FROM THE OFFICE OF PUBLIC AFFAIRS

Dear Conferee:

We are pleased that substantial progress has beenmade toward implementing the terms of the historic bipartisanbudget agreement between the President and the Congress. We lookforward to continuing bipartisan cooperation as we work togetherto produce a tax-cut package that fulfills the agreement and bestserves the American people. To that end, I would like to sharewith you the Administration’s views on major issues inconference on the tax portions of revenue reconciliation. Inaddition, we expect to communicate further with you regardingprovisions not addressed in this letter.

In general, as we have previously indicated, theAdministration strongly believes that any tax-cut package mustmeet four basic tests to reflect sound policy. First, the taxcuts must be fiscally responsible by avoiding an explosion inrevenue costs in later years. Second, the tax cuts must provide afair balance of benefits for working Americans. Third, the taxcuts must encourage economic growth. Fourth, the tax package mustreflect the terms of the bipartisan budget agreement, including asignificant expansion of opportunities for higher education forAmericans of all ages. Neither bill meets these tests.

While the Senate bill is an improvement over theHouse bill, both bills provide too little tax relief tomiddle-income families. In both the House and Senate bills, themiddle sixty-percent of families receive just one-third of thetax cut; these families would receive twice as large a shareunder the President’s proposal.

Education Tax Incentives

We are pleased that each bill contains a versionof the President’s HOPE Scholarship proposal. Nonetheless,both the House and Senate bills are inconsistent with thebipartisan budget agreement because they fall far short ofmeeting the specific agreement of providing roughly $35 billionover five years of higher education incentives along the lines ofthe President's HOPE Scholarship credit and tuition deductionproposals.

While the HOPE Scholarship credit as modified inthe Senate bill is an improvement over the version in the Housebill, each bill significantly reduces the value of educationbenefits for millions of students attending low-cost institutionsby cutting the percentage of expenses covered by the credit (50%in the House bill, 50% to 75% in the Senate bill).

Neither bill includes a widely available tuitiondeduction or credit to help beyond the first two years of highereducation that is consistent with the tuition deduction in thePresident’s budget proposal. We are particularly concernedthat neither bill significantly promotes life-long learning,which we believe is a critical component of education in ourchanging economy. In addition, neither bill offers low-incomestudents and students who work to pay tuition meaningful helpbeyond the first two years of higher education. Instead, thebills require taxpayers to have the funds available to put intosavings in order to be entitled to any assistance other than forthe first two years.

We also object to the education IRAs and prepaidtuition account provisions of both bills. These provisions failto place sufficient limits on the income of contributors, theamounts contributed, and the uses of funds to ensure that the taxbenefits go to those who need real relief from the costs ofhigher education. Because most workers already have anopportunity to contribute to tax deductible IRAs and thePresident has proposed to allow penalty-free IRA withdrawals tobe used to finance higher education expenses, the education IRAsand prepaid tuition plans in the House and Senate bills willlargely become vehicles to provide tax breaks for saving by upperincome taxpayers that would have occurred anyway. We also objectto the provision in the Senate bill that allows tax-freewithdrawals from these accounts for primary and secondary schooltuition, because it provides Federal subsidies to parents whosend their children to private elementary and secondary schools.

Overall, as compared to the President’sproposals, both packages direct more benefits toward upper-incomefamilies while reducing the benefits to lower-income families,particularly those who rely on their earnings to finance highereducation. The packages are clearly inconsistent with thebipartisan budget agreement.

Administration Position:

 

HOPE Scholarship and 20 percent Tuition Credit: The Administration remains strongly committed to the principle that the education tax incentives must be fair, must genuinely expand educational opportunities for Americans, and must promote life-long learning. To accomplish these objectives, the Administration believes the conferees should provide roughly $35 billion over five years for higher education by adopting the HOPE Scholarship, which gives a credit of 100 percent of the first $1,000 of tuition and fees, and 50 percent of the next $1,000 in 1998 through 2002. Students must attend school at least half time in the first two years of a post-secondary degree or certificate program. If a student is not eligible for the HOPE Scholarship but is pursuing a post-secondary degree or certificate or is enrolled in classes to improve job skills, a 20-percent credit for tuition and fees up to $5,000 through 2000 and $10,000 thereafter should be granted.

 

This proposal addresses Congressional concerns in two ways: it lessens concerns about tuition inflation by limiting the marginal subsidy of the HOPE Scholarship to 50 cents on the dollar (rather than dollar for dollar) for students with tuition between $1,000 and $2,000. It also increases the progressivity of the tuition deduction by converting it into a 20-percent credit.

