Episode 123: Midterms & your Wallet with Brian Riedl

Announcer:
This is The WealthAbility® Show with Tom Wheelwright. Way more money, way less taxes.

Tom Wheelwright:

Welcome to the WealthAbility Show, where we're always discovering how to make way more money and pay way less tax. Hi. I'm Tom Wheelwright, your host, founder and CEO of Wealth Ability. So the midterm elections are coming up. If the Democrats win both the House and the Senate or even the Senate without the House, what impact is that going to have on your taxes? What impact is that going to have on your business? What impact is that going to have on your investments? That is to me an enormous question because as we get closer, it seems like the Democrats get closer and closer to retaking the House on the Senate. So with that, we have one of my favorite guests, Brian Riedl. Brian Riedl is from the Manhattan Institute. And Brian, if you would just remind us a little bit of your background and what you do now.

Brian Riedl:

Sure. I'm a research fellow at the Manhattan Institute specializing in budget, tax, and economic policy. Before that, I spent six years as the Chief economist to senator Rob Portman from Ohio. I was also the staff director of the Senate Finance Subcommittee on fiscal responsibility and economic growth, some campaign experience. I was the director of budget policy and tax policy for the Rubio campaign in 2016, and an advisor on budget policy for the Romney campaign in 2012. And I also worked at the Heritage Foundation for a decade.

Tom Wheelwright:

Wow. Quite the resume. So I've been waiting with bated breath for this interview just because I think that these midterm elections a year ago, nobody would've thought the Democrats had a chance. A year ago the Republicans were going to retake the House, they were going to retake this Senate. No problem. You had Afghanistan disaster and now you've got inflation. From a policy standpoint, there's no way that the Democrats should retake those two houses. However, that's now we are in a different place because we have Trump, we have all of the candidates that were Trump candidates that may have a difficult time in general elections. And then we have the question, will the Republicans come out and vote?

So with all of that going on, what I'd like to explore with you today, Brian, is let's go to this land where the Democrats do win, and let's start with where they win, both the Senate and the House. To begin with, can you explain what freedoms does that give the Democrats in their tax policy and their budget policy?

Brian Riedl:

Well, as we know, the Democrats have had a big problem for the last two years in that they seem to have 48 votes for a lot of what they want to do, at least 48 public votes. Senator Manchin and senator Sinema had difficulties getting them to 50. So if the Democrats win, say two more seats, they get up to 52 seats, Manchin and Sinema become expendable and the center of power shifts a bit left in the Democratic majority.

Now, one could say that the Democrats still may have some challenges passing their tax agenda because there may have been other silent democratic senators who were skeptical of their tax agenda, but were letting Manchin and Sinema take all the fire. But let's set aside that possibility and look at a world where Democrats are united outside of Manchin and Sinema in that world. I think we come back to where President Biden was about a year ago on Build Back Better. When the Democrats were talking about raising taxes by trillions and trillions of dollars, President Biden was looking at a Build Back Better plan that would be 3 trillion to 5 trillion over the decade. And at least he had pledged would be fully financed by new taxes.

In that world, you're likely going to have a higher income tax rate, 37% would certainly go up. Capital gains taxes would likely go up closer to 30%. You're going to have probably fewer tax deductions. On the corporate side, you're going to see probably the corporate tax rate had way back up towards, again, going back to the highest and the OECD, fewer deductions, you're going to probably punish multinational companies. And if the problem that Democrats face on taxes, quite frankly is there's actually not enough money for them to raise to pay for their agenda. A lot of the policies Democrats talk about on taxes doesn't actually raise as much money as Democrats hope it would raise, which means they're going to have to dig deeper, which means the pledge of President Biden of we're not going over under $400,000. They might be hitting everybody at that point.

Tom Wheelwright:

Well, let's unpack a few of those things because we need to unpack the most recent so-called Inflation Reduction Act because that has an impact here and that $400,000 pledge. But first if you would just explain why it's 50 votes? Why isn't not 60? Because everything else other than the budget and judges require 60 votes. In the Senate, why is the budget requires 50? Can you walk through the budget reconciliation process and basically how many shots would the Democrats have over the next two years?

