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In just a few short days, Democrats will officially control both houses of Congress and will have the authority to set the congressional agenda. Of course, that does not mean the Democrats will have a free hand to pass whatever tax laws they feel like; there is still the matter of a president wielding a veto pen and a Senate in which it will be difficult to find a 60-vote majority on major tax legislation.

Nonetheless, the Democrats will likely try to work toward some long-term goals while also enacting short-term fixes. Deficit concerns and promised “pay as you go” budgetary rules will make it harder for the Democrats to maintain the current level of services and even harder for them to follow a progressive agenda. They will have to turn quickly to the revenue side of the ledger to bring the budget closer to balance and to restore priority funding. Perhaps the best hope of finding new funding streams will lie in “green revenue”: taxes or other regulations that generate revenue while protecting the environment.

First, don’t expect a wholesale rejection and reversal of the so-called Bush tax cuts. The Democrats, on balance, support plenty of changes that happened over the last several years, such as the increase in amount of the child tax credit and the reduction in the income tax rates for low- and moderate-income taxpayers. In fact, the child tax credit is one item that the Democrats will likely wish to expand by making the credit available to more low-income workers.

To the extent that recent tax changes are reversed, look to targeted corporate benefits and the rates for high-income individuals. There are the easy targets—loophole closures on corporations are a perennial favorite, and further boosting IRS compliance efforts to close the approximately $350 billion annual tax gap could potentially yield tens of billions of dollars, if not more. New pay-go rules will provide lawmakers with additional incentive to scrub the code as new initiatives are proposed.

Over the long-term, however, we are looking at a fiscal gap that is beyond quick fixes. Ten-year deficit projections begin to show the strain on the system by Medicare and Social Security. Clamping down on annual discretionary spending is neither sufficient nor necessarily desirable to solve the entirety of the problem. Instead, Congress will have to begin looking at significant new revenue streams.

The most common new source of revenue mentioned in tax policy circles is a VAT. VATs are a major revenue source abroad, especially in Europe. In the United States, a VAT has been seriously mentioned as a replacement for a significant portion of current revenue or as an add-on to the current system. However, implementing a VAT would create significant and well-known challenges, including adverse distributional consequences. Unless it was paired with a significant and popular national initiative, such as a revamping of our nation’s healthcare system, a VAT is unlikely to be added to our nation’s tax code in the foreseeable future.

Other sources of revenue would include a reversal of the Bush tax changes for high-income earners. Sen. John F. Kerry, D-Mass., set the high-income bar at $200,000, and that level seems to be where policy discussions often tip. Revenue increases on high-income earners will likely be needed to fund any fix to the alternative minimum tax, which also affects that group. One could see a 1986-style cleaning of the code in which AMT reform, loophole closures, and rate adjustments on the top end form a revenue-neutral reform package for those earning more than, say, $200,000. But would Congress also raise revenue from those changes? At this point, simply preventing tax changes that give huge cuts to the wealthy would be a success for the new Congress—and given the estate tax changes and capital gains expiration on the horizon, that is not a given.

If the Social Security debate returns (bets, anyone?) we might see a renewed interest in increasing or removing the cap on taxable earnings subject to the payroll tax. But in the absence of that debate (or a broader debate on tax reform), Congress may not want to reopen the Pandora’s box that was forced closed last year.

So what does that leave? Over the next two years (and likely beyond) we should expect—and perhaps demand —a renewed interest in generating revenue from taxes or regulations that protect the environment. A carbon tax or a cap-and-trade program with auctioned permits could generate significant revenue, while at the same time reducing greenhouse gases and cleaning the environment.

To get the greatest gains overall, the green revenue would have to be used to offset other taxes (or to prevent rates from increasing in the future) that create efficiency losses. While the amount of revenue that could be raised from a carbon cap-and-trade program is potentially enormous,1 we must also recognize that some of the money will be used to partially compensate businesses that might be disproportionately affected and low-income consumers, who spend a higher share of their income on energy-sensitive products. The green revenue could be part of a larger tax reform, or it could be used to pursue an aggressive, innovation-driven energy strategy through investment in research on renewable, low-carbon technologies. Also, there ought to be enough revenue to put a dent in the deficit.

Enacting any one of the changes above would be a major achievement for the new Congress, but will any of those changes make it by the president and the 250 or so signers of Americans for Tax Reform’s anti-tax pledge?2 What Congress has to realize is that we need more “good” taxes and fewer “bad” taxes and that we must work toward reducing long-term deficits rather than hoping that everything will work out OK in the end.

Finally, the enactment of tax policy over the last several years has been a mess. The tax code is now riddled with temporary or phase out rules for everything from the AMT “fix,” to the estate tax, to the research credit. While not every tax provision has to be fixed now, responsible tax stewardship will mean that whoever is in power will be forced to revisit those issues in the years to come.

Endnotes

1The amount of revenue raised depends on the targeted emissions limit as well as the resulting market price for the permits. Estimates range from tens of billions of dollars annually to $100 billion or more. (E.g., see Congressional Budget Office, “An Evaluation of Cap-and-Trade Programs for Reducing U.S. Carbon Emissions,” June 2001, or Energy Department, Energy Information Administration, “Analysis of the Impacts of an Early Start for Compliance with the Kyoto Protocol,” July 1999.)

2 See Americans for Tax Reform’sWeb site, at http://www.atr.org/content/pdf/2006/may/052306pr-109thsigners.pdf

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