Capitol Hill

With the so-called "Bush tax cuts" scheduled to expire at the end of the year, President Obama and Congress face one of the most important tax policy decisions in recent years—whether to raise taxes. Congress is expected to address this question this month, but it is unclear whether lawmakers will be able to reach agreement before tax increases take effect in 2011.

What's at stake

According to current law, tax rates on individual income, capital gains and dividends that were enacted in 2001 and 2003 will expire Jan. 1, 2011. If Congress fails to pass legislation to extend the existing rates, the result will be substantial tax increases for most Americans. In this scenario, income tax rates at all levels would increase; the 15 percent rate on dividends would increase dramatically to regular income rates; and the capital gains rate would increase from 15 to 20 percent.

In addition, the estate tax is scheduled to revert to its pre-2001 rate of 55 percent. Congressional Republicans claim allowing these lower tax rates to expire would result in the largest tax increase in U.S. history.

NRCA has been advocating for the extension of the lower tax rates for years and recently joined other business associations in sending a letter to Congress urging that all the existing tax rates be extended. The letter notes the "impact of the higher tax rates on the small-business, entrepreneurial sector of our economy is particularly troubling" because such businesses "are a critical source of innovation and job creation."

Opposing sides

Obama and most Democrats in Congress support extending the current tax rates for individuals making less than $200,000 per year and families making less than $250,000 per year. They argue tax increases for higher earners are justified because "the rich" should pay their "fair share" of taxes and higher taxes are needed to reduce government deficits.

Nearly all Republicans support extending the lower tax rates for all levels of earners, arguing that lower tax rates are vital to providing the capital needed for investment that leads to economic growth and job creation. Republicans further argue that increasing taxes for high earners will impede economic growth, further exacerbating growing deficits.

A small group of Democrats have indicated they may side with Republicans in voting for the lower tax rates to be extended for all income levels, at least temporarily. These lawmakers fear a political backlash at the polls if they vote to raise taxes a few weeks before elections.

Further complicating the situation are congressional budget rules, which require tax cuts or spending increases to be offset by other tax increases or spending cuts to avoid increasing the deficit. Because tax rates are scheduled to increase under current law, the official budget baseline assumes taxes will increase Jan. 1, 2011. Therefore, according to the budget rules, legislation to extend the lower rates will be "scored" as adding about $2 trillion to future deficits during the next decade unless coupled with offsetting tax increases or spending cuts.

It is unclear whether Democratic leaders will be able to gather the votes to pass their preferred option—extension of lower tax rates for the "middle class" only while allowing taxes to increase for high earners. However, if they can't get the votes for this option, they are unlikely to introduce legislation extending lower tax rates across the board, which they oppose.

Looking ahead

If Congress fails to act on this issue before the elections, it could be dealt with in a lame-duck session expected between Nov. 2 and the end of the year. But lame-duck sessions are hard to predict, and, therefore, it is possible gridlock in Congress could result in tax increases beginning in 2011 for nearly all Americans, including many small-business owners. There is much uncertainty regarding how and when this high-stakes battle will be resolved, as well as the potential implications for the economy.

Duane L. Musser is NRCA's vice president of government relations.