Democratic discontent, Republican satisfaction

The tax cut compromise in Washington between President Obama and congressional Republicans has sparked a heated round of internecine feuding among Democrats. Obama's left flank is incensed by what they perceive as the president caving on a signature campaign promise. This is his George HW Bush "read my lips" moment.

The deal that Obama struck with Republicans is about more than extending the Bush tax cuts for all income brackets for two years, which has topped the news. It also involves a 2% cut in the payroll tax (the US version of the NI tax) for employees and a 35% estate tax rate, rather than the 55% rate that current law requires, beginning 1 January. All that Republicans had to do was agree to a 13-month extension of unemployment benefits for Americans who can't find work as a result of the recession.

But the Democrats aren't the only ones facing dissension in the ranks. While Republicans should be roundly hailing this as a victory – and most are – there is some strong resistance among those who worry the bill adds to the deficit and involves a tax increase that forces them to violate their principles.

Since the estate tax was legally bound to lapse to zero for 2010, they see the 35% rate as an increase and an unwelcome addition to the deficit. Of course, if one compares the rate to the 55% it will be on 1 January if Congress does nothing, then it is actually a tax cut – but no matter: led by Senator Jim DeMint of South Carolina and assisted by some influential outside groups such as the Club for Growth, an undefined number of congressional Republicans are quietly expressing dissatisfaction with the deal. In addition to the estate tax, they are also upset that the extension of unemployment benefits is not paid for with cuts from anywhere else in the government's budget.

The deal should pass and become law. There are enough Republicans who support it, including incoming House budget committee chairman Paul Ryan. They are assisted by the likes of influential anti-tax campaigner, Grover Norquist, who has called it a good deal and the 35% estate tax rate a victory for Republicans.

The bigger issue to watch going forward (and some Republicans are already raising their voices about this) is what the United States does about fundamentally restructuring its complicated and outdated tax code. As I have argued elsewhere, Republicans should take the current deal, say it is imperfect, and then get busy with some forward-leaning tax reform proposals as they look forward to 2012.

Two important things happen in 2012 that make an early, aggressive debate about tax reform strategically important for Republicans: Congress will be deciding in autumn 2012 what to do about the two-year extension that they are currently debating (assuming they pass it), and the United States will be electing a president at the same time. This bodes well for Republicans, as the two-year extension could be replaced by a pro-growth tax reform agenda that their presidential candidate could also support. That would likely find a lot of popular support and put Obama on the defensive. If enough Republicans were to torpedo the current deal, they would likely find it harder to get some serious tax reform options on the table next year.

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