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February 23, 2021

How Do Federal Tax Laws Get Passed?

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With Democratic victories for the two U.S. Senate seats in Georgia, the Democrats now have control of the U.S. House of Representatives, Senate, and the presidency. With Democratic leadership comes the likelihood of significant changes to current individual income, corporate, gift, and estate tax laws. However, given the slim majorities of the Democrats in the House and Senate, aggressive tax policy changes may still face an uphill battle. A review of the legislative process for passing federal tax law may help us better understand how and when proposed tax changes may occur.

Sign outside the heqring room for the Committee on Finance
diagram of the path tax legislation takes to become law

Step 1: The President Proposes Tax Legislation

Most recommendations for new tax legislation come from the president and are based on recommendations from the Treasury Department, the IRS, or individuals in business or professional fields. The Treasury Department often has the primary responsibility of drafting proposed legislation.

Step 2: The House Committee on Ways and Means Marks Up the President’s Proposal to Draft Legislation

Our Constitution states that all legislation concerning taxes must “originate” in the House of Representatives. Accordingly, all tax legislation begins its journey through Congress in the House Committee on Ways and Means. The committee holds hearings to listen to testimony on how the legislation will affect the overall economy and specific interest groups. Once the hearings are concluded, the committee members meet in a session to “mark up” or revise the proposal and turn it into “draft legislation.” 

Step 3: The Full House Passes the Draft Legislation and It Becomes a Bill

The draft legislation is introduced to the full House of Representatives for consideration. If passed by simple majority of the representatives (218 out of 435), the “bill” now moves to the Senate.

Step 4: The Senate Finance Committee Reviews the Bill

The first stop for the tax bill passed by the House is the Senate Finance Committee. The Senate Finance Committee operates similarly to the House Committee on Ways and Means but instead of looking at the president’s initial proposals, the finance committee focuses on the tax bill passed by the House. After holding its own hearings, the committee sends the marked up House bill along with a report explaining the markups to the full Senate for floor action.

The entire Senate debates the bill as reported by the Senate Finance Committee. During the debate, the senators may further amend the bill before bringing it to a vote. However, the bill can meet resistance through a tactic known as a filibuster. Senators use a filibuster to prevent a measure from being brought to a vote by extending debate on the measure. The rules permit a senator, or a series of senators, to speak for as long as they wish, and on any topic they choose, unless three-fifths of the senators (currently 60 out of 100) vote to bring the debate to a close. While there was a recent push to repeal the “filibuster,” a repeal was not accomplished and filibuster remains a stall tactic.

However, additional maneuvers have cleared the way for some legislation to avoid filibusters. For instance, budget bills can pass through the Senate via a procedure known as budget reconciliation. Budget reconciliation has generally been used to shrink the deficit through spending reductions, revenue increases, or a combination of the two. Because reconciliation was originally supposed to be used to reduce the deficit, the rule states that only provisions directly impacting government spending or taxes can be passed through reconciliation. This means anything going through reconciliation has to directly impact the federal budget—and if it doesn’t, then the Senate can’t pass it through reconciliation. This rule is referred to as the Byrd rule after Robert Byrd, a senator from West Virginia who was its principal sponsor. The Byrd rule has been law since 1990, and it has been used successfully dozens of times to block so-called extraneous (unrelated) provisions that should not get passed through reconciliation. One of the six criteria used to determine whether a provision in a bill violates the Byrd rule is whether the provision increases the deficit beyond a certain number of years.1 Hence, this is the reason why many tax cuts last for only a small number of years and have sunset provisions.

With budget reconciliation, the Senate can use the fast-track process to consider legislation that brings spending and revenue in line with the budget resolution. Debate on a reconciliation bill is limited to 20 hours so it cannot be filibustered on the Senate floor. This reconciliation process allows such legislation to be passed in the Senate by a simple majority vote. Most recently, the Tax Cuts and Jobs Act of 2017 was passed through the budget reconciliation process.

If the Senate passes the House version of the bill without further amendments, the bill gets sent directly to the president for signature. However, if the Senate passes its own amended version of the bill, then the bill with the Senate amendments is sent back to the House of Representatives for review. Unless the House agrees to accept the Senate version, a conference committee is appointed to iron out the differences between the two bills.

Step 5: The Conference Committee Takes Action

A conference committee — a joint committee composed of senior House and Senate members that originally considered the legislation — reviews the two versions of the bill and returns its own version back to both the House and Senate for vote. If this new version is passed, the revised bill is sent to the president. If it is not passed, that bill is dead.

Step 6: The Executive Branch Takes Action

Once the president receives the bill, the president will get additional advice from the Secretary of the Treasury and other federal agencies before making a decision. If the president signs the bill, the IRS will take action to carry out the provisions of the tax bill. 

If the president vetoes the bill, the bill is returned to the House with a statement of what was objectionable in the bill and then the House must (1) attempt to override the veto (which requires a two-thirds vote of both the House and the Senate) or (2) make the requested changes.

Looking Forward 

During his presidential bid, Joe Biden proposed an overhaul of many tax provisions that impact income taxes for individuals and corporations, capital gains taxes, payroll taxes, and estate and gift tax laws. Biden will likely receive additional input from the Treasury and his initial proposals may be scaled back before the proposed legislation is formally submitted to Congress for review.

In our narrowly divided Senate, getting tax legislation through by the budget reconciliation process could be a way forward for many of President Biden’s tax proposals. While much of Biden’s platform is concerned with raising revenue, there will likely also be some spending provisions in the proposed tax legislation. In light of the Byrd rule, the time frame for some of the new legislation may also be limited and given that there are other important matters on the new administration’s agenda (like the coronavirus pandemic), immediate action on tax changes may not happen. That said, given the history of tax legislation, it seems inevitable that some significant changes to our tax laws will be made during the Biden administration.

If you are interested in learning more about possible tax law changes and how the changes may affect you, please contact your B|O|S wealth management team to review your situation.

Resources:

Wikipedia, “Reconciliation (United States Congress),” https://en.wikipedia.org/wiki/Reconciliation_(United_States_Congress)

Wikipedia, “Reconciliation (United States Congress): Byrd Rule,” https://en.wikipedia.org/wiki/Reconciliation_(United_States_Congress)#Byrd_Rule

Footnote:

1 The Byrd rule defines a provision to be “extraneous” — and therefore ineligible for reconciliation — in six cases: 1) It does not have a budgetary effect; 2) It has a budgetary effect, but the effect is not what the budget resolution called for; 3) It’s outside the jurisdiction of the committee recommending it; 4) It does have a budget effect but is “merely incidental” to the nonbudgetary components of the provisions; 5) It increases the deficit beyond a certain number of years (usually a period of 10 years); or 6) It is about Social Security.

Filed under: Tax Planning

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