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Democrats Relish Battle Over High-Income Tax Cuts: Albert Hunt

For the past three decades in America, there have been heated fights over federal taxes. Politically, Republicans usually win.

This autumn, on the eve of an election in which the Democrats are struggling, Congress faces an epic political and economic battle over extending President George W. Bush’s tax cuts and other levies, including the controversial estate tax. This time, the Democrats may hold the upper hand.

The tax cuts, scheduled to expire at the end of 2010, were enacted during Bush’s first term. President Barack Obama and congressional Democratic leaders want to extend them only for couples making less than $250,000 and individuals making less than $200,000; Republicans have said they will only go along with a measure that includes breaks for the 2 percent or 3 percent of wealthier Americans, too.

“Raising taxes in this economy is a bad idea,” says Representative Paul Ryan of Wisconsin, the Republicans’ leading economic-policy authority in Congress.

“We like this argument,” White House Chief of Staff Rahm Emanuel said in an interview. “We stand for middle-class tax cuts; the Republicans are willing to hold that hostage on behalf of the top 2 percent.”

This isn’t a slam dunk for Democrats. By allowing the tax cuts for upper-income Americans to expire, opponents charge they would be jeopardizing an economic recovery and engaging in class warfare. Some Democrats are defecting.

Deficit Strategy

The Republicans’ difficulties are deeper. Out-of-control deficits have become a staple of the party’s midterm strategy; all but a handful of Republican lawmakers opposed extending unemployment benefits, demanding that Democrats find a way to pay for the $34 billion one-year cost. Extending the upper- income tax reduction would add more than $40 billion to the deficit the first year; if permanent, it would cost an estimated $800 billion over the next decade.

Yet proponents are resisting paying for these taxes.

Thus, Republicans are in the position of championing a provision that benefits only the top 2 percent to 3 percent of U.S. income earners and adds to the already huge deficit, which the Obama administration forecasts will be $1.47 trillion this year and $1.42 trillion next year.

The more articulate Republican advocates such as Ryan argue that the top tax brackets chiefly affect small businesses. Actually, fewer than 2 percent of small businesses fall into these brackets, according to the Tax Policy Center in Washington. And much of those are business income, partnerships and royalties from billionaires, athletes, lawyers and entertainers. There are few mom-and-pop corner stores or job- creating little ventures.

Little Stimulus

The case that these tax cuts are central to economic growth also falls apart, according to expert analyses. The Congressional Budget Office examined 11 different ways to stimulate the economy, and found extending the high-end Bush tax cuts provides the least bang for the buck. Channeling funds to states to avoid service cuts and higher taxes would generate three times the economic activity, the CBO reported. Goldman Sachs Group Inc. (GS) similarly estimates state and local assistance would boost economic growth by about twice as much as extending the tax cuts for wealthier Americans.

Almost certain to be thrown into the mix will be the estate tax. At the start of the decade, opponents of this tax imposed on only the richest of estates played budgetary gimmicks; the estate tax was eliminated entirely this year and then comes back in 2011 at the highest rate in years. Democrats want to impose a 45 percent estate tax only after exempting $3.5 million for an individual and $7 million for a couple; this is the level that prevailed in 2009.

Estate-Tax Fight

Republicans, with some supporting Democrats, want to exempt up to $10 million for a couple and reduce the rate to 35 percent, arguing they’re doing it to preserve small family businesses and farms. Two facts: At the 2009 rates, only one in every 400 estates paid any levy and, according to the Tax Policy Center, there were only about 100 genuinely small business or family farms. The more generous Republican proposal would create about $7 billion more red ink than the 2009 rates in the first year and more than $15 billion over two years.

The Democrats come to the table with two other strong suits. One is congressional budgetary rules, which allow for simple extension of the middle-income tax cuts. Simultaneously, there is a requirement that an extension of the upper bracket tax cuts must be offset with other tax increases or spending cuts.

Pay-as-You-Go Rules

For the $40 billion extension, proponents would then have to find massive spending cuts to finance lower taxes for the wealthiest Americans or waive the budget rules. That’s a fight Democrats relish.

The same budget rules require offsets for any estate-tax relief beyond the 2009 levels.

Moreover, the Democrats have politically attractive fallbacks if the argument that a tax increase will impede economic progress resonates. They could make the middle-income tax cuts permanent, while only extending those for the upper- income for a year. Privately, some Republicans know that would be the death knell for the upper-bracket cuts as they only have political juice when joined with overall tax cuts.

Alternatively, the Democrats could kill those tax cuts for the affluent and substitute a combination of assistance to hard- strapped state and local governments and a dose of deficit reduction. That would head off some tax increases from those places and avoid laying off cops, firemen and teachers. The Democrats have the better of this argument on deficit reduction, stimulus and politics.

September Battle

This will culminate in high political drama when lawmakers return in September. The measure probably will be considered initially by the Senate. Inaction, always a favorite fallback of politicians when there are tough fights with an election looming, is almost impossible; even worse for these politicos would be facing the voters with a massive tax increase on the horizon.

The calendar adds one more element to the Democrats’ rare upper hand in a tax fight.

(Albert R. Hunt is the executive editor for Washington at Bloomberg News. The opinions expressed are his own.)

To contact the writer of this column: Albert R. Hunt in Washington at ahunt1@bloomberg.net

To contact the editor responsible for this column: Max Berley at mberley@bloomberg.net.

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