Brian Riedl:

Yeah. So we have a budget reconciliation process that essentially says that while the typical legislation requires 60 votes in the Senate to avoid a filibuster, you're allowed to pass probably one bill per year. There's some debate whether or not you can do it more than once, one bill per year under a process called reconciliation. Reconciliation can only be used for tax and budget bills. You can't make regulatory changes, you can only turn tax and budget dials.

However, reconciliation cannot be filibuster, which means you do not need 60 votes to close debate and bring it to a vote. Reconciliation has been used significantly in the past. The 2001 tax cuts were passed under reconciliation. The 2017 tax cuts were passed under reconciliation. Much of Obamacare was passed under reconciliation and the Inflation Reduction Act, the reconciliation bill that just passed was another example. Whenever you can't get 60 votes, you basically get that one get out of jail free card every year. You get the one bill that you can pass with just 50 in the Senate, but you're limited. Like I said, it only can turn tax and budget dials. You can't make regulatory changes. It also-

Tom Wheelwright:

Well, for example, this is why we didn't get a minimum wage in [inaudible 00:07:19]. On the prescription drugs, it was only Medicare prescription drugs because that's a budget issue, whereas you can't just regulate all prescription drugs that way because that's not a budget issue. So those are the types of things that you can't have in there, but you can't have any tax issues, which is what we're really focused on here is the tax side of things. So basically the Democrats had two shots at Build Back Better, they skimmed it down and they got it through it at their $700 billion. This says, “Hey, now a trimmed bill is 750 billion,” which is just shocking that a trimmed bill can be that much money.

Okay. So let's say that they get what they want. Let's unpack some of this because like you said, they really can't get to the numbers of having it be revenue neutral, so to speak, where you've got enough pay-fors to pay for it and they seem to want to do that. But let's talk about that 400,000 just for a minute because treasury secretary Yellen, said something very interesting when it came to the 80 billion that the IRS got, and she said that the proportion of people under 400,000 would not go up. Well right now, that proportion, what I've seen, now you can correct me on this, Brian, I've seen that's around 90% is under $400,000 of the audits are on people making under $400,000. So that means that under what secretary Yellen said, that means that with twice as much money, basically the IRS now can audit twice as many people making under $400,000. Are my numbers close there?

Brian Riedl:

Yeah. I mean there's a lot of wiggle room with what the administration has said. They have asserted again that if you're earning under $400,000, you have nothing to fear. This Congressional Budget Office, when they first scored the new tax compliance revenues, they assumed that a significant portion of the revenues would come from those earning under $400,000. Then the administration went to CBO and went to Treasury and said, “No. Do not increase the proportion of audits under 400,000.” Now proportion doesn't mean there's going to be no additional audits over what there was last year. It just means that they would rise proportionally with audits for those earning over 400,000, which means there would still be a significantly higher percentage of audits all the way up and down the income letter just at a ratio that was proportionate to what we had before.

So there's really a lot of wiggle room. Furthermore, keep in mind that this is a 10 year appropriation for the IRS and President Biden's only going to be in office for perhaps two at most six more years. There's no promise that audits won't rise for everybody else as soon as President Biden leaves office. Again, this is a 10 year appropriation. This money and auditing capability is going to well outlast whatever guidance President Biden gives to the IRS.

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That's a really good point. Now I want to go to, you talked about something else just a minute ago where you said they don't have enough pay-fors and one of the pay-fors which is very distressing to US tax professionals, is that for the first time that in my recollection, I've been doing this in this business over 40 years. First time, my recollection, the IRS their job has not been to administer the tax law. Their job now is to raise revenue and that is new. They've actually been given very specific guidance that you're supposed to raise revenue here. We're including it in our estimate and we're estimate where actually including it in the bill itself and saying it's going to raise.

Now what's interesting is Chuck Rettig, the current IRS commissioner and the Democrats seem to think, or the administration that they could raise anywhere from 600 billion to a trillion dollars of this so-called tax gap. The Congressional Budget Office said, “No. That's more like 180 billion.” So why the big discrepancy here?

Brian Riedl:

Yeah. There is a very large discrepancy in how much money can actually be raised. A lot of the difference is that Larry Summers, who is a former top economist in the Obama administration, has written that the tax gap is growing every year and that basic tax compliance can raise hundreds of billions of dollars over the decade, perhaps as much as a trillion. The Congressional Budget Office, like I said, is a little more realistic. I think they look at historically how much has been raised from IRS compliance and they look at the fact that some of the tools that President Biden wanted to give treasury got rejected by the IRS.