 

Administration Position on Other Features in the Education Packages

 

In addition to providing $35 billion for the HOPE Scholarship and 20-percent tuition credit, the Administration believes that the tax package should do the following:

 

Adopt proposals to aid K-12 public school construction (and other activities) in poor neighborhoods.

 

Make permanent the exclusion of employer-provided educational assistance from taxable income and extend the exclusion to graduate education (Section 127).

 

Adopt a student-loan interest deduction and a loan forgiveness exemption similar to those contained in the Senate bill.

 

Provide tax incentives to help public elementary and secondary schools obtain up-to-date computer technology.

 

Include a proposal to repeal the $150 million bond cap for new capital expenditures by private colleges and universities.

 

Child Credit

We are pleased that both the Senate and Housebills include credits for families with children. We are deeplyconcerned, however, that relative to the President’sproposals, the Senate bill denies the child credit to 3.8 millionlow-income, working families who earn less than $30,000, and theHouse bill denies the credit to 4.8 million of these workingfamilies. These families pay significant payroll and otherfederal taxes, and deserve a child credit to help raise theirchildren just as much as other families. Accordingly, we objectto stacking any portion of the child credit after the earnedincome tax credit unless the child credit is fully refundable. Wenote that both the 1995 Balanced Budget Act passed by Congressand the legislation introduced by Majority Leader Lott (S.2) thisyear, stacked the child credit before the EITC, as did theDemocratic alternatives drafted by Representative Rangel andSenator Daschle. The Democratic packages also containedrefundability features consistent with the Administration’sproposal. In addition, we have a major objection to the provisionin the House bill that would reduce tax benefits for many workingfamilies who are entitled to a tax credit for their child-careexpenses under current law.

Administration Position: The Administration believes the child credit should be stacked before the EITC. The $500 child credit ($400 in 1998) should be available for children under 17 through 2002 and under 19 thereafter. In addition, the child credit should be refundable to the extent that the family’s payroll taxes exceed their earned income tax credit. The credit should be accompanied by an optional Kidsave Account that allows parents the option to contribute up to the amount of the credit plus $500 per child to a nondeductible, backloaded IRA-type savings vehicle. Under this proposal earnings could be distributed tax-free for a child's post-secondary education or purchase of a first home, or for the parent’s retirement, and the income limits would be the same as in the President’s proposal (phased out between $60,000-$75,000 through 2000, and $80,000-$100,000 thereafter). The child credit and its income thresholds should be indexed for inflation.

 

We note that the Senate adopted Senator Kohl’s amendment to provide new incentives to expand the availability of licensed, accredited day-care facilities for working parents. Improving the quality and availability of child care for working families is an objective we share.

 

Capital Gains Relief

We are pleased that both the Senate and Housebills contain the President’s proposal to exclude up to$500,000 of capital gains from home sales. The Administration hasrecently announced its intention to expand the scope of existingprovisions for targeted small-business capital gains relief. Weare pleased that the Senate bill incorporates a provision thatis, in many respects, consistent with our proposal, although wehave concerns about certain aspects of the Senate version.

We object to the additional across-the-boardcapital gains relief in both bills, which is too generous andwould disproportionately benefit the wealthy over lower- andmiddle-income wage earners. Moreover, we are opposed to indexingcapital gains as is done in the House bill. Indexing wouldcontribute to an explosive revenue cost after 2007, possiblyjeopardizing all our important work on deficit reduction. Inaddition, indexing is enormously complex and would be difficultto administer. We also object to the provision in theHouse bill for corporate capital gains relief, which isunwarranted and unlikely to create any significant economicgrowth.

Administration Position: The Administration urges the conferees to provide a 30-percent exclusion for long-term capital gains. This reduces the top rate on capital gains to 27.72 percent for taxpayers in the 39.6 percent bracket. The President’s proposal reduces the tax rate to 19.6 percent for taxpayers in the 28 percent bracket and reduces the tax rate to 10.5 percent for taxpayers in the 15 percent bracket. The proposal would include the President’s home sale provision and targeted small-business capital gains relief.

 

Alternative Minimum Tax Relief

We are pleased that the House bill incorporates aversion of the President’s proposal to exempt smallcorporations from the AMT. We also acknowledge the importance ofprovisions in each bill designed to compensate for the previouslack of indexing of the individual AMT exclusion for inflation.We object, however, to the House provision that would provide $22billion over five years in unwarranted AMT relief for largecorporations.

Administration Position: The House provision for AMT relief for large corporations should not be adopted.

