Tax Cut Politics

The Bush administration is understandably upset that its proposal for a $726 billion tax cut has effectively been watered down to $350 billion in the Senate and $550 billion in the House. However, this is less of a barrier to enactment of the administration’s initiative than it may appear at first glance. The situation is very confusing, but bear with me.

First, it is important to understand that President Bush actually asked for a tax cut of $1.3 trillion in the first place, not $726 billion. The balance is mostly an extension of tax cuts enacted in 2001 that, because of a Senate rule, were required to expire in 2011. This rule mandates that tax cuts (or increases) may not be in effect for more than 10 years if enacted under a procedure called “reconciliation.”

Reconciliation is a provision of the Budget Act of 1974 originally designed to enact spending cuts or tax increases necessary to achieve budget targets. These targets are contained in a budget resolution that Congress is required to enact annually, which sets a limit on spending and a floor on revenues. The critical importance of reconciliation is that it imposes a limit of 20 hours on debate.

Although designed to cut spending or raise taxes, Republicans figured out that reconciliation could also be used to cut taxes. The benefit is that it prevents Democrats from filibustering such legislation in the Senate. It is important, therefore, to understand that all of the numbers we hear in the press — whether $726 billion, $550 billion or $350 billion — apply only to that portion of the tax cut that would be passed under reconciliation. Larger tax cuts could be passed under the budget resolution, but would be threatened by a Senate filibuster. It takes 60 votes in the Senate to break a filibuster, but Republicans only have 51 votes.

It is also important to understand that whatever number governs the tax cut is a net number — that is, its impact on the deficit. Consequently, even if forced to work within a $350 billion tax number, Congress could enact a tax cut much larger so long as sufficient revenue raisers offset it. For example, Congress could enact a $1 trillion tax cut that includes $650 billion in tax increases, leaving the net increase in the deficit at the $350 billion allowed in the Senate.

Those curious about how Congress might raise revenue to offset the gross cost of a tax cut should consult a new publication from the Congressional Budget Office called, “Budget Options.” Chapter 3 contains a laundry list of ideas for raising taxes that Congress often turns to when the need arises. Another source is the so-called tax expenditures budget. Tax expenditures are provisions of the Tax Code that are deemed to be illegitimate “tax loopholes,” even though tax experts judge many of them to be entirely appropriate and, indeed, necessary.

Then there is the problem of Sen. Charles Grassley, R-Iowa, chairman of the Senate Finance Committee, who gave his word to Sens. George Voinovich, R-Ohio, and Olympia Snowe, R-Maine, not to support a tax cut larger than $350 billion in conference.

However, House leaders think refusing to go to conference and forcing a Senate vote on a $550 billion House bill can avoid this prohibition. The Senate parliamentarian has ruled that despite a proviso in the budget resolution limiting the tax cut to $350 billion in the Senate, a $550 billion could still be passed under reconciliation rules in this way.

Finally, just to make the situation totally incomprehensible, the $350 billion or $550 billion limit is an aggregate, 10-year figure. There is nothing in the budget resolution that says such a tax cut must be done in $35 billion or $55 billion per-year increments. Therefore, in theory, Congress could enact a $350 billion or $550 billion tax cut that is in effect for just a single year and then expires, and still fit within the parameters of the budget resolution. Indeed, it is almost certain that whatever tax cut Congress enacts will be front-loaded in order to maximize its short-run stimulus.

At this point, it is impossible to predict what will happen. All we know with certainty is that the House Ways & Means Committee will report a tax cut worth $550 billion by May 8. Since President Bush asked for $726 billion, something will have to give. By that same date, the Senate Finance Committee is required to report a $350 billion tax cut, so something more will have to give. What legislation — if any — can or will pass Congress and what it will contain at the end of the day, no one can say. But even the lower number leaves lots of room within which to maneuver.