Tax Cut Endgame

Published: November 11, 2005

Despite intense pressure from Senate leadership, Sen. Olympia Snowe has continued to point out a connection in fiscal rationality the public already sees. Though Congress has split its budget bills between spending and tax cuts, the two are linked, and the cuts to spending programs while also offering tax breaks overwhelmingly to the upper tax brackets are unacceptable.

With the Senate Finance Committee split, with 11 Republican and eight Democratic members and one independent who will vote with the Democrats, Sen. Snowe's vote is crucial for Republicans to avoid a 10-10 deadlock. There are other ways for Republican leadership to move tax cuts to the floor of the Senate, and indeed some, such as the alternative minimum tax exemption and a research and development tax cut, expire this year and should be extended.

Sen. Snowe's justifiable objection is to extending tax breaks for capital gains and dividends, breaks that will not expire until 2008 and disproportionately benefit the very rich, those with incomes above $1 million annually. These extensions are being proposed as both House and Senate contemplate reducing services in areas such as foster care, Medicaid, food stamps and Temporary Assistance for Needy Families. Sen. Snowe has made the connection; the question is whether a sufficient number of other senators will too.

If the tax-cut legislation makes it to the floor of the Senate, Sen. Snowe will need to be joined by a large majority of Democrats and seven or eight Republicans to strike the objectionable language. The vote by Sen. Susan Collins will matter enormously if these cuts are to be removed, but Sen. Collins says the cuts provide economic stimulus and should be extended now.

Economists at the Tax Policy Center recently looked at capital gains rates going back to 1955 and conclude the following: "Capital gains rates display no contemporaneous correlation with real [gross domestic product] growth during the last 50 years," nor do they show a significant effect when accounting for a lag of up to five years. In a related paper by economists William Gale and Peter Orszag, on the effects of the 2003 tax cuts, including cuts on capital gains and dividends, the cuts "almost uniformly raise the user cost of capital," when the cost of the deficit is taken into account.

Even if there is a benefit to the economy in the extensions, it will not be found this year or for the next several. Meanwhile, the reductions in programs will arrive and the deficit will deepen.