 

IRAs and Other Savings Incentives

The Administration continues to believe stronglyin the importance of encouraging savings, particularly forretirement and education, and supports the IRA concept. ThePresident’s proposal includes a new saving vehicle targetedtoward middle- and lower-income families, allowing parents tocontribute to Kidsave accounts for their children’seducation, first-time home purchase, or the parents’retirement. The Administration’s proposal would alsoencourage increased savings by middle- and lower-income familiesby making existing IRAs more flexible.

We believe it is important that new savingsincentives be sufficiently targeted in order to ensure theygenerate new savings and to provide savings for those who needthem most. The back-loaded IRAs in both the Senate and Housebills are not sufficiently targeted to lower- and middle-incomefamilies. The lack of income limits for contributors to theseback-loaded IRAs compounds the out-year cost explosion. Out-yearexplosion of revenue cost is inconsistent with the bipartisanbudget agreement. Because most workers can contribute totax-deductible IRAs, the new provisions will largely displacesaving that would have otherwise occurred by upper incometaxpayers. Targeted incentives such as the Administration’soptional Kidsave proposal will be more successful insignificantly increasing new saving. The back-loaded IRAprovisions contained in the Senate and House bills also addsignificantly to the problem of unfair distribution of taxbenefits.

Administration Position: The current structure of IRAs should be continued with the following modifications. Penalty-free withdrawals from existing IRAs should be allowed to finance higher education expenses, for first-time home purchases, and for certain other limited purposes. Optional Kidsave accounts should be provided for taxpayers who are entitled to a child credit, with contributions limited to the amount of the child credit plus $500 per child.

 

Estate Tax Relief

We are pleased that both the Senate and Housebills have included versions of the Administration’sproposal to provide liquidity relief for estates containing smallbusinesses and farms. We object, however, to the sweeping estatetax relief in both bills because it is too expensive and will beof no benefit to average Americans. It contributes to the problemof exploding out-year costs. We also object to the provisions inthe Senate bill that would allow inappropriate tax-planningopportunities by providing special estate and gift tax treatmentfor pre-paid tuition plans and an estate tax exclusion forconservation easements. Further, the unlimited repeal of theso-called "throw-back" rules in the House bill wouldallow certain trusts that are already tax-advantaged to reapadditional, unwarranted tax benefits. We believe that estate andgift tax relief is most productively targeted to owners of smallbusinesses and farms, along the lines of the small-business andfarm provisions in the Senate bill.

Administration Position: The Administration believes a special exemption should be given for $900,000 of value in a qualified farm or small business in addition to the $600,000 value of the unified credit; the value of estates eligible for liquidity relief should be included as proposed in the Administration’s FY 98 budget. The throw-back rules should be repealed, but the status quo should be retained under the throw-back rules for the pre-1984 trusts that are already entitled to a special exemption from the multiple trust rules.

 

Distressed Areas and Urban Tax Initiatives

The May 15, 1997 letter to the President fromSpeaker Gingrich and Majority Leader Lott pledged to seekinclusion of the President’s proposals intended torevitalize distressed urban and rural areas throughout thecountry. We object to the inclusion in the Senate and House billsof only very limited aspects of some of these initiatives, andomission of other important initiatives altogether. For example,the President's brownfields proposal, which provides a taxincentive for environmental cleanup and encourages economicdevelopment in formerly contaminated areas, has been stronglysupported in urban and rural communities and by the Nation'smayors. In addition, while we are pleased the House included amodified version of the President’s welfare-to-work taxcredit proposal, we are disappointed the Work Opportunity TaxCredit (WOTC) contained in both the House and Senate bills allowsemployers to claim the WOTC for hiring workers for a very shortperiod of time and does not expand the Food Stamp target group inthe WOTC to cover childless, able-bodied adults ages 18-50 whoare subject to the Food Stamp time limit and work requirements.

We are also pleased that both the Senate andHouse bills include tax incentives for the District of Columbia,but we have significant concerns with specific proposals in bothbills. We look forward to working with you to pass a package ofD.C. incentives that will be of greater benefit low-incomeDistrict residents.

Administration Position: The tax bill should include the following provisions to help address the problems of distressed areas and our cities.

 

Include the President’s D.C. incentives.

 

Provide tax incentives to clean up brownfields in distressed communities across the United States.

 

Expand Empowerment Zones and Enterprise Communities.

 

Stimulate investments in Community Development Financial Institutions.

 

While we would support the House provision on the enhanced welfare-to-work tax credit for long-term welfare recipients, the credit should be changed to 50 percent for both years. In addition, we would make no change in the current structure of the WOTC regarding number of hours or credit structure, and would expand the Food Stamp target group to cover the 18-50 year olds. The package should also include provisions to facilitate restructuring our Nation's affordable housing portfolio, and provide tax incentives for new economic activity in Puerto Rico.

