Lame Ducks Could Dump Deficit Choices on New Congress

Democrats returning to Washington for the lame duck session in two weeks face a quandary. Should they temporarily renew the Bush era tax cuts, whose expiration, most agree, would threaten a fragile economic recovery? Or, should they let the incoming Republican majority extend the cuts in January and take responsibility for substantially foregoing $3.3 trillion over 10 years in deficit-reducing revenue.

It’s not the only issue that outgoing Democrats could throw into the Republicans’ laps by not taking action during the lame duck session. A host of popular tax breaks and spending programs that expire at the end of the year or begin in January include business tax breaks for research and development, extended unemployment insurance, the elimination of the estate tax, reinstating the alternative minimum tax (AMT), and Medicare physician pay rates, which are slated to undergo a 20 percent cut unless Congress acts.

"It’s amazing how much work we have left to do," said one high-ranking Democratic aide. "There’s a part of me that says they’ll do the bare minimum and get out of town to let the new Congress deal with these problems."

How these issues play out in the lame duck session will say a lot about how the vanquished Democrats plan to respond to a new era where Republicans intent on shrinking the size of government control the House of Representatives. Renewing the Bush era tax breaks for all taxpayers, not just the middle class, will ensure an additional $114 billion to next year’s deficit, which is already projected to be north of $1 trillion, according to Congressional Budget Office estimates published in August.

President Obama refused to give marching orders or tip his hand during his post-election press briefing on Wednesday. While he pledged to look for common ground with Rep. John Boehner (R-OH), the incoming Speaker of the House, and Senate minority leader Mitch McConnell (R-KY), he only called for renewing the middle class portion of the Bush era tax cuts, not the upper income tax cuts, which Republicans want.

One compromise suggested raising the income floor for households hit by the tax to $500,000. That would shave about $37 billion off its price tag.

"My goal is to make sure we don’t have a huge spike in taxes for middle-class families," the president said. "Not only would that be a terrible burden on families who are going through tough times, it would be bad for our economy." During his news conference, Rep. Boehner said, "we believe continuing all the current tax breaks for all Americans is the right policy at the current time."

With permanent extension of the tax cuts off the table, speculation centers on whether the Democrats will support a one- or two-year extension, or simply extend part of the tax cuts. One compromise floated by the Center for American Progress, a Democratic Party-oriented think tank, suggested raising the income floor for households hit by the tax to $500,000. That would shave about $37 billion off its price tag.

The $68 billion time bomb
Then there’s the tax break that no one mentions, and few even know about it. The stimulus bill included additional tax cuts for low- and moderate-income households earning less than $95,000 a year. Its expiration will take $68 billion next year out of the pockets of people who tend to spend everything they put their hands on – a good thing when economic activity is in the doldrums as it is now. Some liberal Democrats may try to sneak some of its provision onto the Bush tax cut extender bill if it comes up in the lame duck session, which Republicans will oppose.

The price tag for maintaining the Bush era tax cuts jumps sharply as soon as Congress makes its annual fix to the AMT. About four million households are now hit by this special levy on higher-income households when their deductions and exemptions substantially reduce their tax burden. A failure to index it for inflation would make over 20 million households subject to the tax.

But the fix gets more and more expensive every year. Next year, according to CBO, it will cost $72 billion to keep the number of taxpayers subject to the tax constant. That will also deny the Treasury an additional $86 billion next year from the income tax extension, since the two breaks interact. Instead of costing $114 billion, the cost of extending the Bush tax cuts for a year rises to $200 billion. "What is surprising is that nobody is speaking about it," said Alan Viard, a tax policy expert at the conservative American Enterprise Institute. "Sen. (Charles) Grassley (R-IA) said we need to move on it, but by and large everyone else has been silent."

The so-called tax cut "extenders" which are also on the table for the lame duck session include a number of provisions popular with business. The research-and-development tax credit is renewed every year because it is seen as crucial to maintaining U.S. competitiveness. But renewing it and the other extenders for another year results in $197 billion less in tax collections in the first year, and $2.2 trillion over ten years, according to CBO.

Unemployment and Medicare Costs
Another expensive item on the lame duck plate is extension of unemployment insurance benefits for the long-term unemployed, which had nearly universal support from both political parties in the past. "For the economy, that’s the most important thing besides the tax cuts," said Chuck Marr, a tax analyst at the liberal-leaning Center for Budget and Policy Priorities. "If that’s not extended, it’s a major blow. It’s about $5 billion a month and all that money gets spent. Taking that out would be very negative."

With a number of physicians among the incoming Republican class, GOP leaders may want to address scheduled cuts in physicians’ Medicare pay – the annual ritual where Congress repeals a decade-old attempt at health care cost control. Technically, the lower rates were already supposed to have gone into effect, but Medicare continued paying at the old rate in anticipation of Congressional action. Bringing the law in line with reality will cost $17 billion for a one-year fix, according to CBO. "The Republicans may want to get this off their plate," said the Democratic aide, "but I don’t see us doing more than a one-year fix."

Kicking many of these issues into the new Congress will present major difficulties for the Internal Revenue Service, which says it needs two months to prepare mailings for the 2010 filing season. However, the AMT fix wasn’t passed until December 26th in 2007, and the IRS still got its documents out on time.

And then there’s the sleeper issue of the lame duck session – renewal of the estate tax. The Bush reductions expired at the end of last year, and in 2010 all estates were entirely exempt from what Republicans call "the death tax." At least five billionaires died during the year, including New York Yankees owner George Steinbrenner, Texas oil man Dan Duncan, and advertising mogul John Kluge. Eliminating the old tax rate of 45 percent on any estates over $3.5 million for just one year cost the Treasury nearly $10 billion on just those five estates.

But the one-year exemption is itself temporary. Starting January 1, 2011, the estate tax reverts to its 1990s rate, which was 55 percent on everything over $1 million. "The Democrats have a lot of leverage because if there’s no compromise, it goes back to those higher rates," said Roberton Williams, a tax expert at the liberal Urban Institute.

Related Links:
Deficit Commission at a Stalemate as Time Runs Out (The Fiscal Times) 
The 5 Trillion Hidden Debt (The Fiscal Times)
The Health Care Economy (Kaiser Health News)