 | Tax Cut Update |
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Back in August, we forecast that all the income tax rate cuts of 2001/03, as well as the 15% tax rate on dividends and capital gains, would be extended through the end of 2012. At the time, most observers still expected the top tax rate on regular income to go back up to 39.6%. They also saw the capital gains rate going back to 20% and the tax rate on dividends going to at least 20%, perhaps as high as 39.6%.
Also back in August, we said the extension of the tax cuts was unlikely to happen before the election. It could possibly happen during a lame duck session of Congress (after the election), but was most likely early next year. As a result, the tax code would temporarily revert back to where it was in 2000, with higher tax rates across the board, but then the lower tax rates would come back and be made retroactive to January 1, 2011.
Now, our prediction – that lower tax rates would ultimately be extended – has become a mainstream view. In addition, it is now clear that the 2001/03 tax cuts will not be extended before the election. The House is already in the process of adjourning. However, there is growing and public sentiment among Democrats to extend the tax cuts for high earners: 30 House Democrats have come out in support of extending all the tax cuts and 47 have come out in favor of extending the tax cuts on dividends and capital gains.
As a result, the odds are going up for a "lame duck" extension of the lower tax rates. It now looks 50/50 whether the extension happens in the lame duck session or early next year.
Previously, we had thought that in a lame duck session, Speaker Pelosi would not want to do any heavy lifting to extend President Bush's tax policies for two more years. It would be humiliating to have argued so vociferously against a full extension of the tax cuts for everyone and then have the public see you shepherding that very idea through Congress. Why not just wait for the new Congress the following year to do the work?
But if there's enough sentiment among Democrats to support an extension, other raw political considerations could lead Speaker Pelosi to act before 2011. If the GOP wins the House in November, enacting the tax cuts this year, before a Republican takes the Speaker's chair, would be a way for the Democrats to deny the incoming majority a quick legislative victory. And if the Democrats somehow keep control of the House, but supporters of extending the tax cuts have a working majority, it's better to face the inevitable around the holidays when the public is paying less attention.
The one thing that will not happen, barring some sort of major and unnecessary capitulation by the Republicans is what President Obama says he wants: an extension of the tax cuts that excludes top earners and a top rate of 20% for dividends and capital gains.
The Democrats failed to pass a budget resolution earlier this year and any extension of lower tax rates is "scored" as a revenue loser, so a 50-vote option in the Senate is not available unless the Democrats want to go through the always arduous and time consuming task of passing a budget resolution late in the year, when members want to go home. In addition, such a move would have to publicly breach the same PAYGO budget rules the Democrats enacted earlier this Congress.
Instead, the only legislation that has a reasonable chance of being enacted requires 60 votes. And the only way to get to 60 is for Democrats to agree to the broader extension that Republicans support. Otherwise, President Obama risks substantially higher tax rates across-the-board (and a somewhat slower recovery) in the early stages of his re-election fight. If you think he won't blink before accepting this outcome, we have a bridge to sell you in Brooklyn. In fact, we would not be surprised at all if, behind closed doors, the President supported an extension just out of political self-interest. This may seem inconsistent with his public comments, but when a politician wants something but his opponents want it more, it's worthwhile to pretend not to want it at all. That way you can extract maximum concessions from the other side.
The one area where President Obama will try to hold the line, and where Republicans may fold, is on the estate tax. We highly doubt that the zero tax rate on estates extends beyond this year. More likely, the parties compromise on a large exemption, in the $3 - 5 million range, with a top tax rate somewhere between 25% and 45%. This would allow the President to "save face" on the tax issue while giving Republicans an issue to run on in 2012. Sadly, in Washington, DC, that's what's known as a "win-win" political deal.
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