Senate Begins to Take on Taxes

What to do about the 2001 and 2003 tax cuts that are set to expire at the end of the year has been a critical question that Congress has largely ducked so far. But a Senate hearing yesterday marked the beginning of what will likely be a contentious debate. The hearing previewed some of the messages that will be used during the upcoming debate and underscored the need for serious reform of the tax system and an eye on debt reduction.

Shaping the tax debate are rising concerns over the long-term budget picture and election-year politics. President Obama has promised to permanently extend the tax cuts for the “middle class” – classified as those individuals who make less than $200,000 a year and families that bring in less than $250,000. But leaders in Congress, looking for ways to close the fiscal gap, have signaled that they won’t necessarily follow that path.

Senate Finance Committee Chairman Max Baucus (D-MT) kicked-off the hearing by stating that the budget deficit was the “elephant in the room” in considering extending the tax cuts and questioned whether tax breaks for the wealthy could be maintained in such a fiscal environment. He urged his colleagues to proceed with “an eye on the budget picture.”

Witnesses at the hearing were CRFB board member Douglas Holtz-Eakin of the American Action Forum, Donald Marron of the Tax Policy Center, Leonard Burman of Syracuse University, CPA Carol Markman, and David Marzahl of the Center for Economic Progress. While they disagreed on what to do exactly about the tax cuts, there was broad agreement on the need for comprehensive tax reform.

Burman argued against permanent extension of the tax cuts because it would make tax reform more difficult; stating in his written testimony that “A system-wide reform along the lines of the Tax Reform Act of 1986, but with the goal of eventually raising enough revenue get the national debt out of the red zone should be a top priority for the Congress.” At the same time he asserted that allowing the middle-class tax cuts to expire now would hamper the economic recovery. He proposed a two-year extension, with Congress committing to a tax reform plan before the temporary extension expires.

Burman also advised a focus on reigning in America’s long-term debt and suggested the solution will be a combination of taxes and reduced spending. His recommended three goals for budget and tax policy:

• Do not stifle the nascent economic recovery.

• Implement a credible plan to get the debt down to a sustainable level within the next decade.

• Reform the tax system to make it simpler, fairer, and more conducive to economic growth.

Holtz-Eakin agreed with Burman on the need for deep tax reform, but contended that extending the tax cuts would ease the path to reform, not make it more difficult. He also agreed that the growth in debt must be addressed, but contended that the focus should be on reducing federal spending.

He argued for a “ruthless” focus on economic growth and claimed that extending the tax cuts would promote growth through providing tax law certainty and lower rates for small businesses, while a temporary and partial extension would not encourage sufficient growth. Burman, on the other hand, testified that a continuation of current policy would not promote growth, instead putting us on the path to being Greece. Whereas Burman argued that temporarily keeping the tax cuts affecting middle- and lower-class taxpayers would aide the economy by propping up consumer spending while higher marginal income tax rates for high-income earners would have little impact on spending or entrepreneurship, Holtz-Eakin countered that maintaining lower rates would help small businesses while some provisions like refundable tax credits and marriage tax relief have no impact on growth.

Marron concurred that fundamental tax reform and debt reduction must be pursued. He also noted that many analysts believe that the economic benefits of extending some or all of the tax cuts will be maximized if they are offset.

The House leadership is reportedly considering a one-year extension of the middle-class tax cuts and a two-year extension of the “patch” preventing the Alternative Minimum Tax (AMT) from hitting middle-class taxpayers. CRFB supports fundamental tax reform that broadens the tax base and is more efficient. We have also suggested a temporary extension of the tax cuts in conjunction with a commitment to adopt a credible plan to stabilize the debt at a reasonable level.