Experts Weigh In on Next Four Years

Mon November 15, 2004 - Northeast Edition
Pete Sigmund

How will the reelection of President George W. Bush affect the construction industry? Here are the opinions of industry economists and other observers on such pressing issues as taxes, highway spending, social security and trade.

Simplifying the Tax System

The administration is taking a long, hard look at ending the present progressive tax system, eliminating taxes on savings and investments to encourage ownership and finance business expansion, technological innovation and better productivity. Bush is making a simplified tax code a centerpiece of the program for his second term.

Exactly what plan the President will propose, and how he will do it, is unknown at this time. One approach could be a so-called flat income tax. Another is a national sales tax. Both would focus on consumption to encourage more savings and investment. A group including Vice President Dick Cheney is said to favor the consumption-based approach.

“It’s still at the very early stage as far as figuring out which plan he will back and whether Congress will go along,” said Ken Simonson, chief economist of the Associated General Contractors of America (AGC) in Washington, D.C. “There are a lot of objections to any of the ways by which the tax system might be overhauled.”

A sales tax on consumption raises the question of whether the sale is for final use or for business purposes. This is an important issue for construction. Should a sales tax be placed on home purchases? Such a tax would make a huge difference in the cost of home construction.

By abolishing the income tax, a sales tax could possibly remove the deductibility of home mortgage interest and property taxes. Homebuilders and realtors would be expected to strongly oppose this. (President Bush, however, has said he wishes to retain the deductions for mortgage interest and charitable giving.)

“Presumably you would tax any sale, unless you come up with some exemptions,” Simonson commented. “The more things you exempt, the higher the rate has to be. It’s one of those tough tradeoffs in any overhaul of the tax system.”

The second consumption-based approach — a flat tax on income — would abolish the progressive tax system in which higher levels of income are taxed at higher rates.

Taxpayers, including contractors and dealers, would all be taxed at the same rate — 20 percent to 25 percent under most plans. This would raise taxes for someone now paying 10 percent and lower them for someone paying 35 percent.

Besides being a flat rate, the tax would allow taxpayers to deduct income that goes to savings or investment.

Supporters of the sales tax and flat tax say they would be made more equitable by exempting many low and middle income people, and would stimulate capital investment, business expansion and productivity by eliminating taxes on savings and investment.

The sales tax and flat tax proposals are controversial. Democrats favor the progressive tax system. A group within the administration including Treasury Secretary John Snow is said to also favor a progressive system, which would reduce rates but also cut special-interest tax breaks and eliminate most deductions (except for home mortgage interest and charitable giving).

In 2003, the Administration proposed abolishing the tax on dividends. Congress cut tax rates on dividends and capital gains instead. Eliminating the tax could be part of the new tax overhaul.

The Administration also proposed expanding the program of tax-free savings accounts so that individuals could shelter up to $15,000 a year. This proposal may be reintroduced.

Further Tax Cuts?

Industry sources interviewed by Construction Equipment Guide (CEG) believe Bush’s reelection makes further tax cuts more likely.

“Further tax cuts are possible,” said Simonson. “The biggest thing that has to be done right away is to provide relief from the Alternative Minimum Tax (AMT). That’s something that affects many middle class taxpayers. Congress has been dealing with this on a one-year-at-a-time basis. It’s very expensive to provide permanent relief. Without this relief, a lot of small businesses, including many contractors, will pay more through what is sort of a hidden income tax, a second income tax calculation. The president has been conspicuously silent during the election in dealing with the AMT. It’s just not a big vote-grabber to say you want to clear up this tax that many people aren’t aware of. There has been much more attention on cutting more explicit rates.”

(The AMT is an alternative set of rules under which some people must pay an extra tax on top of their regular income tax. In theory, these rules determine minimum tax that people at different income levels must pay. A taxpayer would add back certain deductions and income exclusions, subtract an exemption amount, and pay a flat 26 percent or 28 percent on the balance. The final tax is the higher of the taxpayers’ normal computation or the AMT.)

The individual AMT was introduced in 1978 to close loopholes through which wealthy citizens escaped taxes through deductions and shelters. Its tax brackets and exemptions, however, aren’t adjusted for inflation, so that it applies to more and more people in an improving economy, often increasing their taxes. The IRS says it now hits approximately 2.6-million taxpayers. Some estimates say that as many as nine million taxpayers could fall under the AMT by 2007 unless the formula is modified.

Making Tax Cuts Permanent

President Bush also backs making the tax cuts permanent that were enacted in 2001, 2002 and 2003. The Congressional Budget Office said this would increase the projected federal debt by approximately one third ($2.2 trillion) by 2014.

