'Super' failure signals tax gridlock

The failure of the deficit reduction supercommittee last week all but guarantees that the gridlock over tax reform, including the Bush-era tax cuts, will continue beyond next year's presidential election. In fact, unless Republicans or Democrats take control of the White House and both houses of Congress, there is a good chance that no substantive tax legislation will be passed for the foreseeable future. “We've dug in,” said Clint Stretch, principal for tax policy at Deloitte Tax LLP. “We've gone to our corners. Absent something happening outside the political system, we are not going to be able to address the tax side of the debt question and tax reform very easily,” Mr. Stretch said. The bipartisan supercommittee, established last summer by legislation that lifted the debt ceiling, had a mandate to propose at least $1.2 trillion in deficit reductions by last Wednesday. It threw in the towel Monday. Republicans on the panel offered about $300 billion in revenue increases and $750 billion in spending cuts. But they insisted on lowering tax rates across the board by 20%, effectively making the Bush tax cuts permanent. Democrats balked. They want the wealthy to pay more in taxes before entitlement programs, such as Medicare and Medicaid, are scaled back significantly. That is the framework on which all tax battles and the election will be fought. The next casualty could be the payroll tax cut, which expires Dec. 31. President Barack Obama previewed the fight last week when he spoke at a rally in Manchester, N.H. He said that the loss of the payroll tax cut would amount to a tax increase of $1,000 for “the average family” and challenged Republicans to back an extension.

'SIMPLE CHOICE'

“Congress has a very simple choice next week,” Mr. Obama said. “Do you want to cut taxes for the middle class and those trying to get into the middle class? Or do you want to protect massive tax breaks for millionaires and billionaires, many of whom actually want to help?” Mr. Obama asked. The challenge will be in coming up with a way to pay for maintaining the payroll tax cut. One idea would be to couple the payroll cut with a tax “surcharge” on millionaires, according to Phillips Hinch, assistant director of government relations at the Financial Planning Association. But because most Republicans have vowed not to raise any taxes, there is little chance that the GOP would accept such a compromise. “It wouldn't come out of the House and might not come out of the Senate” with the surcharge attached, Mr. Hinch said. But there is “some hope” that a payroll tax cut extension will get through alone because of worries on Capitol Hill about the economy, he said. Mr. Stretch isn't as optimistic. Even if a payroll bill got through the House, it could become a vehicle for controversial amendments in the Senate seeking to extend all the Bush tax cuts or just those for the middle class, he said. “We would be in a big, ugly fight again,” Mr. Stretch said. Although the supercommittee maintained an air of civility, its failure didn't surprise the financial markets, which had low expectations for it anyway, according to Jeff Kleintop, chief market strategist for LPL Financial LLC. A stalemate on the payroll tax would further undermine the market's confidence in the political leadership. “If the payroll tax cut expires, it would be another reminder that Washington is unlikely to get anything of substance done before the 2012 elections, which is certainly not market-friendly,” Mr. Kleintop wrote in an e-mail. The election, however, might not resolve anything. For instance, one popular scenario is that the Republicans keep control of the House and gain the Senate, while Mr. Obama wins re-election. Regardless of which party takes the Senate, it almost certainly won't achieve the 60 seats required to overcome a filibuster. “We could have an election that doesn't provide clarity, that continues divided government,” said Dean Zerbe, managing director of alliantgroup, a tax services provider for small and midsize businesses. “The only thing we're certain about is uncertainty.” The supercommittee was envisioned as the way to overcome Washington's tendency to put off hard decisions until after the next election. Even with the participation of some of the most senior and influential members of Congress, it fell short. “There just isn't really anybody who's leading, and there's no one willing to sacrifice,” said Remmelt Reigersman, an attorney at Morrison Foerster. Ultimately, lawmakers are the only ones who can fix the deficit problem and set tax policy. “We are in this mess until the political class decides we can no longer be in this mess,” Mr. Stretch said. Email Mark Schoeff Jr. at mschoeff@investmentnews.com