The Tax-Cut Tango

Conservative rate-cutters and moderate redistributionists are still miles apart, but both sides have their reasons to get in step -- and soon

By Howard Gleckman

Take a ringside seat. House and Senate negotiators are about to get into a classic ideological slugfest over the fate of the $1.35 trillion, 11-year tax cut. The House-Senate conference on the tax bill begins on May 22.

In one corner, there are conservatives, most of them in the House, who want to see deeper rate cuts, especially for top-bracket taxpayers. In the other sits a band of about a dozen Democratic and Republican Senate moderates. They hold the key to the future of this bill. And they're insisting that the final version include new benefits for low- and moderate-income taxpayers.

When the dust clears -- House and Senate leaders say they want a final measure by Friday, May 25 -- President Bush and his congressional allies will get most of what they want. But not all. The moderates will give them their tax bill, but they'll extract a price.

Here's where we're at: The House bill followed President Bush's model and cut the top tax rate from 39.6% to 33% -- a level that has taken on great symbolic importance for conservatives. The Senate bill merely cut the top rate to 36%. Senators used the money that might have gone to a lower 33% rate for the wealthy to attract the support of such moderates as Olympia Snowe (R-Maine), Blanche Lincoln (D-Ark.), and their ringleader, John Breaux (D-La.). How? The Senate bill provided new benefits worth hundreds of dollars a year to working families making up to $30,000. And it gave a new tax deduction for college-tuition payments that would mostly benefit the middle class.

10% BRACKET.

  Underlying the whole debate is the very unusual way in which the Senate bill phases in tax breaks. It's extremely generous to low- and moderate-income taxpayers in its early years. For instance, folks making up to $40,000 would get nearly one-third of all the tax cuts this year, while those making more than $100,000 would get barely 2%, according to the Congressional Joint Committee on Taxation. That's because the Senate bill would immediately create a new 10% bracket (instead of the existing 15% rate) for taxable income below $6,000 for singles, or $12,000 for couples. The newer tax rate will help everybody, but it benefits those at the bottom of the economic food chain the most. In addition, those targeted breaks for low-income families and the college deduction would start right away.

By contrast, it will be years before the wealthy enjoy the tax cuts intended for them. Top-bracket rate reductions don't completely kick in until 2007, and other income tax cuts wait until 2009 or 2010. And estate-tax repeal won't happen until 2011. And when all that happens a decade in the future, the benefits of this tax cut will flip, according to a comparable -- though slightly different -- analysis by a private group called the Citizens for Tax Justice. In 2011, those earning less than $44,000 -- in 2001 dollars -- would get about just 15% of the benefits. But those making more than $147,000 would get 46%.

Conservatives aren't stupid. They know that tax cuts that are supposed to kick in 2011 are problematic at best. And when it comes to tax policy, Rule No. 1 is take the money and run. So they are digging in for a fight.

SMALL CHANGE.

  There are both political and economic reasons for their hard line. The politics is that the Senate tax cuts would provide little more than small change for many GOP constituents when they go to the polls for the 2002 election. But Democratic voters would enjoy a sweet little windfall. And if this bill is going to boost the economy, psychology matters. The extra cash in people's pockets this year is one dimension of the expectations game. But at the second level, there's the euphoria over more tax breaks to come. Trouble is, who is going to save and invest more today on the promise of tax cuts five years from now?

In the end, don't be too surprised if House and Senate negotiators knock that top rate down another notch -- perhaps to 35% or even 34%. But they'll find a way to fund those lower-income tax breaks as well -- and make them take effect immediately upon the final measure being signed after Memorial Day. How will they squeeze an extra $100 billion or so in a bill whose price is suppose to be capped at $1.35 trillion? The answer to that, I suspect, will be more gimmicks and more phase-outs. In Congress, you can always get what you want. You just have to rejig the numbers a bit.

Gleckman is covering the tax bill for Business Week from Washington. Follow his views every Tuesday in Washington Watch, only on BW Online

Edited by Douglas Harbrecht