REVIEW & OUTLOOK
A GOP Tax Increase?
Some Senators are eyeing rates on capital gains and dividends.
The stalwart performance of stock and bond markets in the past three weeks suggests that investors believe the U.S. economy can bear the shock of Katrina. The political shock from the Beltway is a more serious matter.
Markets have begun to get rattled in the last couple of days, both in fear of further damage in the Gulf region from Hurricane Rita, and in response to the bad ideas that are starting to flow fast and furious from Congress. These include Senate Minority Leader Harry Reid's endorsement of energy price controls (to stop "gouging"), gasoline tax increases, suspension of the new bankruptcy law, and even a revival of the oil "windfall profits" tax. When Jimmy Carter embraced this latter brainstorm in the 1970s, it exacerbated the energy crisis by slowing oil exploration in America and keeping oil prices higher than they had to be.
But the worst news is that a handful of GOP Senators think a tax increase is needed to pay for Katrina spending. Their immediate target is the 15% rate on capital gains and dividends that was a crucial part of the wildly successful 2003 tax cuts. Those rates are set to expire in 2008, which would mean a big tax increase back to a 35% rate on dividends, and 20% on capital gains.
To prevent such a tax hike, Republicans have included a two-year extension on the 15% rates, to 2010, in this year's budget reconciliation bill. Under Congress's arcane budget rules, this means the extensions can pass with 50 Senate votes, instead of 60. Before Katrina, they were all set to pass.
But now some GOP Senators are suggesting that they should redo reconciliation and drop the capital gains and dividend tax cuts. We're told Ohio's George Voinovich, New Hampshire's Judd Gregg and Maine's Olympia Snowe are three of the troublemakers. As ominously, Majority Leader Bill Frist's chief budget aide, Bill Hoagland, has floated the idea on the record in this newspaper. If this is the kind of advice Mr. Frist is getting, much less listening to, he's going to have a hard time ever becoming President. One bit of good news is that Senate Finance Chairman Chuck Grassley is so far holding firm on the extensions.
Someone should tell Mr. Frist about the following number: $262 billion. That's the amount of additional revenue that the federal government will collect in the fiscal year that ends this month, a roughly 15% increase. This is the largest annual increase in federal revenues, even after inflation, in American history. And it had reduced this year's federal budget deficit--before Katrina--by more than $100 billion, to about 2.7% of GDP, or close to the modern average.
One large reason for this revenue boom is the lower tax rates on capital and income. Since they passed in 2003, the economy has grown at an average rate of roughly 4%, the stock market has recovered most of what it lost when the tech and dot-com bubbles burst, and some four million more Americans are working and paying taxes. All of this has helped fill federal coffers and will also help offset the cost of Katrina.
The tax hike crowd will fret about "deficit spending," as if they're worrying about that as they use Katrina as an excuse to spend more on everything. But the budget impact of dropping the rate cuts would be small--a mere $20 billion from 2008 to 2010--even under the static revenue calculations of Congress's Joint Tax Committee. In the real world where people consider incentives to invest, the revenue "loss" would be much less, and maybe none at all. In any case, how does canceling the extension of tax cuts scheduled to expire in 2008 help to finance the immediate and one-time cost of underwriting Katrina's cleanup?
Investment decisions are already being made with the year 2008 in mind, so failing to extend the lower rates will soon have economic consequences. Worse, dropping them from the budget would send markets the signal that Washington is back in a tax-raising phase. It would say that, even with their strong Congressional majorities, Republicans lack the political will to make any of the Bush tax cuts permanent. For that matter, it will signal that the entire Bush agenda is moribund, and that the political rout to 2006 is on.
We can understand why some Democrats would want Republicans to repudiate their own tax policies. But why Republicans would want to join in this act of masochism is a mystery. President Bush has ruled out tax increases to finance Katrina relief, but we hope someone in the White House is telling him what Members of his own party are doing in the Senate. Katrina has already done enough damage, without the political class compounding it with policy blunders.
