Bush Pushes Retroactive Tax Cut to Jump-Start Economy

Wednesday, February 28, 2001

Deloitte & Touche OnLine

Calling tax relief an “urgent” priority to stimulate a flagging economy, President George W. Bush on February 27 repeated his call for a broad-based retroactive tax cut before a Joint Session of Congress.

“To create economic growth, we must put money back in the hands of the people who earned it, and we must act quickly. I want to jump-start the economy by making the tax cut retroactive,” Bush said. “In my plan, no one is targeted in and no one is targeted out. Everyone who pays taxes should get their taxes cut.”

The address served as a preview of the president’s budget plan. Bush is set to release an overview of his budget February 28; he will submit a more detailed budget in late March or early April. The budget submission is expected to reaffirm his commitment to a 10-year $1.6 trillion tax cut but is likely to offer no more details than a version of his proposal sent to Congress on February 8. (For prior coverage, see Tax News & Views, Vol. 2, No. 9, Feb. 8, 2001).

Only an Opening Bid -- Bush’s budget submission is only a request for legislation. It is up to Congress to accept, reject, or modify any of his proposals.  One of the uncertainties for the Bush plan is whether what has been proposed fits within the $1.6 trillion figure.

Because he is working with a Republican Congress, Bush’s proposals will likely receive a more sympathetic reception than those put forth by President Clinton.  “I’m ready to respond to the president’s request,” House Ways and Means Committee Chairman Bill Thomas, R-Calif., said after Bush concluded his address. “We’ll move the tax bill quickly and make it retroactive,” he said.

Senate Finance Committee Chairman Charles Grassley, R-Iowa, proved equally receptive, noting that “we’ve overtaxed the people at the highest levels since World War II.” The magnitude of Bush’s proposed tax relief “is the third smallest tax decrease we’ve had in the last century,” he said.

President Bush’s Program -- Citing a litany of proposals targeted largely toward individuals, the president pledged to --

• reduce marginal income tax rates from 15, 28, 31, 36, and 39.6 percent to 10, 15, 25 and 33 percent;

•  eliminate the estate tax;

• double the child credit to $1,000;

•   reduce the marriage penalty by allowing a lower-earning spouse to take a 10 percent second earner deduction;

•  increase charitable contributions principally by allowing individuals to claim an above-the-line deduction on donations; and

• expand education IRAs to elementary and secondary school students and raise contribution limits.

The only significant business tax proposal expected to appear in Bush’s budget is a permanent extension of the research and development (R&D) tax credit, currently scheduled to expire on June 30, 2004.

To deal with the politically sensitive issues of Social Security and Medicare, the president proposed two initiatives. First, Bush’s budget included a $1 trillion set-aside from Social Security and Medicare surpluses of uncommitted funds that may be used to finance private retirement accounts, according to published reports. This proposal would not affect the amount of money available for tax reductions since funds for that purpose come from non-Social Security revenue.

Second, he would like to establish a blue-ribbon commission that would recommend changes to Social Security to bring the program into long-term actuarial balance. Together, these proposals are likely to shield Bush and congressional Republicans from charges that they were seeking to cut taxes at the expense of future retirees.

Do All The Pieces Fit? -- But objections to the size of the tax plan are already coming from Democrats and moderate Republicans.  They claim that the cost of the proposed relief is understated and would, when combined with projected spending increases, exceed projected surpluses.  Led by Senate Budget Committee Ranking Democrat Kent Conrad, D-N.D., critics charge the Bush tax plan would cost $2.2 trillion over 10 years.  They claim proponents have disregarded increased interest costs necessary to finance the publicly held debt, as well as increased incidence of the alternative minimum tax on individuals brought about by the tax plan.  Enacting routinely extended expiring tax provisions, such as the subpart F exemption for active income financing, would add approximately $100 billion to the price of tax relief, bringing the total to $2.3 trillion.

This problem is further exacerbated by the fact that recent estimates by the staff of the Joint Committee on Taxation (JCT) indicate that permanently extending the R&D credit could cost $47 billion over 10 years. That estimate, if accurate, may make such an extension too expensive.  Last year, a permanent extension was estimated by the JCT at $23 billion.  JCT Staff Chief Lindy Paull has noted that this increase is due partly to adding another year to the budget cycle, but is attributable primarily to increased use of the credit by U.S. companies.

