November 7, 2010

Big question left for 2010: What about the tax cuts?

This op-ed was published in the New York Post on Nov. 7.

Roast turkey with all the trimmings—that’s usually the biggest thing on the plates of Congress during a lame-duck session. But this fall features around 70 lame ducks and a lot of unappetizing legislative work on the menu, including the biggest tax question in a decade.

Set to expire on Jan. 1 are the 2001 and 2003 Bush tax cuts, plus the Obama tax credits enacted in the stimulus bill. Both expirations would immediately lower workers’ paychecks in January, so the congressional Democrats’ last majority hurrah will be important.

And there’s even more tax action. Tax provisions that expired at the end of last year need attention. Without retroactive changes for tax year 2010, these provisions would raise the amount many taxpayers send in with their 2010 tax returns this spring. The alternative minimum tax (AMT) is the biggest of these already-expired tax provisions, but another group of provisions called “tax extenders” (because they’re extended in law one year at a time) are politically important to certain constituencies. The R&E tax credit is big for many companies; the property tax deduction for non-itemizers is a recent, popular add-on; and the deduction for general sales taxes paid is big for people in states that levy high sales taxes but low income taxes (like Florida and Texas).

Due to the chance that some tax rates may go up in January, workers and investors, especially those with high incomes, should have the phone numbers of their tax advisors and stock brokers handy as the lame ducks deliberate. If investors see capital gains tax rates going up in January, many should take gains before New Year’s Day. Also, should workers expect higher wage tax rates for 2011, those in a position to do so should accelerate work and invoices in 2010. Then there’s the morbid question of timing one’s death. Wealthy, terminally ill people and their families are facing the question of whether or not to shift deaths from 2011 into 2010 to avoid a big estate tax bill in 2011. (Estate tax is zero in 2010.)

Republicans favor extending the expiring Bush tax cuts for everyone in addition to enacting a permanent AMT patch. Making the Bush tax cuts permanent is their ideal, but Republicans are mum on the fate of the tax cuts in the Obama stimulus bill, many of which came in the form of refundable tax credits that disproportionately favor low-income Americans. In his 2011 budget, President Obama pushed for extending all the tax cuts in the stimulus bill for at least another year, as well as pushing for a permanent patch for AMT and a permanent extension of the Bush tax cuts for those with incomes below $250,000.

So if Vegas were taking bets on this question, where should you put your money? What are the odds that the lame-duck Congress will fully or partially extend the tax cuts? Could the lame-duck Democrats enact little or nothing, punting these tax headaches to the new Congress in January?

The annual AMT ritual is considered a pain by most legislators and taxpayers, but it could operate as a useful political spur to the lame ducks to do something about the entire tax mess. Most other action could conceivably be punted to the new Republican Congress – let them handle these headaches with retroactive legislation. However, the AMT and the extenders can’t wait unless Congress wants one out of every five taxpayers to face a nasty surprise when filling out the 1040 this spring.

The Democrats can’t allow that, especially because blue-state residents are disproportionately hit by the AMT. So “something” will be done on taxes, with two scenarios on the Bush tax cuts likely taking shape: (1) a one- or two-year extension of all the Bush tax cuts and some of the stimulus provisions (probably not making-work-pay); or (2) the same extension but with higher tax rates for people earning over some high threshold such as $500,000 or $1 million.

I would not bet on full, permanent extension despite the big Republican wins last week. In fact, political gridlock leading to total expiration of the Bush tax cuts is still more likely than full permanent extension, but the odds of both are slim.

Looking beyond the lame-duck session, where could liberal President Obama and a conservative House compromise on taxes? Here are two possibilities.

President Obama and the Democratic majority in the Senate may be willing to swallow a cut in corporate taxes to get climate legislation (or at least a gas tax increase) through the Republican House. Or maybe Republicans could accept a tax increase in the form of a reduced mortgage interest deduction in exchange for Fannie and Freddie reform.

Such compromises will now be essential for almost anything to pass, and there is some recent precedent for bipartisan compromise on major tax legislation. The Democratic Congress that came together with President Reagan in 1986 to pass tax reform included such liberal lions as Bill Bradley and Dick Gephardt. And in 1997, President Clinton and the Gingrich Congress compromised on capital gains taxes and education credits. Hopefully after the lame-duck Congress enacts some temporary fix, the new Congress will find areas of agreement in making the tax system simpler, fairer, and more pro-growth.

Gerald Prante, Ph.D., is senior economist at the Tax Foundation, a nonpartisan think tank in Washington, DC.