One of the most common complaints I have heard about President Bush’s tax plan is that it is cutting revenues “permanently.” With the federal government facing enormous long-term fiscal pressures resulting from the impending retirement of the baby-boom generation, permanent tax cuts are irresponsible, we are repeatedly told.
This criticism is simply absurd. No tax change is ever really permanent. Ot0herwise we would still have the tax system instituted in 1913 — which would be fine with me. The top tax rate at that time was just 7%. In the years since, there have been thousands and thousands of tax changes and there will be thousands more changes in the future.
Still, there is a difference between enacting a tax initiative permanently, even if everyone knows that the law could change any time in the future. One reason is that budget projections henceforth will assume that this initiative will be part of the law. By contrast, temporary tax changes are assumed to expire, even if everyone knows that they will be extended.
In fact, one of the main reasons why the total revenue impact of President Bush’s proposal is so large at $1.4 trillion over 10 years is that 41% of the cost results simply from extending expiring provisions of law. This is because in years past, Congress tried to minimize the revenue effect of tax changes by having them expire at some future date. The most egregious example is the estate tax, which is abolished in 2010, but comes back in 2011 as if nothing had happened.
Of course, Congress is not going to let this happen. But the revenue estimators must assume exactly that. So federal revenues are expected to be higher in 2011 and years after because estate taxes will be collected then that will not be collected in 2010. Now, President Bush must expend political capital to make permanent many of the tax cuts enacted in 2001 that, under current law, expire in 2011. Altogether, extending these provisions adds $600 billion to the cost of his tax plan, according to the Treasury Department.
Unfortunately, it is almost a certainty that any new tax cuts enacted this year will suffer the same fate. That is because it will take 60 votes in the Senate to make a tax cut permanent. It takes that many votes to cut off a filibuster, which Democrats would use to defeat the effort. Therefore, tax-cut supporters will have to use a complicated legislative procedure known as reconciliation to avoid a filibuster.
Under reconciliation, only a simple majority is needed because there is a statutory time limit on how long a reconciliation bill may be debated. But the catch is that no changes in law enacted under reconciliation may be made permanent. They can only be in effect for 10 years at most. That is why the estate tax comes back in 2011. The repeal enacted in 2001 was only allowed to be in effect for 10 years.
Assuming that reconciliation is used, the same problem will arise this year as well. If taxes on dividends are cut or any other provision of President Bush’s proposal is enacted, it cannot be made permanent and must go away in 10 years. Therefore, taxpayers cannot really make plans beyond 2013 based on any tax changes that might be implemented this year.
At a minimum, this refutes the charge that President Bush is somehow crippling our nation’s finances for all time. There will be ample opportunity in future years to revisit every single provision of this year’s tax bill, and failure to take action on extending its provisions will result in their automatic repeal and a de facto tax increase. Indeed, there is already a well-organized effort to keep the estate tax after 2010 and not allow its expiration to be extended. The same will happen to the dividend proposal and every other initiative that may be enacted this year.
Of course, this is a stupid way to make tax policy. People need some minimal degree of assurance that actions they take today based on today’s tax law will still be there in years to come. For example, the administration has proposed savings accounts that would have no taxes on withdrawals in order to stimulate saving. If the law allowing such accounts expires in 10 years, does this mean that all withdrawals will become taxable? Fear that this might be the case could seriously undermine the effectiveness of such accounts and make financial planning unnecessarily difficult.
Unfortunately, the prospects for improving tax policy are nil because it would take 60 votes in the Senate to change the rule that prevents tax provisions from being in effect for more than 10 years at a time. Until that happens, everyone should just strike the term “permanent tax cut” from their vocabulary.