The Democratic wins in both Georgia Senate runoff elections create an opportunity for the Biden administration to pass at least part of his domestic policy agenda once political tensions ease. With narrow Democratic majorities in the Senate and House, President-elect Biden will have to satisfy a small group of Democratic moderates and reach out to moderate Republican senators to pass legislation. This dealmaking and consensus building necessarily limits the Biden administration’s ambitious campaign proposals.
A Biden administration will likely pursue proposed increases to top income tax rates for both individuals and corporations, along with other broad changes to the tax code, through the annual budget reconciliation process. Tax reconciliation requires only 51 votes to pass the federal government’s budget, avoiding a potential Senate filibuster. Reconciliation was previously used to pass President Trump’s tax cut and tax reform bill in 2017, a substantial portion of President Obama’s health reform, and President George W. Bush’s tax cuts in 2001-2003. The Senate rules require that such legislation only include matters which affect government spending or revenue and do not increase the deficit beyond the 10-year budget period. This is a slow process, driven by congressional committees, and a final agreement between the executive and legislative branches likely would only come after months of negotiations.
Estate Tax and Capital Gains Proposals
Proposed changes to inheritance taxes and capital gains taxes show the limitations on likely legislation during the Biden administration. During the 2017 tax reforms, the Trump administration doubled the federal estate tax exemption to a current $11.7 million. This exemption allows a married couple to gift or bequeath $23.4 million without any federal estate or generation-skipping taxes. Due to budget reconciliation rules in 2017, the increased exemption will be phased out in 2025. Biden’s campaign proposed an immediate reduction in the federal estate tax exemption to $3.5 million. In the 2010 tax negotiations, however, then-Vice President Biden personally negotiated an inflation-adjusted $5 million estate tax exemption with Senator Mitch McConnell. We anticipate that President Biden will again negotiate an inflation-adjusted $5.8 million federal estate tax exemption.
History has shown bipartisan resistance to retroactive tax increases, and the Biden administration needs only to accelerate the reduction in the federal estate tax exemption to claim success on its promise to undo the Trump tax cuts for “wealthy” Americans. Usual compromises are to make the tax increase effective either as of the date the legislation was introduced or as of the date of the compromise. As a result, business owners and wealthy individuals likely have a limited period during 2021 to engage in estate planning designed to lock in their estate tax exemption.
While the Biden campaign proposed increasing the capital gains tax rate from 20% (23.8% including the 3.8% net investment income tax) to 39.6% for taxpayers with more than $1 million in income, the financial markets would have a strong and immediate negative reaction to eliminating the tax preference for capital appreciation. Similarly, the Biden campaign proposed taxing the unrealized capital gains on appreciated assets by eliminating the basis “step-up” at death. Such dramatic changes in long-standing tax policy are opposed by Republicans and moderate Democrats, and unlikely to pass.
Other Tax Proposals
The fate of other proposed changes in corporate and individual tax policies are difficult to project given the likely negotiations necessary for any legislation. The Biden administration will likely pursue the following corporate tax changes:
- Raise the statutory rate from 21% to 28%.
- Add a 15% minimum tax for corporations with over $100 million in profits, even if deductions would require them to pay less.
- Double the 10.5% tax on foreign income from licensing and fees on intellectual properties and eliminate the exemption for certain returns based on qualified business asset investment (QBAI), on a country-by-country basis.
For individuals, the Biden campaign has proposed the following changes affecting individuals:
- Increase maximum individual ordinary income tax rate from 37% to 39.6% on income over $400,000.
- Cap itemized deductions at 28% of income on those earning more than $400,000.
- Increase maximum earnings subject to 12.4% Social Security payroll tax.
- Phase out the Code Section 199A deduction on certain pass-through income for taxpayers with income of more than $400,000.
- Lift $10,000 cap in itemized deduction for state and local income taxes paid.
- Expand Earned Income Tax Credit (EITC) and Child and Dependent Care Tax Credit (CTC)
- Retirement Plan, IRA, and other retirement savings initiatives.
The Biden administration is most likely to achieve some success on targeted tax cuts and means-tested ETIC and CTC programs for low- and middle-income households. The committee-driven budget process may result in legislation changing retirement plans, IRA, and other retirement savings initiatives, which tend to receive bipartisan support.
Tax policy changes are difficult to evaluate during normal legislative sessions, and the Biden administration may be forced to confront tax policy in pursuing its priority COVID-19 package. While it is currently uncertain what tax proposals may receive support or be included in specific upcoming legislation, spending and budget issues play a central role in the infrastructure, health care, climate change, and other environmental initiatives likely to be pursued by the incoming Biden administration.