The growing U.S. deficit and the increasing attention being paid to it by financial markets is creating what many see as the “perfect storm” that will drive the debate over tax reform. Whether “tax reform” will include tax increases –and whether “tax simplification” will include a flattening of existing tax rates through cutting back on deductions and credits to which many individuals and businesses have grown accustomed– are questions that will soon be raised as Congress starts a tough fight over the FY 2012 federal budget.

Consensus had been that nothing would get done on taxes until after the 2012 presidential elections and that tax changes would not take effect until 2013. Now, with inflation looming, if Congress does not show quickly that it can control the deficit, the timetable may be getting pushed up. While tax changes may still not take place until 2013, decisions over what those changes will be may be made earlier. The compromise on taxes made between Republicans and Democrats late in 2010 extended the so-called “Bush tax cuts” for two years, through 2012. The temporary nature of that delay makes a decision on what to do about taxes for 2013 pivotal to the current tax reform debate.

Two versions of tax reform

The House approved a FY 2012 budget resolution ( HConRes 34) on April 15 along a party-line vote (235 to 193). The resolution proposes to reduce federal spending by more than $6.2 trillion over 10 years. HConRes 34 proposes to replace the current marginal rate structure ranging from a low of 10 percent to a high of 35 percent with just two rates: 10 percent and 25 percent. The 10 percent rate would apply to single individuals with taxable income under $50,000 and to married couples filing jointly with taxable income under $100,000. The 25 percent rate would apply to single individuals with incomes over $50,000 and married couples filing jointly with incomes over $100,000. The budget resolution also proposes to reduce the corporate tax rate to 25 percent.

Meanwhile, President Obama described his vision for reducing the federal budget deficit and tax reform on April 13. The president is opposed to renewing the Bush-era individual income tax cuts for higher-income individuals, which the White House defines as single individuals with incomes over $200,000 and families with incomes over $250,000. The president also proposed more than $3 trillion in cuts to federal spending over 10 years.

We will continue to monitor events in Washington and how the outcome of the current debate on tax reform will impact our clients.