Wall Street’s conventional wisdom is that markets like political gridlock — but not if inaction means hitting a weak economy with a big tax hike. When Congress returns from vacation, it needs to deal with the expiring tax cuts signed by President George W. Bush. The Obama deficit panel, however, could limit any extension of them.
The Obama administration says it wants to extend only that portion of the 2001 and 2003 tax cuts affecting the middle-class. Doing so would cost $1.3 trillion over 10 years, according to the congressional Joint Committee on Taxation, not counting borrowing costs. Allowing upper-income rates to rise on investment and labor income, on the other hand, is predicted to generate about $678 billion over 10 years.
Few in Washington want to let all the cuts disappear at year-end. Doing so could potentially knock between 1 and 3 percentage points off GDP growth next year, according to various estimates. But that will be the undesired outcome if Congress can’t reach agreement. While most Republicans want to keep all the 2001 and 2003 Bush tax cuts, President Barack Obama and most congressional Democrats want to let the ones for the richest expire. Treasury Secretary Timothy Geithner says he’s confident the fledgling economic recovery could withstand the blow.
But news of decelerating U.S. growth is hardly helping his argument. And given voters’ anxiety about the economy, Congress – with the entire House and a third of the Senate up for reelection in less than three months – might not be quite as risk tolerant as Geithner. A new NBC News-Wall Street Journal survey finds 71 percent of respondents would accept extending all the tax cuts until the economy recovers.
The political calculus is complicated. Congressional Democrats trying to follow the Obama plan could hold a pre-election vote. But Republicans would likely reject a permanent middle-class extension if the upper-income tax cuts weren’t also included. If Democrats offered a full, temporary extension, the GOP would probably accept that compromise. Such a deal would run contrary to the White House’s intentions — but Obama hasn’t vowed a veto either.
Muddling matters further is the president’s deficit commission. One recommendation could be to cut future Social Security spending in exchange for expiry of Bush tax cuts for the richest. That means even an agreement on a one- or two-year extension could get partly overwritten soon after. The only thing for sure is that following the messy passage of stimulus, health care and financial reform, the battles aren’t getting easier. And the tax debate isn’t doing anything to help clarify America’s cloudy economic outlook.