House Makes the First Move -- The House GOP leadership seems determined to move all or part of the Bush tax cut as soon as possible regardless of the formal budget process restrictions.  A Ways and Means Committee markup of legislation that would reduce marginal income tax rates could come as early as March 1. Republican tax aides, however, have indicated that a markup may have to wait until next week because JCT cost estimates of marginal rate cuts are totaling more than expected. This problem could be aggravated now that Bush is calling for retroactive tax cuts. Consequently, members may need more time to fine-tune their proposals. The legislation could reach the House floor for a vote by mid-March.

The House is expected to move other legislation implementing Bush’s proposals in piecemeal fashion following efforts to reduce rates.  It also may consider other tax relief proposals outside of the Bush plan, including bills that would raise contribution limits on tax-deferred retirement savings accounts -- such as 401(k)s and individual retirement accounts -- and eliminate the telecommunications excise tax.

House Speaker Dennis Hastert, R-Ill., has said Congress should pass large tax reductions by July 4. House leaders have said they hope their efforts to push a tax bill sooner rather than later will create additional momentum in the Senate.

Senate Action to Follow -- In the Senate, tax legislation will move more slowly, though Senate Majority Leader Trent Lott, R-Miss., has indicated he too would like to move a bill by the July 4 recess.  Senate Republicans have expressed a desire to pass a budget resolution -- a fiscal blueprint agreed to by both the House and Senate that lays out a set amount of funds available for a tax cut -- prior to moving tax legislation.  Importantly, the budget resolution is the only vehicle that can authorize reconciliation, a procedure by which tax bills can be granted safeguards in the Senate, including immunity from extended debate. 

Insiders speculate that it will be impossible for the Senate to pass a tax bill if it does not have reconciliation protection.  Senate leaders will likely move one or two tax bills this year.  Because the Constitution requires all tax legislation to originate in the House, the Senate will likely wait until the House has acted on at least several bills before moving a larger one of its own.

Historical precedent would suggest that Congress is unlikely to complete the budget resolution until some time in April.  It is as yet unclear if there will be enough support in the Senate to pass a resolution calling for $1.6 trillion in tax relief.  Published press reports indicate that Senate Budget Committee Chairman Pete Domenici, R-N.M., has told President Bush he may not have enough votes to bring the resolution through his committee.  If the committee were unable to pass the resolution, Senate leaders could bypass the panel and bring it directly to the floor for a vote. Senator Lott has said he believes he may have sufficient Democratic support to pass it on the floor.

Too Good to Be True? -- Although there is broad support for tax relief among both Republicans and Democrats, the form and scope tax cuts may take is unclear.  Most Republicans support tax cuts of at least $1.6 trillion over 10 years. Democrats would like to keep the amount closer to
$750 billion, but have not decided which specific tax cuts to embrace. They have merely agreed to devote one-third of the surplus each to cutting taxes, repaying the publicly held debt, and increasing spending. 

“We can’t spend the entire surplus on a tax cut. If what the president said tonight sounds too good to be true, it probably is,” said House Minority Leader Richard Gephardt, D-Mo., during the Democratic response to the president’s address.

Senate Minority leader Thomas Daschle, D-S.D, agreed. “We want a significant tax cut this year, but we want a different kind of tax cut -- one that is part of a responsible budget. All Americans deserve a tax cut, but surely the wealthiest shouldn’t get it at the expense of working families.”

“The president’s tax plan is far more expensive than the $1.6 trillion he claimed,” Daschle continued. “The president’s plan relies on a 10-year budget forecast, which is no more reliable than a 10-year weather forecast. No one’s crystal ball is that good.”

Moreover, neither side has indicated that it is completely committed to the Bush proposal and may wish to add other priorities.  As mentioned, Republicans may wish to expand tax-preferred retirement savings vehicles, while Democrats may want to target more provisions to middle-income taxpayers.  An evenly divided Senate may force GOP members to compromise with Democrats or even among themselves along either of these two dimensions in exchange for votes.

The Budget Constraint -- The Congressional Budget Office forecasts a $3.1 trillion non-Social Security surplus between 2002-2011, which Republicans say is more than enough to finance tax reductions.  Democrats, however, say this amount should be reduced to $2.7 trillion, as they argue surplus Medicare funds should not be used for tax reductions.  While these surpluses seem to indicate that there are enough resources available for a $2.3 trillion tax cut, they assume discretionary spending will grow at the rate of inflation. 

Over the past three years, discretionary spending has grown by an average of 6 percent per year, almost twice that of inflation.  Although President Bush wants to reduce spending growth to only 4 percent per year, this may not be enough to satisfy the appetite of congressional appropriators.  It is as yet unclear if there will be enough funds to both reduce taxes and increase spending.  Moreover, it is not certain how appropriators would be able to implement significant tax cuts and spending increases without triggering a budget deficit -- a difficult choice.

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