Tax reform appears to be on the horizon in the U.S.: The president, speaker of the House and Senate majority leader have all called for it, and their proposals are largely in alignment.
Many observers have focused on the details and various consequences of the tax reform proposals, but the procedure – the method by which tax reform occurs – will inevitably shape the details of any laws that are finally enacted.
Given the balance of power in both the executive and legislative branches, there are many avenues that tax reform could take, but there are also many procedural hurdles that will likely have to be overcome. This is particularly true for the avenue apparently most favored in Congress, a process known as budget reconciliation. This process allows Congress to change current laws, including revenue laws, to bring them into conformity with Congress’ annual budget policies as defined in a concurrent resolution of the House and the Senate. Budget reconciliation loosens certain procedural requirements associated with bill passage, most crucially allowing the Senate to bypass cloture requirements to overcome filibuster by a minority party.
This process is not simple, however. Budget reconciliation involves a complex set of congressional procedures and has been marked by several changes over the years “to fit changing political and budgetary circumstances.” The complexity of the process, and one of its chief limits, emerges from rules that require the process to be, by varying measures, deficit-neutral. One of those rules – the Byrd Rule – is the largest procedural hurdle to overcome in the reconciliation process. A chief purpose of this Rule is to forbid legislation that would increase the deficit for a fiscal year beyond the budget window (usually 10 years) covered by the reconciliation measure. On its face, the Byrd Rule disallows permanent tax cuts without offsetting increases in revenue or cuts in spending elsewhere in the reconciliation legislation. However, this Rule can be easily circumvented by attaching so-called “sunset provisions” that cause the tax cuts or portions of them to expire at the end of the budget window. It is because of the Byrd Rule that the 2001 and 2003 Bush tax cuts expired after 10 years.
Though limited by the Byrd Rule and other restrictions such as the PAYGO rules, Congress is not without options for permanent tax reform. To circumvent the Byrd Rule prohibition on deficit increases beyond the budget window, Republicans could put forth deficitneutral legislation, where tax cuts are accompanied by certain deficit-reducing measures. For example, the House Republicans propose eliminating all individual deductions other than mortgage interest and charitable deductions. The elimination of these deductions or other similar revenue reduction mechanisms in the tax code could offset some or all of the costs of any proposed tax cuts. If the Republicans can show that it is deficit neutral for a period beyond the budget window, then the legislation will not be subject to the points of order created under the Byrd Rule.
There are other ways in which Congress could potentially bypass the Byrd Rule and institute tax cuts that are not required to expire, including changing the baseline budgetary projections by repealing the Affordable Care Act or by mandating that the Congressional Budget Office use dynamic scoring in its official cost estimates of proposed tax reform legislation. These methods are discussed more fully in my article, “Budget Reconciliation: Procedure and Possibilities for Permanent Tax Reform.”
Whether Congress manages to overcome the Byrd Rule and institute permanent tax reform will almost certainly have a critical effect across several industries and tax practices. For example, if the repeal of the estate tax is required to sunset after 10 years, trust and estate lawyers will likely maintain their traditional practices, since their clients may die after the repeal sunsets. If Congress enacts a permanent repeal of the estate tax, however, the practice of trusts and estates may change dramatically. Similarly, a temporary decrease in personal and corporate income tax rates would likely cause practitioners to recommend accelerating gains prior to any expiration of those rate decreases.
Lawyers, accountants and other tax professionals will need to pay close attention to which provisions of the new legislation are set to expire, if at all, especially since portions of the tax legislation enacted through budget reconciliation could expire while others could be written permanently into the code – until, that is, a new legislature changes the rules all over again.