Deficit Reduction Commission Reports to President

WASHINGTON, DC - DECEMBER 01: The National C...
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“On December 1, the co-chairmen of the President’s Deficit Reduction Commission (DRC) released the commission’s plan for reducing the deficit by $4 trillion over the next five years. The plan calls for fundamental tax reform (via simplification, including potentially repealing all tax expenditures) by 2012, deep spending cuts, major changes to Social Security and Medicare, budget process reforms, and other proposals. The co-chairs say they want the 18 commissioners to vote on whether they support the co-chairmen’s plan on Friday (December 3). That date may slip.

Currently, insiders think that as many as 10 of the commissioners may support it. However, 14 of the 18 are required to transform the plan from a proposal into a recommendation. There appears to be no realistic chance that Congress will vote on this plan this month. But it is viewed as a major initiative that will get a great deal of attention in the 112th Congress that convenes in January.

Tax Reform-Individual:

The DRC co-chairs plan starts by suggesting that all tax expenditures (which are characterized as a form of spending) be repealed. Among these to-be-repealed tax expenditures would be the tax deferral for the growth of life insurance and annuity cash values, and most employer-provided benefit programs that utilize life and health insurance, and/or annuities. It would also eliminate the special rate for capital gains and dividends, and instead tax this investment income as ordinary income. The result would be significant deficit reduction and tax rates as low as eight percent, 14 percent, and 23 percent (individual), and 26 percent (corporate).

However, bowing to political reality—and recognizing the policy underlying some tax expenditures—the plan goes on to say that Congress may wish to add back some tax expenditures at the price of higher rates. The plan provides one “illustrative” proposal that adds back limited tax expenditures for:

Limited retirement savings ($20,000 or 20 percent of income, whichever is lower, in just one form of retirement savings plan, plus an expanded Saver’s Credit)—this add-back may or may not include savings inside of an annuity or life insurance policy

Cap on employer-provided health insurance—the cap would be at the 75th percentile of premium levels in 2014

Other add-backs would include the earned income tax credit and the child tax credit, the standard deduction and exemptions; a 12 percent non-refundable tax credit for mortgage interest on a principal residence only, capped at mortgages of $500,000; and a 12 percent nonrefundable tax credit for charitable gifts, available at above two percent of adjusted gross income. All other tax expenditures (e.g., cafeteria plans, long-term care insurance, disability income insurance, group term life, etc.) would be repealed.

The income tax rates under the “illustrative plan” would be 12 percent, 22 percent, and 28 percent (individual), and 28 percent (corporate).

Under both the “zero” plan and the “illustrative” plan, income from capital gains and dividends would be taxed as ordinary income. Both plans would also repeal the alternative minimum tax (AMT).

Tax Reform-Corporate:

The DRC co-chairs plan also suggests corporate tax reform. Generally, the corporate income tax system would consist of one single rate (between 23 percent and 29 percent, depending on “adjustments” included). The corporate plan would “close loopholes” and would also adopt a territorial system (based on income generated within national borders) of taxation. These suggestions could affect NAIFA members’ corporate clients, and thus their decisions about whether to use life insurance in their businesses.

Among the corporate changes suggested are:

Elimination of corporate tax expenditures (this would include COLI)

Changes in tax rules governing foreign-source income

The DRC co-chairs plan also includes an “illustrative plan” to include some policy and politics-based add-backs. No corporate tax expenditures (the plan says there are more than 75 of them) are added back in.


Of great significance is the report’s proposal that tax reform be done on a legislative “fast track.” To do this, the plan proposes including a “failsafe” that would be automatically triggered if Congress fails to enact (and/or the President fails to sign) a new tax reform law by the end of 2012. The “failsafe” would—starting in 2013— trigger across-the-board reductions in itemized deductions, above-the-line deductions, nonrefundable credits, the exclusion for employer-provided health insurance, general business credits, and the domestic production activities deduction. The deductions limitations would phase up, and raise $80 billion in fiscal year 2015 and then rise to $180 billion by 2020.

NB — Prospects for Repeal of Tax Expenditures:

While the Republican commissioners and many GOP lawmakers are adamantly opposed to raising taxes, a growing number are beginning to view tax expenditures as a form of spending—and the GOP, in general, does support substantial spending cuts. Thus, proposals to repeal tax expenditures must be taken very seriously.

Health Care/the CLASS Act:

In addition to numerous proposals to reform Medicare and Medicaid, the DRC co-chairs proposal suggests either repealing or reforming the CLASS Act (the new federal disability income/long-term care insurance program enacted in health reform). The plan notes that many experts view the CLASS Act program as “financially unsound,” and thus likely to need “large general revenue transfers.” Thus, the plan says, the program must be fundamentally reformed or repealed. The plan notes that repeal would create the need for a revenue offset—the CLASS Act is scored as a revenue raiser in health reform, due to its collection of premiums for five years before any benefits could be paid. The DRC co-chairs plan says that this CLASS Act “on paper” revenue would have to be replaced with “real options that truly save the federal government money.”

Social Security:

The plan includes several major suggested changes to Social Security, including:

A delay (over 75 years) in both the “early” and the “normal” retirement ages to 64 and 69 respectively, with a “hardship exemption” for those who cannot work beyond age 62—this proposal would also allow some flexibility in when a person can claim their Social Security benefits by allowing a person to take half at early retirement and the other half at normal (or later) retirement age

Reform of the Social Security benefit formula to make it more progressive

A gradual (an almost 40 year phase-in) increase the taxable amount of Social Security benefits to cover 90 percent of wages by 2050

Changes in the program’s COLA formula, including adoption of an “improved measure” of the consumer price index (CPI)

Enhanced minimum Social Security benefits for low-wage workers

Enhanced Social Security benefits for the very old and the long-time disabled (this would be a “20-year bump-up” to protect Social Security beneficiaries who might otherwise outlive their benefits)


The DRC co-chairs plan also proposes deep cuts in discretionary spending—taking federal spending down to below 2008 levels by 2013. Limits on spending would be separated by security versus non-security spending, and budgeting for emergency expenditures would be required.

Bottom Line:

This plan is radical and is expected to generate substantial opposition. However, it is also expected to play a significant role in the deficit reduction and tax reform initiatives that insiders expect to begin early in 2012 “