President Barack Obama, offering a consolation prize to high-income Americans whose income taxes he wants to raise next year, is proposing to scale back a scheduled increase in the tax on dividends.
Budgetary legislation that he signed this year, however, may keep the president from meeting that goal.
A cut in the dividend rate to the current 15%, from rates as high as 39.6%, was among tax measures enacted under President George W. Bush. All those cuts are scheduled to expire Dec. 31, and unless Congress acts, the previous higher rates will return next year.
Although Mr. Obama's proposed 20% dividend cut is an increase from this year's levy, it qualifies as a tax cut because it is less than the rate scheduled to take effect for 2011. Under the budget rules, any tax cuts benefiting individuals who earn more than $200,000 a year or couples who earn more than $250,000 must be offset by new tax revenue or spending cuts elsewhere.
Passing Mr. Obama's plan under the so-called paygo rules would require lawmakers to find a combination of revenue and spending cuts of about $100 billion over 10 years.
This would be difficult in an election year, tax experts said. The alternative — finding the 60 senators required to vote for waiving the budget rule — would be equally challenging, they said.
Paygo “could make it virtually impossible” to cap the dividend rate at 20%, said John “Buck” Chapoton, a top tax official in President Ronald Reagan's administration who is now a partner in Washington at Brown Investment Advisory and Trust and supports the lower dividend rate. The budget-balancing law, Mr. Chapoton said, “just makes Congress dysfunctional in a lot of ways.”
The same conundrum doesn't apply to Mr. Obama's proposal on capital gains rates, which would also increase to 20%, from 15%, for high incomes. That measure wouldn't have to be offset by new revenue or tax increases because 20% is the rate that prevailed before the Bush-era tax cuts were enacted.
The paygo rules were first enacted under President George H.W. Bush in 1990 to require Congress to rein in deficit spending. The rules expired in 2002, months before Congress set the lower rates for dividends and capital gains that expire this year.
Paygo was reinstated in February and has delayed or caused Democrats to scale back some of their legislation. It has also impeded renewal of about 75 expired tax breaks known as the “extenders,” which include a research credit for businesses and personal deductions for state and local sales taxes.
Congress has begun deliberation on extending $4 trillion in expiring Bush-era tax cuts under the shadow of a deficit forecast by the White House budget office to be a record $1.47 trillion for 2010 and $1.42 trillion for fiscal 2011, which starts Oct. 1.
Paygo allows specific pieces of the 2001 and 2003 tax cuts totaling about $3 trillion to be financed with deficits. They include sustaining the lower 10%, 25% and 28% income-tax brackets; relief from the so-called marriage penalty that used to tax couples more than if they were single; the $1,000 per-child tax credit; and subsidies for day care, college tuition and adoption.
The law also doesn't require offsets for the next two years to prevent the alternative minimum tax from subjecting 30 million households to $65 billion in additional taxes. And it would allow the top estate tax rate to be set at 45% next year only.
The estate tax was repealed for this year alone, though it will return at a 55% rate if Congress doesn't act.
Republicans and Democrats agree on the need to extend the vast majority of the Bush-era cuts.
The biggest area of contention is over the $700 billion of higher taxes that would be paid by 3% of tax filers earning more than $200,000, if Congress lets their Bush tax cuts expire. Lost revenue from extending those tax reductions would have to be paid for unless budget rules were waived.
Republicans want the cuts ex-tended, along with rates for lower incomes, and have indicated that they may block the entire package if it doesn't include the high-income measures.
In addition to higher rates for capital gains and dividends, under Mr. Obama's plan the top marginal- income-tax rates would increase to 36% and 39.6% from 33% and 35%, respectively. Proposals to limit the estate tax on large estates would also need to be funded.
For Republicans to obtain the 60 Senate votes required to waive the rules, they would need the support of at least 20 Democrats. Democrats control 59 seats, and Republicans have 41.
So far, Republicans have the support of four Democrats and Joseph I. Lieberman, a Connecticut independent who usually votes with Democrats. One Republican, Sen. George Voinovich of Ohio, has said that he won't vote to extend any tax cuts that aren't paid for.
Mark Bloomfield, president of the American Council for Capital Formation, a group that advocates lower taxes on investments, said that he expects lawmakers eventually to waive the rules. “Paygo is paygo, but it's got termites in it,” he said.
