Uncertainty continues as Congress kicks Bush tax cuts, extenders into lame duck session
The House and Senate wrapped up an abbreviated fall
work session September 30 without addressing the pending expiration of the
2001 and 2003 Bush tax 
cuts – reduced income tax rates as well as lower
rates on dividends and capital gains – or other urgent legislative priorities
such as the extension of business tax incentives that expired at the end of
last year, a permanent fix for the estate tax, and a “patch” for
the individual alternative minimum tax (AMT) for 2010. With lawmakers now in
full-time campaign mode in advance of the midterm elections, further action
on all of these issues is officially on hold until they return to Washington
for a lame duck session, which is scheduled to begin on November 15 and is
expected to last into December.
Exactly what will come out of the lame duck session is unclear. Democratic leaders in both chambers have publicly committed to taking care of the Bush tax cuts after the elections, but there is little unanimity over whether to extend the middle-class provisions temporarily or make them permanent, or whether to extend upper-income provisions in some fashion or allow them to expire. Leadership has been less vocal about their plans for extenders and the estate tax.
Adding to this uncertainty is the fact that the political dynamics of the lame duck session are likely to be shaped by the election results.
With these caveats in mind, here are our thoughts on the potential risks for the business community and high-income individuals when Congress returns to Capitol Hill after the election.
Bush tax cuts
We anticipate that any of several possible scenarios could come into play when Congress takes up the Bush tax cuts:
- There will be an agreement to extend low- and middle-income tax cuts – There is little doubt that Congress will extend either permanently or temporarily the tax cuts for low- and middle-income taxpayers, and will adopt a short-term AMT patch. These provisions have no opposition in either party. The difficulty will be accomplishing this objective in the context of disagreements over how to deal with high-income tax cuts.
- There is concern on both sides of aisle to keep capital gain and dividend rates lower – Congressional Republicans and some Democrats would like to preserve lower rates for long-term capital gains and dividends. If the Bush tax cuts expire, the top rate on capital gains will increase to 20 percent and the top rate for dividends will jump to 39.6 percent in 2011. Continuing to align the dividend rate with that of capital gains will require Congress to confront pay-as-you-go (PAYGO) rules, which mandate that the cost of cuts in this area be offset with revenue raisers. If Congress decides to pay for the relief, a lower dividend rate is more likely to be only temporary. It’s likely a compromise will be reached to keep the dividend rate at least somewhat lower than ordinary income rates.
- In the House, election results will shape the debate over high-income tax cuts – Tax cuts for high-income individuals will remain in play, and the outcome of the midterm elections may cause House Democrats to rethink their positions. President Obama and House Speaker Nancy Pelosi, D-Calif., have maintained that tax cuts for high-income taxpayers – individuals earning over $200,000 a year and joint filers earning over $250,000 – should be allowed to expire. But many election-vulnerable conservative and moderate Democrats in that chamber now favor at least a temporary extension of high-income taxpayer cuts. The elections will either bolster this position or liberate members to support the position of the administration and their leadership. This will be true particularly in the case of lawmakers who have lost their re-election bids. As such, it’s hard to predict exactly how the House will act on these.
- Senate more likely to extend tax cuts for all taxpayers – The Senate currently seems poised to extend all the Bush cuts temporarily (and patch the AMT), which could result in a fight between chambers.
- ‘High-income’ could be redefined – Members in both chambers may seek to redefine ‘high-income’ and develop thresholds higher than the current $200,000 for singles and $250,000 for couples. Some members have suggested thresholds of either $500,000 or $1 million.
- Meltdown – Congress could reach an impasse and not resolve the tax cut issue until early next year, although at this point the risk of this happening seems low. However, if Republicans secure a majority in the House and stronger representation in the Senate, they may try to position themselves for this option, giving them greater influence on the outcome.
Estate tax
Thus far, the estate tax has not been actively tied into the debate surrounding expiring tax cuts. The Senate and House continue to take different paths in reforming the tax. Recent proposals in both chambers would be more generous than a return to the pre-2001 estate tax structure in 2011, but the Senate has generally sought a lower rate and higher exemption for the largest estates as opposed to the more progressive rate structures considered by the House.
Congress may attempt to reform the estate tax during the lame duck session, but it’s more likely that the pressure of time and politics in the Senate will cause the issue to spill over into the new Congress. Taxwriters have already let this issue lapse once with little consequence. Expedient resolution remains a lesser priority than the overwhelming issue of expiring income tax rates.
PAYGO risks ahead
Whatever happens during the lame duck session will take place against a backdrop of rising concerns over federal deficits, spending demands exacerbated by the recession, fear that tax increases could stall the recovery, and a potentially more polarized post-election political environment in Washington. But even though uncertainty abounds, there are a few observations that may help define the realm of what’s possible.
First, regardless of the outcome of the midterm elections, one thing is clear: Congress will require that any new spending or tax cuts be offset by comparable tax increases and/or spending cuts. The statutory PAYGO rules enacted earlier this year provide exceptions for permanent extensions of middle-income tax relief enacted in 2001 and 2003, a temporary AMT patch, and a temporary fix to prevent the estate tax from returning to its pre-2001 levels next year. The PAYGO rules do not, however, explicitly address keeping the tax rate on qualified dividend income at 20 percent for upper-income taxpayers, nor do they exempt extensions of expired business and individual tax incentives.
Second, in the lame duck session, revenue offsets such as carried interest, GRATs, increases to the oil spill liability trust fund tax, boot-within-gain, offshore reinsurance, and other corporate and international tax increase proposals that have been introduced over the course of the past year are still expected to comprise the menu of options as lawmakers struggle to pay for priorities not covered by extant PAYGO exceptions. While the current Democratic majority has turned to tax provisions to satisfy PAYGO, Republicans have sought to pay for tax relief with spending cuts. As a result, significant Republican gains in the midterm election in either the House or the Senate would only serve to make it more difficult for members to identify or introduce new revenue-raising options in lame duck.
Third, because there is no congressional budget agreement in place, lawmakers cannot rely on reconciliation instructions to fast-track legislation through the Senate. Any tax bill will have to move through the Senate under regular order which, in essence, means that 60 votes are required for passage.
Finally, the current legislative environment marks a departure from historical operations under PAYGO rules. In the past, tax increases under PAYGO have been dedicated as offsets to pay for tax cuts. However, several legislative proposals put forward this year, including the recently enacted H.R. 1586, have leveraged tax increases to offset spending priorities outside of the jurisdiction of the taxwriting committees. This trend, when taken in the context of Congress’s growing reticence for deficit spending, could have broad implications both for revenue-raising risks (to pay for both tax and nontax legislative priorities) and member willingness to preserve PAYGO exceptions as they confront the 2001 and 2003 tax cuts and other tax legislation in lame duck and beyond. Similarly, any Republican-backed efforts to use spending cuts to offset tax cuts would significantly complicate the tax legislative process.
Depending on the outcome of the elections and on what lawmakers are able to accomplish in the lame duck session, the current level of tax uncertainty may continue as the 112th Congress convenes in January. We will keep you apprised of developments in the post-election session as they occur, and offer our thoughts on how those developments will shape the tax landscape for next year.
— Clint Stretch
Managing Principal, Tax Policy
Deloitte Tax LLP