The present tax rate on corporate profits is 35 percent. The top rate on individual incomes, including S corporations, partnerships and sole proprietorships, also is 35 percent (cut from 39 percent) in 2004 and 2005.

In 2003, the Administration proposed abolishing the tax on dividends. Congress cut tax rates on dividends and capital gains instead. Eliminating the tax could be part of the new tax overhaul.

The White House also is expected to make permanent repeal of the Estate Tax part of its second term agenda. Under the Administration’s 2001 tax relief law, the amount an individual can pass on, free of estate tax, gradually increases from $1.5 million in 2004 to $3.5 million in 2009, with no estate tax in 2010. Rates also gradually decrease from 48 percent in 2004 to 45 percent in 2007, 2008, and 2009.

But nothing is certain in today’s world. One can’t be sure, absent further legislation, what will happen after the tax phases out in 2010?

“There’s still a lot of uncertainty over what will happen after 2010,” said Christian A. Klein, Washington, D.C., counsel for the Associated Equipment Distributors (AED) headquartered in Oakbrook, IL. “If you are a responsible business owner concerned about protecting your company from the impact of the Death Tax when you die, you are probably continuing to fund your estate plan, taking all contingencies into account.

“Eighty-eight percent of respondents to an AED survey of dealers in 2003 said they were continuing to devote resources to Death Tax plans, if they had such plans, even though the tax will phase out. One of our major arguments on Capitol Hill for getting rid of the Death Tax is the fact that family businesses around the country are devoting these resources to estate tax planning which they could otherwise spend on hiring new employees, investing in new equipment and generally growing their businesses. If the Administration makes repeal permanent, it will be an economic stimulus freeing up a tremendous amount of resources. On the other hand, if it does nothing now, the estate tax will come back with fury in 2011.”

Changing Social Security

The Bush Administration has proposed changing the social security program to allow workers to divert part of their payroll taxes into individual investment accounts rather than putting funds into the Social Security Trust Fund.

Under the present system, contractors and other employers pay 7.6 percent of an employee’s wages into the trust fund. The employee also pays 7.6 percent. Under the Bush proposal, at least some of the employer and employee contributions would now go into the employee’s private account, and the funds could be invested in the financial markets, with the potential for higher returns as well as greater risk.

“As I understand it, the employer contributions could go into something like a 401K plan but the contribution itself would be at the same rate,” said Simonson.

On the flip side of the coin, the voluntary system would reduce the input into the fund which helps pay benefits for current retirees.

Spending Hits Limits

“I have been saying that the election would not make that big a difference in terms of the total amount of spending,” said Simonson. “This was simply because whoever was elected was going to be very constrained by the large current deficits and the prospects that, once the new Medicare benefit kicks in, the deficit might get even bigger.

“The large amounts being spent on such mandatory entitlements, plus defense and domestic security, will create tremendous pressure to hold down all types of discretionary spending such as highways, clean water, and wastewater treatment.”

(Discretionary means spending that is not mandatory and which must be voted upon affirmatively each year in order to be spent. Entitlements like social security, Medicare, and interest on the national debt are examples of non-discretionary spending, which does not need a vote except to change a law.)

Highway Bill Still Pending

Congress is re-adjourning the week of Nov. 14. It is expected to try to pass a new six-year highway and mass transit bill in this “lame duck” session.

It is still questionable whether President Bush will support authorizing more than the Administration’s proposed $256-billion ($214 billion for highways and $44 billion for transit).

“I don’t know the answer to that question,” said Matt Jeanneret, a spokesperson of the American Road & Transportation Builders Association (ARTBA) in Washington, D.C.

“Before Congress recessed, the number people were throwing around was a guaranteed level of $284 to $299 billion in contract authority. Bill Thomas (R, CA), chairman of the House Ways and Means Committee, said that was something the Administration would support, though the Administration, to my knowledge, never confirmed this figure publicly. Whether the report is true or not is not known.

“The bottom line facing Bush remains the same. The election didn’t change what the documented needs are. We are laying out that they total about $335 billion.

“The donor-donee issue also hasn’t changed. It has emerged as the central issue why this [highway funding] bill hasn’t passed. There is not enough money to solve all the political issues out there. You need a pot of money big enough to satisfy the [states’] minimum guarantee. The central issue is whether they can come up with a number and a formula that will satisfy all the states. Everyone wants 95 percent, but you can’t get that with the current funding. Are people willing to settle for less and would that win enough support? States like Pennsylvania and Florida would fare very badly in the scenarios they’re discussing.