You remember a year ago, President Biden basically wanted to give the IRS the ability to spy on your bank accounts. And after a congressional backlash, he didn't get that authority. So what CBO is saying is that the additional agents probably will raise closer to the 180 billion over 10 years rather than the trillion because we're not giving them new tools such as the power to spy bank accounts to the degree that Secretary Summers have proposed and that other Democrats have [inaudible 00:14:11].

Tom Wheelwright:

So let's talk about this. Let's say that the Democrats retake the House and they retake the Senate and they get that 52 votes. Do you think that creeps back up? Do you think there are enough Senate votes that you could have this reporting, which would be horrendous? The reporting of all bank accounts and basically the IRS saying every dollar deposited in your bank account is taxable and we're going to assess it unless you prove that it was something other than income.

Brian Riedl:

The Democrats, if they retain the House and expand their Senate majority, I think ultimately they're going to go back to the IRS well for and give it more tools. And that's be simply because there's not enough easy money to raise outside of that. Like I said, I've broken down Democratic tax proposals for a long time and what I determined was that they don't raise nearly as much money as Democrats claim they raise. There's just not as much money out there in taxing the rich to feed their huge and growing spending appetite.

When that happens, they're going to go to what they consider to be the low hanging fruit and they would say tax compliance and tax enforcement is easier for them to sell to their base. We're going after rich Republican tax sheets than higher tax rates, especially on the middle class. So I think ultimately Democrats are going to go more aggressive in this scenario towards tax compliance because it's just lower hanging fruit politically than trying to raise taxes, particularly on the middle class.

Tom Wheelwright:

Commissioner Rettig says that it's going to take them four to five years to even get their auditors up and running. So given that by then that's like a lifetime from now for voters, four to five years. It won't be for 5, 6, 7 years before voters start feeling the audits. Once voters feel the audits, then we have HW again coming in saying we need to kinder, gentler IRS, which he did right in the late eighties because the IRS had gotten out of control. The audits were horrendous back then. I'm old enough to remember those. They were not pretty. So we've gone the opposite. We've swung all the way the other side and now we're swinging back. And one of my questions is, so it's interesting to me that they gave so much to enforcement and not to technology because do you think that they will use some of that enforcement money for enforcement technology? Because to me, the best way to enforce tax law is through technology.

Brian Riedl:

Yeah. I mean, if you just break down the 80 billion I have in front of me, about 46 billion went to… This is one of my frustrations. So as one of the frustrations we have with the IRS is that they're slow and unresponsive. It takes forever to get a tax return. It takes forever to get through to the IRS. In many places in the country, they're still processing returns by manually typing what all of the numbers in your tax return into a computer, and they're hundreds of thousands of returns behind. And yet of the 80 billion, only 8 billion went to modernization of business systems and taxpayer services. Fixing the backlogs and speeding up, 72 billion went to enforcement and operations. Some of this will likely go into technology, perhaps not enough. Well, I think what you're going to get a lot of though is direct and aggressive auditing of individuals.

And as you mentioned, this is cyclical. In the eighties and early and nineties, you had an overly aggressive IRS that was harassing Americans, seizing their property, going well beyond what the tax law required. And my old boss, senator Rob Portman led some of the hearings in the reforms to ring in the IRS. We also saw another round of this under the Bush or under the Obama presidency when Lois Learner and the IRS, was basically caught harassing conservative organizations denying them tax exempt status, harassing them. That's one of the issues that motivated Republicans to defang the IRS again about 10 years ago because it wasn't an issue of Republicans don't want people to pay their taxes or don't want the tax code enforced.

The issue was we couldn't trust the IRS to treat people fairly and make sure that they're not going to harass or single out conservative groups for unfair treatment such as denying their nonprofit status. So it's not a matter of wanting the tax code to be enforced. It's a matter of trusting the IRS and this go through cycles.

Tom Wheelwright:

Yeah. I'd be shocked you'd find anybody in America who says, “I trust the IRS.” So that would be very interesting. And honestly, I think most IRS auditors are trying to do their job. I don't think they are trying to be difficult. I don't think they're trying to be overbearing. I think they lack tools. And I think that if they were to put the money towards technology and customer service, I think we'd go in enormous ways to actually increasing enforcement, voluntary compliance.

