November 22, 2006

Why We're (Cautiously) Optimistic About the Next Congress

November Election a Stunning Victory for Progressive Taxation

On Tuesday, November 7, the Democrats took both chambers of the U.S. Congress, gaining six seats in the Senate and at least 29 seats in the House (some recounts are pending). No Democrats lost a seat.

Perhaps less noticed are the consequences for tax policy. Of the 24 incumbents who ran for reelection and lost, 23 received a failing score on CTJ's Congressional Tax Report Card published on October 16. (The only one with a passing grade was Rhode Island's Senator Lincoln Chafee, who received an 80%.)

Also, of the 24 who ran for reelection and lost, 21 actually scored a zero on CTJ's report card. (The exceptions are Senator Chafee, Ohio's Senator Dewine with 20% and New Hampshire's Representative Charles Bass with 17%).

CTJ's report card looked at six key tax votes in the House and Senate. Five are bills that were enacted into law. They included the big 2001 tax cuts, the 2002 corporate tax cuts, the 2003 capital gains and dividend breaks, the 2004 corporate tax giveaway, and the 2005 tax cut bill (which was actually enacted in early 2006). The bill that was narrowly rejected was the 2006 effort to repeal the estate tax.

While it is too early to know if the new members will strongly support progressive taxation, these results are extremely encouraging. They signal that voters are not blindly supporting any type of tax break regardless of who it benefits or what it means for our nation's fiscal health.

Tough Choices Ahead on AMT, PAYGO

But that doesn't necessarily mean easy sailing for progressive taxes and fiscal sanity. The Democratic Congress that takes power in January will inherit massive deficits and regressive tax breaks (income, capital gains, dividend and estate tax and other types of tax breaks) that won't expire until 2010. Any attempt to repeal them now would surely be vetoed by the President.

What the Democrats really need to decide is how far to go in extending tax breaks that help the middle-class (as they often pledged to do during the campaigns) and also how to pay for them. Charlie Rangel (D-NY), who will become the chairman of the House Ways and Means Committee that will initiate tax policy, has talked of making permanent the research and development credit (which is currently part of the tax extenders that must be renewed every couple years), making college tuition permanently deductible and preventing the alternative minimum tax (AMT) from affecting middle-class families. The last point is one that would get wide agreement in principle but a conflict could easily erupt over how it should be paid for.

The AMT is basically a backstop to the federal income tax designed to ensure that wealthy people with deductions, credits, capital gains or other tax advantages are not able to avoid paying their fair share. Unless it is changed, the AMT will start affecting more middle-class and upper-middle-class people because the exemptions built into it are not indexed for inflation and because the Bush tax breaks generally lowered taxes without changing the AMT.

The tax reconciliation bill Congress passed early this year included a "patch" for this problem, increasing the exemption levels through 2006 and extending a rule allowing taxpayers to use non-refundable personal credits to offset the AMT. Extending this patch for one year is estimated to cost $40 billion and providing a permanent fix could cost nearly $1 trillion over a decade.

Whereas the outgoing Republican leadership saw no problems with deficit-financed tax breaks, the new Democratic leadership has pledged to restore pay-as-you-go (PAYGO) rules, meaning any new entitlement spending and any new tax breaks (including changing the AMT) must be paid for. Democratic leaders have discussed ways to offset tax breaks by increasing compliance and closing corporate loopholes. The big unanswered question is whether Democrats - perhaps with the help of moderate Republicans - will be able to reconcile their desire to move forward with some tax breaks with their pledge not to increase the deficit.

One of the best rhetorical weapons used by critics of the President's tax breaks is that they are not paid for. The President is digging us in a hole by giving away tax breaks to rich people. It would sure be a shame if Democrats ceded the high-ground forgetting about PAYGO, which is the only budget process reform that has ever effectively reduced deficits.


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