Will Congress play 'kick the can' with tax rates?

Tuesday's election results provided political certainty — Republicans will lead the House, Democrats the Senate. It remains to be seen, however, if lawmakers will extend tax cuts set to expire at the end of the year. Indeed, a roster of marginal-rate tax cuts implemented under President George W. Bush — as well as reductions in capital gains and dividend taxes — is set to expire on Dec. 31 unless Congress renews them. Lawmakers will return to Capitol Hill for a lame-duck session of Congress in two weeks to sort out those and other niggling issues — such as approving a new federal budget. But following an exhausting election, members of Congress may be suffering from both legislative fatigue and burnout from campaigning, which may result in modest lame-duck productivity. “What I think you'll see is Congress and the administration kick the can down the road by extending the Bush tax cuts for all income levels for one or two years,” said Dan Crowley, a partner at K&L Gates LLP in Washington. Senate Majority Leader Harry Reid, D-Nev., began to outline the Democratic approach on Wednesday. “We are going to cut taxes for the middle class,” Mr. Reid said in a conference call with reporters. “I would hope that Republicans would not block that.” The Obama administration and congressional Democrats are seeking to extend the Bush tax cuts permanently for individuals who make less than $200,000 and families who make less than $250,000 while letting rates snap back to their pre-2001 levels for high-income earners. Republicans want to renew the cuts for all income levels, arguing that raising anyone's taxes will further slow a tepid economic recovery. Mr. Reid, however, dismissed a proposal by Senate Minority Leader Mitch McConnell, R-Ky., that permanently renews the Bush tax cuts for all income levels. Mr. Reid said that it would add nearly $4 trillion to the burgeoning national deficit. “That won't happen,” Mr. Reid said. In a speech in Washington on Thursday, Mr. McConnell didn't indicate that he would give too much ground on taxes. “In the short term, we have to make sure that taxes don't go up on anybody,” Mr. McConnell told an audience at the Heritage Foundation. “What I think we'll do is come together here in the lame duck and agree to extend the current tax policy for everyone.” Also on Thursday, the Securities Industries and Financial Markets Association praised the Obama administration for reiterating its support for keeping the capital gains and dividends tax rates at 15%. “Given the state of the nation's economy, a tax hike could have a negative impact not only on individual investors, but America's families, seniors and businesses,” SIFMA chief executive Tim Ryan said in a statement. Maintaining the 15% rate “will establish a solid and robust foundation for healthy and sustainable economic growth and job creation.” President Barack Obama signaled on Wednesday that he will sit down with Mr. Reid and Mr. McConnell to work out a deal on tax cuts. He said in a White House press conference that he was “absolutely” willing to negotiate. Nonetheless, no one knows what kind of tax policy will emerge from the additional weeks that Congress will work in November and December. The new Congress will be seated in January. “The politics and processes of a lame-duck session are unpredictable,” said Clint Stretch, managing principal for tax policy at Deloitte Tax LLP. “It really comes down to whether the Senate can pass a compromise bill or whether Republican leadership thinks they can hold out and get a better deal next year.” One of the notions floating around the capital is that the middle-class tax cuts would be extended permanently but those for upper-income Americans would get only a short-term renewal. Mr. Stretch doubts that conservatives would allow that scenario to play out. “They lose bargaining leverage that way,” Mr. Stretch said. The estate tax is also in limbo. It is not in effect this year but will snap back to a 55% rate and a $1 million exemption in January, unless Congress acts. From negotiations, it appears that there may be a compromise between a 45% rate with a $3.5 million exemption that Democrats support and a 35% rate and $5 million exemption that has the backing of Republicans. Determining the estate tax level will occur after marginal rates are sorted out, according to Mr. Stretch. Some observers foresee Democrats proposing a compromise that would raise the threshold for income tax cuts to $1 million. But that could cause significant political crossfire if Democrats accuse recalcitrant Republicans of holding the middle class “hostage” to benefits for millionaires. “That could blow the whole thing off the tracks,” Mr. Stretch said. In that case, tax policy would have to be resolved in “January, February, March or April.” Although there are more tax machinations ahead, the fact that Republicans are in charge of the House will assuage investors' fears, according to Steve Onofrio, managing director of the SEI Advisor Network. “There's hope that [Bush tax cuts] won't be reversed or reduced as much,” Mr. Onofrio said. “If that's the case, advisers can get back to effective planning.” In the meantime, Capitol Hill tension will remain over tax cuts. “There will be uncertainty into December,” Mr. Stretch said. “This is going to be a drama that will take a while to sort out.”