The U.S. legislative system seems, at times, designed not to work. (A more positive spin, of course, is that it's designed to build consensus -- but we'll leave the positive spinning to the legislators themselves.) The Republican's narrow Congressional victory won't have an immediate, dramatic impact on most areas of domestic policy -- with perhaps one exception.
"The odds are we'll see additional fiscal stimulus," says Christopher Wiegand, an economist at Salomon Smith Barney/Citbank. "And that means tax cuts and defense spending -- and we'll see both in the next 18 to 24 months."
First on the Republican agenda will surely be making last year's $1 trillion tax cut permanent. Currently, with the exception of a few provisions, the package is set to expire in 2010, which means in 2011 the tax law will revert to what it was in 2001.
"That's the top priority," says Chris Edwards, director of fiscal policy at the Cato Institute, a right-wing think tank. "That will begin at the start of the new session
in January 2003."
Perhaps the most controversial aspect of President Bush's 2001 tax cut is the elimination of the estate tax. Back in June, Congress voted against making that part of the package permanent. (For more on this, see
Repeal of the Estate Tax Not Good for Any of Us.) This issue will return, and pose a challenge to Democrats.
"This will be a litmus test for Democrats," says Henry Aaron, senior fellow at the Brookings Institute. "If they can't get together on the issue of estate tax
and prevent if from being repealed, they're surrendering one of the fundamental differences between their party and the Republican party."
The Republicans have only a small Congressional majority, likely just 52 Senate seats. "It only takes 41 votes to block any effort to make the tax cut permanent," Aaron says. And if the Democrats are the least bit organized, they'll have the votes to do it.
And Another Thing . . .
The Republicans have more on tap than just last year's tax cuts, though. "Pension liberalization will be a big topic," Edwards says. That sweeping term incorporates a slew of proposals to give taxpayers bigger breaks when investing through their 401(k) and IRA plans. Among them: increasing the annual contribution amounts, raising the age at which IRA withdrawals become mandatory, and greatly increasing or even eliminating the contribution limits for Roth IRAs.
Democrats have already demonstrated a willingness to provide incentives for increased retirement savings. And proposals such as eliminating contribution limits for Roth IRAs may be more appealing, since they won't have an immediate impact on the federal deficit. That's because the money that goes into a Roth IRA has already been taxed (in other words, the government has already collected its revenue), and investors don't get the break until they withdraw funds years later. (That's unlike what happens when contribution amounts to company retirement plans or IRAs are increased: Because the money people contribute doesn't get taxed, the government loses revenue every time it allows people to save more pretax money.) "If the proposals are crafted right," Edwards says, "Congress could get bipartisan support."
But why stop there? Republicans are also sure to raise their old standby of reducing the capital gains tax. "That provides an immediate increase in the value of all stocks," Edwards says. "And it could get the venture capital market moving again, too."
Another possible proposal could be to defer the tax on internal capital gains in mutual funds. Currently, mutual fund investors pay tax on whatever capital gains are generated by the fund manager's buying and selling. Edwards suggests that the Republicans would propose deferring the payment of that annual tax until investors actually sell the fund shares.
Planning for the Long (Over)Haul
It won't be easy for the Republicans to push through tax cuts on two fronts, though. If last year's cuts are made permanent, that allows for less opportunity for bargaining or compromise on other issues regarding overall tax reform. It's unlikely, though, that the Republicans will see it that way -- which means we may see more piecemeal tax policy changes rather than sweeping overhauls.
"Tax reform would be much easier for the Administration if it scrapped the rest of last year's tax cuts altogether," Aaron says. "It would give them more elbow room. That's the soundest way to make sure real reform helps everybody -- but it's not going to happen."
The Republican control of Congress does mean that the party will likely engage in more long-term strategic planning, in the expectation that President Bush will serve another term.
"Now it looks more like a six-year horizon," Aaron says. "Now the Administration is busily planning what to push in 2003 vs. what to hold for 2004 and what to roll out in 2006."
Making the $1 trillion tax cut permanent is clearly top of the Republican itinerary, although it's likely we'll see other proposals in 2003 as well. And while tax cuts are often instituted in hopes of stimulating the economy, tax cuts are also easier to pass when the economy is doing well.
"The more revenue that flows in from a strong economy," Edwards says, "the easier it will be to get more tax cuts passed."