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The $824 Billion Tax Increase That Doesn’t Exist

Yahoo! Finance

By Gordon Gray, Director of Fiscal Policy, American Action Forum

In his drive to tax the rich, the president gets a freebie of $824 billion to start. How can that be?

Among the most important questions any observer of policy debates should ask is: "Compared to what?" Policymakers will debate in terms of changes to current policies — such as "cuts" or "increases." What is often lost in this debate is the counterfactual — what would happen in the absence of the policy change? That context matters, and it can matter a lot. It can make the difference between a tax "cut" or a tax "hike." And in the case of current tax policy, it's an $824 billion question.

The Scorekeepers' View

Under current law, tax policies largely enacted in 2001 and 2003, and extended in 2010 are scheduled to expire at the end of 2012, and snap tax rates and other tax-related policies to 2000 levels. To most families, this would look like a tax increase. In Washington, however, this massive tax increase (on the order of $4.5 trillion over 10 years) is baked in the cake. And that really matters when policymakers sit down to sort out their pending expiration.

When the 2001 and 2003 tax policies were enacted, for reasons specific to parliamentary rules in Congress, they were set to expire by the end of 2010. So, according to the laws on the books, a massive tax increase was scheduled to occur in 2010. As a result, the Washington's budget referees ("scorekeepers" in budget wonkeese) at the Congressional Budget Office and Joint Committee on Taxation, had to assume that those laws would be off the books in 2011. They are the keepers of the all important counterfactual: the budget baseline.

The baseline is based on whatever laws are on the books. It does not attempt to predict future actions, however likely; only the effects of current law on the books.

Accordingly, if the current tax policies are allowed to expire, most families would see what they would consider a tax increase, but what the "scorekeepers" would consider "current law." If the current tax policies are extended, families wouldn't see their taxes change one way or the other. But since the baseline assumes those tax rates are scheduled to go up under current law, any deviation from that would be treated by the "scorekeepers" as a significant (on the order of $225 billion in 2013) tax cut.

Higher Tax Rates Are Coming

Enter the president's recent remarks about how to deal with the fiscal cliff: pass current tax policies except for the top two rates, and fight about the rest later. But "later" means 2013 when the "scorekeepers" have to assume that the top two rates have gone up anyway. That means that every dime of any rate reduction for those brackets would be viewed as a tax "cut" in Washington — never mind that everywhere else it would just be a smaller tax increase. And does anyone think the president would sign a separate bill that Washington budget rules say is composed entirely of tax cuts for the "rich?"

This means is that letting the top rates jump automatically is just an opening gambit in the goal of higher taxes rates. According to the Congressional Budget Office, letting the top two rates sunset would bring in $824 billion. The president will pick up the $824 billion and say, "OK, now it's time for tax reform, for everyone to pay their fair share," and for taxes on the rich to go up even more.

After all, as far as Washington is concerned, the tax hikes haven't even started yet.

Gordon Gray currently serves as the Director of Fiscal Policy at the American Action Forum (AAF). Prior to joining AAF, Gray served as senior policy advisor to Senator Rob Portman and as policy director on the Senator's campaign. Gray has also worked for the Senate Budget Committee as professional staff and before that was deputy director of domestic and economic policy for Senator John McCain's presidential campaign. Gray also spent several years with the American Enterprise Institute.