 

Superfund

Consistent with thePresident’s 1998 budget, the Administration supports theextension of the current Superfund taxes through 2007 in order tofully carry out the President’s initiative to achieveclean-up at two-thirds of the national priority list sites by theyear 2000. Funding for this initiative was a protected priorityunder the bipartisan budget agreement.

Independent Contractors

We object to provisions such as those in theHouse bill that would provide a new safe harbor for independentcontractor status. These provisions would permit employers toavoid essential worker protections and could lead to widespreadshifting of employees to independent contractor status, resultingin loss of worker protections such as pension and healthcoverage, and wage and hour protections, unemployment insurancebenefits and compensation for work-related injuries. An issue ofsuch significance requires much deeper and fuller study and inputfrom all affected parties.

Administration Position: Do not include provisions on independent contractor status.

 

Extension of Airport and Airways Trust FundTaxes

We object to the changes in the structure of theairport and airways taxes made in the House and Senate bills.Just last year Congress directed the creation of the NationalCivil Aviation Review Commission to perform a thorough analysisof the costs of providing FAA services to ensure that any new feestructures would reflect the use of those services. Both theHouse and the Senate bills would set new fee structures withoutthe benefit of the Commission study. These proposed feestructures could have enormous unintended consequences for theU.S. airline industry.

Administration Position: Extend the current airport and airways trust fund taxes so the National Civil Aviation Review Commission has sufficient time to study the issue. When it has completed its work, its findings should be taken into account in modifying or amending these taxes.

 

Tobacco Tax

The Senate bill contains a provision to raisetobacco taxes by 20 cents a pack, using part of the tax to fundchildren’s health care. We have a significant concern aboutthe use of the revenues from this tax. All of these revenuesshould be committed to benefit children and health care, and notto pay for tax cuts. We are also concerned that the funding forchildren’s health derived from the tobacco tax sunsets in FY2002. We urge the conferees to continue funding forchildren’s health beyond FY 2002.

Administration Position: Wesupport a 20-cent increase in the tobacco tax – we agree that it complements the budget agreement – and we endorse the idea of using all of the revenues raised by such an increase for initiatives that focus on the needs of children and health. We urge the Conferees to invest all of these funds wisely in order to ensure meaningful coverage for millions of uninsured children.

 

The Deductibility of Health InsurancePremiums

The Administration does not support the proposalincluded in the Senate bill to increase deductibility of healthinsurance premiums for the self-employed to 100 percent by 2007.It is unlikely that parity between the tax treatment of healthinsurance costs for employees and for self-employed individualswould result from increasing the tax deductibility of healthinsurance premiums for the self-employed to 100 percent. Since itis typical for employers to pay for only a portion of theiremployees’ (or retirees’) health care costs, the restoften is paid by employees and former employees in the form ofafter-tax contributions. The increase to an 80-percent deductionthat the Administration supported in HIPAA will come closer toproviding rough parity between employees over their careers andself-employed individuals than a 100-percent deduction forself-employed individuals. The Administration believes that HIPAAaddresses this issue in an appropriate way and will continue towork in support of proposals that expand health insurancecoverage in an equitable manner.

Explosion of Costs in Out Years

As discussed in the May 15, 1997 letter fromSpeaker Gingrich and Majority Leader Lott, tax provisions of thebudget reconciliation bill "shall not cause costs to explodein the outyears." This statement notwithstanding, the nettax cuts called for in the House bill increase to $40.9 billionin 2007 from $29.7 billion in 2004. The net cuts in the Senatebill increase to $41.1 billion in 2007 from $29.0 billion in2004. This trajectory of revenue loss is not the inevitableconsequence of the tax cuts specified in the bipartisan budgetagreement. The net cuts in the President’s proposal, forexample, only increase from $30.5 billion in 2004 to $34.1billion in 2007.

The tax items causing out-year costs to increasesharply are those that disproportionately benefit high-incometaxpayers. In contrast, provisions that benefit middle-incomefamilies, such as the President’s education proposals andthe child credit, over time become much less significant in theoverall revenue loss under the House and Senate bills. Over thefirst five years, education and child credit provisions accountfor 84.5 percent of the total tax cut in the President’sproposal, 72.1 percent in the House bill, and 70.4 percent in theSenate bill. By 2007, these provisions account for 83.3 percentof the total tax cut in the President’s package, but only38.1 percent in the House bill and 43.2 percent in the Senatebill. While the significance of provisions targeted towardmiddle-income families diminishes over time in the Congressionalpackages, the cost of provisions disproportionately benefitinghigh-income individuals explode. The capital gains, AMT, savingsand estate tax provisions increase from 10.8 and 12.4 percent ofthe total gross tax cuts in the House and Senate billsrespectively over the first five years to 55.4 and 53 percentrespectively of the total gross tax cuts in 2007. The rapidgrowth in the cost of these provisions between 2003 and 2007causes us to be greatly concerned about the cost of theCongressional packages beyond the ten-year budget window.

