What's all this about taxes?

I stumbled into a TEA party event this past weekend (8/7/2010; the event was adjacent to a really cool playground I frequent), and I was informed by its participants of an impending fiscal assault. My informant, despite her animation, seemed only imprecisely informed. But as I was mostly uninformed myself, I resolved to assemble at least a wide angle view of the facts.

Here I will assemble some facts pertaining to the near term outlook for taxes. With respect to the long-term, it is much harder to be precise. Indeed, in agreement with the TEA party philosophy, I think that the long term outlook for taxes is inseparable from the behavior of the fiscal deficit.

1. The Bush tax cuts.

(a) The Economic Growth and Tax Relief Act of 2001 (EGTRRA 2001) provided for reductions of income, estate, and capital gains taxes phased in over time. (It also included some lump sum rebates to taxpayers of record in 2000.) The cuts are scheduled to "sunset" or expire after 2010; that is, rates revert to pre-EGTTRA levels in 2011 if no other action is taken. [Wikipedia entry on EGTRRA]

(b) The Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA 2003) accelerated the phase-in of the previous act, and provided for further reductions of capital gains tax rates (to a maximal rate of 15% for long-term gains). Again, the cuts are scheduled to expire and revert after 2010. [Wikipedia entry on JGTRRA]

2. What happens without further action?

In 2010, we have a maximal marginal rate of income taxation of 35%, a maximal rate of taxation of long-term capital gains of 15%, and no taxation of inherited estate property. If no other action is taken, income tax rates, capital gains tax rates, and estate tax rates will all be higher in 2011. In particular, without some action, the maximal rate of taxation on income will rise to 39.6%, that on long-term capital gains will rise to 20%, and the estate tax will revert to the 2001 levels specifying a rate of 55% with exemption for the first $1 million of wealth. [See the Wikipedia entry on the capital gains taxes in the U.S. or USA Today article, 7/23/2010 for the details on that the capital gains tax.]

3. What are people fighting about?

(a) According to an FT article, 7/25/2010, the Obama administration has favored extending the cuts as they apply to those earning less than $250K/year, while allowing expiration of cuts as they have applied for the wealthiest 2-3% of Americans. Under this plan, the highest marginal rate of taxation of income will rise from 35% to 39.6%, and the (maximal) rate of taxation of capital gains will rise from 15% to "at least" 20%.

Obama has proposed resetting the estate tax rules to the 2009 terms, 45% after exempting the first $3.5 million of wealth. This is higher than the current level (zero), but low by the standards of recent history. It is also much more generous than the terms to be applied without legislative action (see above). [USA Today article, 7/23/2010]

(b) As much as I can see, the opposition simply wants to see the 2010 tax environment extended. My sense is that the consensus of expectations of political observers holds that the Republicans will hold out until after the November elections by continuing to propose extension of the whole package, and that they will refuse to allow only partial extensions to go through. In particular, they will oppose the proposals coming from Democrats to extend only the parts that apply to the "middle class".

This seems likely to be a fight that hinges on spin, since both sides want the middle class part, and because that part is very popular (applying, as it apparently does, to 97-98% of Americans). The key, I think, will be the portrayal of the other side as the side that held up the extension of the part for the middle class. Another part may be the currency of the Republican argument (c.f., Jim Nussle's characterization on CNBC) that high income households are not really "households", but small businesses.

In short, it seems that (i) both sides want to reduce taxes relative to what the laws on the books would say should apply for 2011, but (ii) each side wants to blame the other for "allowing taxes to rise". Thus, (iii) each side will be willing to see policy drive off a cliff if it means that the other side may be more injured by the crash.