One of the first aggressive lobbying campaigns of the tax-simplification season concerns an obscure, but far-reaching, proposal that sounds like a floor wax.
It's called inside buildup, and if Congress decides to tax it, 150 million life insurance policyholders, hundreds of thousands of insurance agents and thousands of insurance companies could be affected.
Compared with the Treasury Department's recommendation to tax many fringe benefits, or to limit deductions for charitable contributions, or to reduce business investment write-offs, inside buildup has received relatively little public attention so far.
But congressional offices are getting hundreds of letters on the subject, and the insurance industry and its allies say many people will quit buying life insurance if the Treasury plan goes through. Treasury officials say the break has become a source of tax-free income for the wealthy; insurance-company executives privately admit the proposal is worse for their industry than the taxation of fringe benefits.
"This is a survival issue for us. We will do everything we can to defeat it," said Richard S. Schweiker, president of the American Council of Life Insurance and former secretary of the Department of Health and Human Services.
Under current law, those who buy life insurance in which the premiums are fixed for the duration of the policy pay for three things: pure insurance, expenses and profit for the company, and an investment component. The insurance company invests the third portion, keeping part of the return and crediting the policyholder with the rest.
The policy builds up value over the years, so that the policyholder could get more money each year if he cashed it in before dying. But he does not pay taxes on that increase in value, some of which is pure return and some of which goes to pay insurance costs that get higher as the policyholder ages.
Except for the fact that the policy is tax-free if paid as a death benefit, inside buildup is treated somewhat like a capital asset, where taxes aren't paid unless the asset is sold. The Treasury wants it to be more like a savings account, where taxes are paid on the interest even if it's re-invested in the account.
Unless the provision is altered in the revised simplification plan due to be issued in May, the Treasury's tax overhaul would take away the tax-exempt status of the return from the investment portion. It would let that money be considered a contribution to an Individual Retirement Account, if policyholders chose that option, but the Treasury still projects the change would raise between $3 billion and $4 billion in revenue every year. Through a phase-in, it would eventually cover existing as well as new policies.
The department contends that inside buildup has really become a tax-free investment, because a relatively small portion of total premiums actually buy pure insurance coverage, and financial deregulation and higher interest rates have raised the earnings potential of the investment portion. And, officials say, the current system is inequitable.
"The benefit of deferring or avoiding tax on the inside interest buildup on life insurance policies goes only to individuals with excess disposable income that enables them to save, and particularly to individuals in high tax brackets," says the Treasury plan, which was issued last November.
The industry, on the other hand, sees the equity issue another way: Officials say it would amount to a tax increase on the elderly. Those taxes could amount to $5,800 over the lifetime of a policyholder who bought insurance this year, Schweiker said. A 35-year-old who paid $535 in annual premiums for a $40,000 policy at age 35 today would have taxable income of $1,098 at age 55 and $1,381 by age 65, according to industry figures.
"It would be like taxing the increase in the value of your home. You don't see that buildup," said Rep. Barbara Kennelly (D-Conn.), who represents the insurance capital of Hartford.
Industry officials aren't waiting for the Treasury rewrite to make their point. The ACLI has sent information kits to 140,000 of the nation's 250,000 life-insurance agents with postcards they can send to their representatives. And its 600 members, plus 1,700 other life-insurance companies, have sent hundreds of letters to members of the House and Senate tax-writing committees and made personal visits.
"I think all the agents of every big company and every small company have written us," said an aide to House Ways and Means Committee member Rep. Sam Gibbons (D-Fla.).
The industry may well accomplish its goal, but more for reasons for weariness than anything else: Congress last year rewrote the tax laws governing the life-insurance industry, and is reluctant to pick up the subject again. However, both Treasury Secretary James A. Baker III and Ways and Means Committee Chairman Dan Rostenkowski (D-Ill.) have said that no tax preference has been ruled out of bounds in the simplification debate.