The signing of the Budget Control Act of 2011 into law on August 2, 2011, simultaneously raised the federal debt ceiling by $900 billion while enacting $917 billion in federal discretionary spending cuts over the next ten years. Additionally, the new law created a bipartisan Congressional committee (“Joint Select Committee on Deficit Reduction” or “Select Committee”) charged with reducing the federal budget deficit by an additional $1.2 trillion over the next ten years, beginning in 2013. Some key points on the Select Committee and its process:

  • Committee is composed of 12 members, including an equal number from each party and each chamber of Congress
  • A plan for deficit reduction may include spending cuts, increased tax revenues, or a combination of both
  • At least 7 of the 12 committee members must agree for a proposal to be sent to Congress for consideration
  • A deficit reduction proposal agreed to by the committee and forwarded to Congress will be fast-tracked and receive a straight “up or down” vote
  • Legislation includes a strong incentive for the Select Committee to reach an agreement on deficit reduction – if no agreement is reached, or if a bill proposed by the committee does not gain approval from Congress and ultimately the White House, automatic cuts in federal spending will trigger
  • This further deficit reduction is tied to a subsequent increase in the debt ceiling of between $1.2T to $1.5T in 2012

How does the automatic spending cut trigger work?
If the Select Committee does not identify a plan to reduce at least $1.2T from the federal budget deficit, a process referred to as sequestration begins. This calls for automatic spending cuts split evenly between defense and non-defense spending programs to begin in 2013. Programs exempt from cuts include Social Security, Medicaid, veterans’ programs, and certain programs directed toward low-income households. Additionally, any cuts to Medicare will be limited to two percent and will not negatively impact any participant benefits, only affect payments to providers such as hospitals and doctors. The premise behind this automatic trigger is that committee members from both parties would prefer to avoid these across-the-board spending cuts and will be incented to reach an agreement.

What is the likelihood of major tax changes occurring out of the Select Committee process?
The Budget Control Act calls for deficit reduction through the committee process but does not mandate how it should be achieved. Certainly, elements for a potential stalemate are present, with Republicans likely opposing tax increases and Democrats contesting cuts to entitlement programs. Another important factor is how the committee’s progress toward deficit reduction is measured. This could impact whether the committee even considers the fate of the Bush tax cuts due to expire in 2013. For example, if the measurement toward the goal of reducing the deficit is based on current law, extending the Bush tax cuts for ANY taxpayers would actually lead to an INCREASE in the deficit and would negatively impact the committee’s efforts toward their deficit reduction goal of $1.2T. This line of thinking would suggest that any move toward major tax reform would occur outside of the committee process. However, there may be other, specific tax-related proposals that may be considered as part of the committee’s process including:

  • Scaling back certain tax preferences for retirement plan contributions, mortgage interest, and charitable contributions
  • Accelerating income phase-outs of certain itemized deductions
  • Changes in the way hedge funds are taxed (i.e., taxing carried interest as ordinary income instead of long-term capital gains)
  • Certain tax deductions for corporate jets
  • Oil and gas tax breaks

While it is difficult to accurately predict the outcome of budget and tax-related discussions in Washington, clients can consider short and longer-term planning strategies to help mitigate the impact of taxes on their personal wealth. Our white paper titled, “Capitalizing on tax clarity” highlights a number of these strategies.