“Our position also hasn’t changed. We still believe that the $318-billion level in the Senate bill is the minimum that we should be investing. That level had the overwhelming support of 76 senators. Whatever happens, whether now or next year, it is going to be a challenge.”

State Referendums

Voters approved 36 of 45 ballot measures to initiate, extend or increase taxes to fund transportation improvements. These included 12 bond measures, 10 measures to levy a new dedicated tax (usually a sales tax), five to increase existing transportation-related tax, and nine to increase existing transportation funding. These measures would generate at least $28 billion in new revenue for work on transportation infrastructure.

Miami-Dade County in Florida approved eight ballot questions for bonds providing $2.93 billion for bridges and public infrastructure projects.

“We think the results of these ballot initiatives speak volumes about where the public stands on these issues; they are clearly ahead of the politicians on this,” said ARTBA’s Jeanneret.

No Increases in Gas Tax

President Bush opposes increasing the federal tax on motor fuels.

“The difference between Bush and Kerry is that Bush has been absolutely adamant against any increase in taxes for the Highway Trust Fund [HTF],” Simonson said. “If the door was open before election day, it has been slammed shut.”

ARTBA’s proposal for a five-cent increase in gas taxes to fund an expanded highway program “is not currently in play,” said ARTBA’s Jeanneret.

Bush signed a new tax bill on Oct. 22, which included fully taxing ethanol at the same rate as gasoline. This raises the federal tax on ethanol motor fuel from 13 cents per gallon to 18.4 cents. Together with a program to crack down on evasions of motor fuel user fees, it will add $24 billion to HTF revenues over six years to help finance highway and bridge improvements.

ARTBA President and CEO Pete Ruane said the ethanol tax reform “is an important step toward addressing the transportation investment gap that is documented by the U.S. Department of Transportation [at $375 billion].”

International Trade

The United States is running record trade deficits (an annual rate of approximately $500 billion) at present. Bush faces the challenge of reducing this deficit, or at least successfully coping with it.

Meanwhile, the dollar has fallen to a record low against the Euro and a 13-year low against the Canadian dollar, putting upward pressure on interest rates. Economists said this situation may be one of the major challenges facing the Bush administration.

The Bush Administration will continue to back open trade with the world, encouraging foreign companies to locate some of their plants here (and pay U.S. workers).

The Association of Equipment Manufacturers (AEM) in Milwaukee, WI, pointed out that the Administration signed two free trade agreements in 2004 — the Dominican Republic-Central American Free Trade Agreement and the Bahrain Free Trade Agreement — which have not yet passed Congress, and is currently negotiating agreements with Thailand and the countries of Southern Africa.

“Expect to see a continued push for bilateral trade agreements,” said AEM’s Advisor Washington, D.C., newsletter, “as well as a continued commitment to the Doha Round of negotiations at the World Trade Organization.”

The Advisor added that “It is also widely expected that the Administration will ask Congress to renew trade promotion authority.”

In his campaign, Sen. Kerry took a somewhat different tack. He advocated reviewing and enforcing trade agreements, including those that call for other nations to remove tariffs, and cutting taxes for U.S. businesses which create jobs at home instead of “shipping them overseas.”

Product Liability Reform

AED and other industry organizations have long advocated enacting a law to protect innocent sellers and renters of equipment from product liability lawsuits.

“I think we will see a renewed focus on tort reform during the second term,” said AED’s Klein. “I think it will be near the top of the agenda because of the costs of liability insurance.”

Depreciation Bonus to Expire

The “depreciation bonus” allowing a tax deduction of 50 percent of the cost of new equipment is due to expire as scheduled at the end of 2004.

“I don’t think the reelection of President Bush will have any impact on the bonus,” said Klein. “The Bush Administration very clearly recognizes the benefits of pro-growth tax policy but the depreciation bonus was intended to be a short-term economic stimulus. Given the fact that the economy seems to be on the mend, I don’t think the bonus will be continued. AED had been pushing to have the acquisition and placed-in-service dates pushed one quarter into next year so that people could still qualify if they bought this year and took delivery next year. Congress decided it was too expensive to do that.”

Majorities in Both Houses

Observers said President Bush has a good chance of getting legislation through Congress because of stronger majorities in both the House of Representatives and the Senate.

The House now includes 231 Republicans, 200 Democrats and one Independent, with three races not yet decided. This is a net gain of four seats.

The Senate includes 55 Republicans, 44 Democrats and one Independent. It needs 60 votes to overcome a filibuster. The key will be Democrats who have frequently voted for Republican-sponsored bills, like Sen. Max Baucus, of Montana.

Challenging years lie ahead for both parties, with perhaps momentous effects on the U.S. people