Politics & Policy

Time to Choose

Which way is Bush gonna go on the tax cut?

Anyone who has ever packed for a long trip knows how the Bush administration is feeling today. There is never enough room in your suitcase for all the things you want to bring with you and some stuff must be left behind. So too, there is just not enough room in the budget for the administration to get all its tax initiatives this year. It is now in the process of deciding what to leave behind.

Deciding what to keep and what to leave behind is mostly an accounting exercise at this point. As a practical matter, all tax initiatives must fit into a suitcase holding no more than $350 billion over 10 years. This is the maximum amount of net revenue loss allowed under the Senate budget resolution. Although the House would support a tax cut as large as $550 billion (or even larger), it will take enormous effort just to get any tax cut through the Senate. Therefore, the Senate constraint effectively is binding for the final legislation.

#ad#How to divide up this precious $350 billion is the Treasury Department’s principal occupation these days. Although the Treasury has its own calculations of the revenue loss associated with the tax proposals President Bush put forward in January, congressional rules require that only the estimates made by the Joint Committee on Taxation are valid. These data are posted here.

Looking at the JCT data, we see that the most popular tax provisions under consideration, those that would pass most easily, use up almost all the revenue available for a tax cut. These include expansion of the 10 percent and 15 percent income-tax brackets, acceleration of tax-rate reductions being phased-in under the 2001 tax bill, expansion of the standard deduction in order to redress the marriage penalty, an increase in the amount of income exempted from the alternative minimum tax, and an increase in the amount of equipment that small businesses can write-off immediately. Altogether, these provisions are estimated to reduce federal revenues by $333 billion between 2003 and 2013.

Clearly, this leaves very little room for President Bush’s signature initiative-eliminating the double taxation of corporate profits. That proposal alone would reduce revenues by $396 billion — more than the total mount of revenue available for the entire tax bill. Obviously, Congress is not going to pass a tax bill that does nothing except cut taxes on dividends. So, the question is, how to shoehorn as much of the dividend exemption into the money that is available.

House Ways and Means Committee Chairman Bill Thomas dealt with the problem by essentially abandoning the goal of fully eliminating taxes on dividends. He would establish a maximum tax rate on dividends of 15 percent — a significant reduction from the 38.6 percent top rate on ordinary income. This cut the cost to $246 billion — still too high for the Senate.

Senate Finance Committee Chairman Charles Grassley proposed phasing in the president’s dividend proposal and then sunsetting it after 2005. Under this plan, taxes on dividends would be eliminated for just one year and then they would be fully taxed, as they are now, beginning in 2006. The sole purpose of this maneuver was to squeeze as much of the president’s proposal into the amount of money available. According to the JCT, Grassley’s scheme would only cost $91 billion.

But even at a minuscule $91 billion — less than a fourth of what President Bush proposed — the dividend plan would not fit into the $350 billion cap without further adjustments. In committee, the dividend provision was further limited to an exemption of just $500 per taxpayer and Grassley proposed raising revenues by $63 billion. This got the net revenue loss for the entire tax bill down to $350 billion.

The Bush administration rejects the $500 cap as unacceptable. But it still has not decided how best to pursue its goal, given that there is really just $80 billion available at this point for whatever it chooses to support. Two options seem to be emerging. One is to press for full elimination of double taxation for just 3 years and then revisit the issue later. According to the JCT, this would cost $78.5 billion between 2004 and 2006. After that, dividends would be taxed as they are now.

The other idea is to do some variation of the Thomas proposal. Cutting the dividend tax and the capital-gains tax to 15 percent could be done for four years at a cost of $89 billion. Raising that rate to 16 percent or 17 percent would get that figure down under $80 billion. Some economists believe that this would give the economy more of a boost than a temporary elimination of double taxation.

In the days to come, President Bush will have to choose which way to go.

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