House Finishes Tax Work; Bill Heads to Conference

December 9, 2005

The House of Representatives yesterday finished its work on its own tax bills for this year, and the issue now heads for conference with a Senate version that is in many ways drastically different. A summary of what the House of Representatives passed over the past week, courtesy Yahoo News (AP):

The House passed a bill Thursday retaining lower rates for capital gains and dividends in 2009 and 2010, a top priority for the Bush administration and its allies in Congress. Opposition from a key senator, moderate Republican Olympia Snowe of Maine, blocked the Senate from working investment tax cuts into their version of a tax bill called for in this year’s budget. That sets up tricky negotiations between the House and Senate, but lawmakers have not given up all hope of finishing this year.

A temporary wall preventing the alternative minimum tax from reaching into the middle class expires on Dec. 31. Both the House and Senate have passed bills keeping that wall in place next year but the issue has become entangled with the debate over capital gains and dividends. Democrats say there’s no urgency to pass tax breaks for investment income, which don’t expire until 2008, when millions of families could face higher taxes next month. Any deal next year on the AMT could be made retroactive to Jan. 1, 2006.

Multiple tax cuts for individuals and businesses expire on Dec. 31, including deductions for tuition, state and local sales taxes and classroom supplies purchased by teachers, along with a tax credit for retirement savings. These extensions have hitched a ride on bills addressing the alternative minimum tax and capital gains and dividends. That means they probably will not be extended until the House and Senate resolve their differences on how to tackle the minimum tax and investment income.

The House and Senate passed separate packages of tax incentives to lure businesses and jobs back into the Gulf Coast after Hurricane Katrina. Lawmakers want to finish this bill before the end of the year.

Lower capital gains and dividends taxes are typically preferred economic policy as they will lead to higher investment (all else equal). There are, however, other factors that need to be in the minds of lawmakers with regards to spending and tax policy, specifically the budget deficit. When governments must borrow, they are taking away money that would otherwise have been invested throughout the global economy, which can be a negative for investment. Therefore, given our current circumstances, there are multiple competing factors playing out when taxes on capital gains and dividends are changed.

As we said earlier, the reason the AMT is a growing problem is because the tax code is filled with tax preferences that distort economic choices. If you eliminate deductions and lower the rates along the lines of the proposals of the President’s Tax Reform Panel, you can have both simplicity by eliminating AMT and a more economically efficient tax system.

Finally, tax breaks for specific geographic areas can lead to distortions in investment choices. If special tax favorability is needed to entice investment in areas destroyed by the hurricane, although it can lead to slightly more overall investment, much of the investment in those damaged areas will come at the expense of investment in other locations.

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