So let's dial this back just a minute before we wrap up here and let's look at what happens… So that's all the, oh my heavens, this is the world is falling apart if the Democrats take both houses, which I think we even see something potentially beyond what Biden asked for, and we get what Sanders asked for, which is a 6 trillion bill. I think that's possible. But let's dive back. Let's say that right now it looks like there's still a chance or a decent chance that the Republicans, while it looks like they're going to lose the Senate again, it looks like they're going to get the house back. What happens in that situation where the will Republicans, in other words, will they not cross over? Do the Democrats have enough Republicans to cross over that they could get something through the House?

Brian Riedl:

I think it's highly unlikely if Republicans take the House that the Democrats would make much progress on fiscal issues. I worked in congress, there's a lot more bipartisan cooperation than people think, but on taxes, this is a line Republicans haven't crossed frankly in 32 years. Last time a single Republican in congress voted for a broad based tax hike was 1990. It's been 32 years since even one Republican voted for a broad based tax hike. I can't imagine a scenario in which they would cross the aisle to raise taxes to pay for new spending, particularly against a weakened president going into a reelection cycle.

Republicans aren't good for much these days, to be honest, but one thing they are good for is not giving the Democrats easy tax hikes to pay for new spending. And I think they would hold firm on that. They may surrender on a whole host of other issues, but keeping taxes from rising to pay for new democratic spending is probably the one thing we can count on Republicans to do these days of taxpayers.

Tom Wheelwright:

So either if the Democrats get less than 52 votes basically in the Senate or that the Republicans retake the House, then you don't see much happening from a tax standpoint and tax increases over the next two years?

Brian Riedl:

I think Republicans will hold firm against tax increases over the next two years. I can't imagine what Democrats could possibly give Republicans in order to support new tax. I think the pressure would be pretty strong against them, and Republicans frankly are going to be shifting their focus. The lawmakers I talk to on the hill are shifting their focus already to what happens in 2025 when part of the 2017 tax cuts begin to expire. If anything, Republicans are going to be looking to Democrats to figure what can we do to get Democrats to extend as much of these tax cuts as possible? Because as long as the economy remains weak, you don't want broad based across the board tax hikes coming in just over two to three years.

Tom Wheelwright:

Actually you're getting some of that all was already next year. You have the reduction in the depreciation. You have some other changes that phase out over the next three years, even before 2025. So that's going to be interesting.

Brian Riedl:

On the corporate side, we're already starting to see parts of the TCJA wind down. And then on the individual side, again, President Biden has said, “I don't want any new taxes on anyone earning under $400,000.” Well, this is going to be a pretty big tax hike if the TCJA expires across the board on everybody. So we'll see if the president meant what he said last time we were in this situation was when the Bush tax cuts were expiring in 2012, 20 13, where both parties came together then to extend the tax cuts for about 98% of taxpayers and let them expire or raise a little bit at for the top 2%. I would predict we go probably towards that direction again, unless Republicans do well in the elections, particularly in 2024, then they might be able to extend them for everyone.

Tom Wheelwright:

Awesome. Thank you, Brian Riedl, the Manhattan Institute. Any final words for us?

Brian Riedl:

If you're a taxpayer, hold onto your wallet because regardless of what happens, as long as the spending deficits rise, it's going to put upward pressure on taxes. So if you want to know what's going to happen with your taxes in the future, take a look at runaway spending and deficits.

Tom Wheelwright:

Excellent. Just remember, yeah, taxes go with spending and deficits. At some point they definitely raise taxes even though both Republicans and Democrats seem to not care so much about the deficit. But in any case, you do see that pressure. So thank you for that. Again, Brian Riedl, it's manhattaninstitute.org. And if you have more questions or more information that you'd like from Brian and his team. Thank you so much for coming. Remember that sometimes we talk about reducing taxes and sometimes it's a matter of going to the polls and it's actually voting for congress, is voting for your senator. And recognize that right now the Republicans and Democrats do vote in a block.

So with very few exceptions, well, my senator, Sinema being one of those exceptions but she voted with this last one. So she was willing to give up that 750 billion. So remember that you do have to look at party affiliation if taxes are important to you, and that is one way to help keep your taxes down. The other way, of course, is to have good advisors and learn more about taxes, watch more of the WealthAbility Show, and then you make way more money and pay way less tax. See you next time

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