Politics, US Economy

Six Degrees of Tax Policy

By, 11/19/2007

Story Outline:

  • Most expect a Democrat President and Congress to let the tax cuts expire in 2010.
  • However, just as the Republicans never repealed AMT, it's conceivable Democrats maintain the tax cuts through one-year extensions for the political leverage.


There's not much in life that can't be tied back to Kevin Bacon (hence the game "Six Degrees of Kevin Bacon").

Freaked Out: Teens' Dance Moves Split a Texas Town
By Susan Warren, The Wall Street Journal

A front page news story in today's The Wall Street Journal perfectly mimics the storyline for Footloose. In one memorable scene from that movie, Kevin Bacon, the new kid in town, plays chicken on tractors with cool kid Chuck Cranston. Take away the tractors, the ban on dancing, and John Lithgow, and you've got a plausible scenario for the next administration's tax policy.

Most folks (whether they like Democrats or not) commonly believe if Democrats take the presidency and both houses in 2008 they'll let the Bush tax cuts sunset—possibly ramming through even more tax hikes. At least, the major Democrat candidates talk like that's the plan. We know markets won't like a perceived tax hike, so Dems sweeping must guarantee a miserable market. Right?

We don't buy it. And mind you, a Republican president doesn't guarantee immunity against tax hikes. (Bush hasn't repealed the AMT in 7 years, why should the next Republican do it?) We can easily fathom a scenario in which a Democrat President and Congress don't raise taxes, net. Here's why. The Republicans did have a chance to repeal that pernicious AMT—they held the presidency and Congress for 6 years! But they didn't get it done. The AMT was specifically designed to ensure the wealthiest Americans cannot avoid paying taxes altogether by socking it away in tax-advantaged municipal funds or other schemes. But over the years, the power of inflation means the AMT threshold has gotten lower and it's ensnaring more folks—quote-unquote middle class folks our politicians vow to "protect." Those getting hardest hit live in high income, high tax states—like California and New York. Blue states! States with big income tax rates (state income taxes are a key AMT preference item excluded from AMT calculations) combined with a higher cost of living—making median incomes higher. Where a cop and a school teacher with a couple of kids and a very modest home may not feel rich, but can get taxed like they are.

What to do? A rational person would say, "Kill the AMT!" (Remember, we're talking about politicians, not rational people.) But why didn't Republicans kill the AMT when they had the chance? Aren't they the tax-cutting party? Each year, our politicians vote on a one-year "patch"—raising the income threshold. They don't have to engage in this farce—they could pass a patch for the next ten years, or kill the thing altogether! But that wouldn't make Democrats squirm. The best bargaining chip is one that must be bickered over every year. Because AMT tends to snag more in huge electoral vote blue states, for years the Republicans have held AMT over the Democrats heads—using it as a battering ram to advance other agenda.

You read the headlines every tax season. Will they pass the patch or won't they? Will the patch be high enough? The Republicans have kept the Democrats dangling on a string by agreeing to pass a one-year patch—usually in dramatic, last minute fashion—only if the Democrats support (however tepidly) some Republican agenda item.

If Democrats sweep, they're not likely to win a filibuster-proof majority. They might gain a few seats—maybe lose a few! (Remember, the only political body less popular than President Bush right now is Congress.) The Democrats aren't going to repeal the AMT (or maybe they will, and maybe unicorns and leprechauns will hand out pots of fairy gold) but they can feel free to pass longer-term patches to their hearts' content.

So, what about the so-called Bush tax cuts? For years, the Democrats have blamed the Bush tax cuts for a raft of perceived ills. Personally, we see the tax cuts, and see years of strong economic growth, positive stock returns, low unemployment, growing wages, and record per capita net worth and think, "Hey! Tax cuts are nice!" But if Democrats let the tax cuts expire, as they will in 2010, there goes one powerful bargaining chip. Just as the Republicans never bothered to repeal the AMT because the leverage was too great, the Democrats will likely not rush to relinquish their own battering ram. It's conceivable Democrats take their cue from Republicans and pass one-year extensions—last minute, in dramatic fashion—to keep Republicans relatively docile on other issues.

This would be very rational behavior. It's likely the Democrats, though they must stump on the evils of tax cuts, can see the economic benefits of keeping taxes low. By passing one-year extensions, they get the best of both worlds. They can wring their hands and howl that Republicans are forcing them to extend "tax cuts for the rich"—allowing them to curry political favor, play to their base, and get some other agenda items passed. Meanwhile, if the economy and market keep cooking along, they can take credit for that as well.

If you fear the market impact of a tax hike—don't assume it's a forgone conclusion. An annual Congressional chicken fight over next year's tax rate isn't the best market scenario, but it's far preferable to the certainty of a tax hike.

For related stories, see

  • "A Capital Gainsay," 11/12/2007
  • "Pass on the Patch," 03/27/2007

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.


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