Simplification

The Administration is strongly committed tosimplifying the tax laws and enhancing taxpayers’ rights. InApril, we released a revenue-neutral package of some 60 measuresdesigned to further these objectives. We are pleased that 48 ofthese proposals are reflected in measures included in the Houseor Senate bills. We urge the conferees to give carefulconsideration to the remaining simplification measures in theAdministration’s package, such as the equitable tollingproposal that would protect the rights of disabled taxpayers, theproposal to simplify the child dependency exemption rules, andthe proposal to modify the rules that apply to financial hedgingtransactions.

We are concerned that the sheer multitude ofmiscellaneous tax code amendments, many with little policy merit,contained in the House and Senate bills will contributesignificantly to complexity for taxpayers and tax planners. Forinstance, a provision in House bill would change the current 110percent safe harbor for estimated taxes to 109 percent for 1997,to 105 percent for 1998, and back to 110 percent thereafter. Thisprovision is simply a budget gimmick to artificially shiftrevenues among fiscal years; it will significantly increasecomplexity for taxpayers who must cope with the changing rules.

We urge that all proposals being considered forinclusion in the conference agreement be carefully analyzed fromthe standpoint of avoiding needless complexity. Treasury and IRSstaff would be pleased to work with Congressional staff on atechnical level to simplify and improve the administrability ofprovisions under consideration.

Other Issues of Concern

The Administration is pleased that the House andSenate bills include a provision for foreign sales corporationtreatment for software licensed abroad. We are also pleased thatboth the House and Senate bills recognize the importance of thecontinued assurance of tax benefits for ethanol to encourage theuse of alternative fuels. Earlierthis year, the Administration proposed extension of the excisetax exemption for ethanol in our ISTEA reauthorization proposal.We would support the Senate bill extending the incentives through2007, but without phasing down the rates of the benefits. We alsooppose the new scorekeeping language included in the House bill.

The House and Senate bills contain otherprovisions, however, that raise significant concerns. Forinstance, the Administration has serious concerns about theprovision in the Senate bill transferring the 4.3 cents pergallon in fuel taxes currently dedicated to deficit reductionfrom the General Fund to transportation trust funds. While thetransfer provision in itself has no revenue or spending effect,transferring the revenue may spur efforts to move the trust fundsoff-budget and create pressure to increase ground transportationspending to levels significantly higher than contemplated by thebipartisan budget agreement.

The Administration encourages the Senate torecede to the House regarding the Generalized System ofPreferences. While we find the current language in the House billunacceptable, the Administration looks forward to working withthe conferees on language providing enhanced benefits to nationsinvolved in the Caribbean Basin Initiative.

The Administration also has technical and/orpolicy concerns about a number of other provisions in the Houseand Senate bills, including, for example: the provision in theHouse bill that extends reporting and proxy tax requirements forpolitical and lobbying expenditures; the treatment of corporatespin-offs within a consolidated group under the House bill’sprovision relating to so-called "Morris Trust"transactions; and the provision that removes controlled foreigncorporations from the application of the passive foreigninvestment company rules. We will be communicating with youfurther about such issues in the future. We believe by workingtogether, our staffs should be able to address many of theseproblems, and we strongly urge the conferees to authorize thestaffs to begin working on such issues as soon as possible.

Both the Senate and House bills are heavily ladenwith special-interest provisions, such as a special exemptionfrom U.S. income tax for foreign seafarers, special tax benefitsfor vacation timeshare associations, new tax benefits for friendsand family riding corporate jets, and special treatment of traveland meals expenses for targeted groups of taxpayers. We believethat it is inappropriate to use this reconciliation bill as avehicle for new tax breaks for special interests. We urge theconferees to keep the revenue reconciliation bill clean of allspecial-interest provisions.

As the revenue reconciliation bill proceeds toconference, we remain eager to work with the Congress on abipartisan basis to fashion, and ultimately sign, tax-cutlegislation that is faithful to the bipartisan budget agreement,meets the four tests outlined at the beginning of the letter, andis fair to all Americans.

Sincerely,

Robert E. Rubin