as for the middle class, a $20 per week tax increase in a growing economy is hardly crippling to any family budget, compared to the revenue it can bring in on the higher ends.

If Obama were to withdraw his promise to preserve the (upper) "middle class tax cuts" no other entitlement reform is essential. The Republicans would have to drop their promise to make the 2001/2003/2010 tax cuts permanent at all costs with no negotiation. Indeed, if the economy is down, President Obama should still play hardball. Liberals will vote for him anyway and in a down economy, he will already lose most independents. Either way, the perception that he is fine with the status quo will force the Republicans to compromise. Not doing so almost assures that they have the upper hand - even though, given their electoral prosepects, they don't deserve it.

Consumption Taxes and Housing

The treatment of consumption taxes on new homes is well known, whether the tax is a contemplated Value Added Tax (VAT) or the Fair Tax. In either case, taxes will be either included in the price and disclosed at settlement or separately charged over and above the price – although the price would be lower for not including taxes during the production stages. Business receipts taxes and residual payroll taxes will not be disclosed, but will still be paid, just as they are now. Indeed, payroll taxes for social insurance and the income taxes of everyone involved in building, selling and financing the house are implicit in both the price of the house and the interest rate charged to finance it. None of this will change the price of the house, although adding consumption taxes to replace some or all of income and payroll taxes will make these taxes more visible.

What is not often spoken of is the extent to which the Fair Tax or the VAT will be collected on the sale of used property. While these taxes won’t be paid explicitly by the buyer, no one should be surprised to see them on the seller’s side of the HUD-1 form.

The first place they will show up (whether VAT or Fair Tax) is in the realtor commissions. Currently, any taxes accruing to these transactions are hidden in the income tax paid by the agents and their staffs. If a VAT is enacted, any high income surtax retained will remain hidden, but some percentage of what was once hidden will show up as VAT. In a Fair Tax, the entire tax will be explicit, but the commission rate will likely be lower.

When a home is sold, there are often renovation costs that are due at settlement. Again, VAT or Fair Taxes will be due on these services, although again they will be paid by the seller in the same way real estate commissions are.

Home Owner Association or Condo Association Fees will also be subject to VAT or the Fair Tax. While in the latter case the fee will be lower because income taxes will no longer be paid for association staff or for utility company employees or contractors, all of these services will be subject to the Fair Tax. Utilities will have to offer two rates – one to associations, which are tax free and one to individual home owners, for whom the tax will have to be collected. When a used home is sold, usually condo fees are due for the remainder of the month by the buyer and often there are past due fees to be paid at settlement by the seller. For each of these, VAT or Fair Tax must be listed.

However interest is taxed under Fair Taxes or a VAT, points will be taxed in the same way. Indeed, if taxation is made explicit rather than implicit for finance charges and other bank services, such taxes will appear on whatever disclosure in necessary in signing the mortgage note(s) and any VAT or Fair Tax paid by the buyer will be added to the amount borrowed, so it will be taxed at least twice.

One last area where tax is due is for capital appreciation. The capital gains exclusion for home sales would no longer apply without the income tax and the tax losses for non-excluded gains no longer taxed must be either included in the Fair Tax rate overall or gains must be subject to tax upon sale. While this won’t be paid by the buyer explicitly, the need to pay such a tax will undoubtedly be considered in establishing the purchase price – especially if the seller is using the proceeds to “move up” to a bigger house. Even though the seller pays the tax explicitly, that tax increases the price of the home – so the buyer pays it implicitly – and if the buyer is financing the purchase with a mortgage interest will be paid on the initial implicit tax payment and tax will be paid on that interest as well.

Is this an increase in taxation? As I stated at the outset, banks, realtors, renovators and HOAs all have staff which pay income taxes. Cities do too, so even the property taxes paid by to escrow accounts includes some kind of implicit tax. Enacting a VAT or Fair Tax will simply make what was hidden explicit. In the end, if the same level of government services are demanded, the amount of tax actually paid will not change much at all.