Capitol Hill

Lost among today's urgent headlines is the fact that the "largest tax increase in history" could be looming. Under current law, the landmark reductions in tax rates proposed by President Bush and enacted by Congress in 2001 and 2003 are scheduled to expire in 2010. It will be up to the 111th Congress, which will convene in January 2009, and the newly elected president, to determine the fate of the so-called "Bush tax cuts."

The outcome of the approaching debate regarding federal tax policy could have huge implications for the U.S. economy. The 2001 tax law lowered the top individual tax rates from 39.6 percent to 35 percent and 36 percent to 33 percent, and it will phase out the estate tax by 2010. The 2003 tax law lowered capital gains and dividend tax rates to 15 percent for most individuals.

Without action by Congress, these tax rates will automatically revert to their previous higher levels on Jan. 1, 2011.

Making a case

On numerous occasions, President Bush has called on Congress to pass legislation to make the 2001 and 2003 tax reductions permanent. And at a recent White House briefing, the president again outlined a case for making the tax cuts permanent.

Arguing that lower tax rates are vital to promoting economic growth, he noted "the economy experienced 52 months of uninterrupted job growth, the longest in the history of the United States" after passage of the 2003 tax cuts. He further noted that failure to extend the tax cuts would result in a tax increase of $280 billion per year, or "the largest tax increase in history."

Finally, the president said "75 percent of the taxpayers who benefit from the reduction of the top bracket are small businesses," which create 70 percent of all new jobs in the U.S. economy.

Implications

Many congressional Democrats have indicated they support "middle-class" tax cuts and may be inclined to extend some portions of the Bush tax cuts. However, a majority of Democrats, including Sen. Barack Obama from Illinois, also support raising taxes on individuals making $250,000 or more per year, as well as raising the rates on capital gains and dividends to pre-Bush levels. (In contrast, Sen. John McCain [R-Ariz.] has pledged his support for making the lower tax rates permanent despite having voted against them previously.) Dem-ocrats argue that tax increases "on the rich" are necessary to reduce the growing federal budget deficits and are a matter of "tax equity."

A key factor driving Democrats to consider raising taxes is their rigid adherence to the "PAYGO" (pay-as-you-go) budget rule they implemented in 2007. Under the PAYGO rule, any tax reduction approved by Congress must be budget-neutral to the federal treasury via corresponding spending cuts or other tax increases.

In effect, this means extending the Bush tax cuts would require Congress to approve offsetting tax increases of an equivalent amount because Democrats are unlikely to propose spending reductions of any significance. This has ominous implications for any effort to extend the Bush tax cuts.

Rep. Jim McCrery (R-La.), ranking Republican on the House Ways and Means Committee, has said the ultimate effect of the PAYGO rule could be a tax increase of $3.5 trillion—the amount needed to "pay for" an extension of the Bush tax cuts and permanently repeal the alternative minimum tax.

Uncertain outlook

Democratic leaders in Congress have chosen to wait until at least next year to address this issue in the hope that Obama will be in the Oval Office. In fact, some Capitol Hill insiders predict Congress will not take up the Bush tax cuts until mid- to late-2010, shortly before they are scheduled to expire.

Duane L. Musser is NRCA's senior director of federal affairs.