Fiscal cliff talks stall. Middle class tax bill won't help.

Fiscal cliff talks are at an impasse, and there has been talk that House Republicans will pass the Middle Class Tax Cut Act approved by the Senate last summer. It's a problematic and ineffective idea. 

With fiscal cliff talks seemingly stalled , there has been growing talk that House Republicans would call President Obama’s bluff and simply pass the Middle-class Tax Cut Act approved by the Senate last summer. But for all the chatter, nobody has paid much attention to what is, and is not, in that bill.

They should, because a close look at the details suggests this option may not be quite so attractive to the GOP, or to anyone else who thinks seriously about tax policy. Granted, it may be politically tempting. In the words of fellow blogger Keith Hennessey (who has great connections with GOP insiders), such a step would be “terrible but not inconceivable.”

The bill extends for one year several provisions of the 2001-2009 tax cuts. For instance, it temporarily continues the low 2001-2003 ordinary income rates for individuals making less than $200,000 or couples making less than $250,000, repeals the limits on itemized deductions and personal exemptions (aka Pease and PEP), and extends marriage penalty relief. It also temporarily extends relatively generous treatment of the child tax credit and the earned income tax credit.

The measure also raises the tax rate on capital gains and dividends to 20 percent for high income households, and retains a zero rate on investments for those with very low incomes.  

However, the measure also allows the payroll tax to expire and does nothing to replace it, a step that would raise taxes on many low- and moderate-income workers. It patches the Alternative Minimum Tax, but for 2012 only. While this addresses the immediate problem for those who have to file their 2012 returns starting in a few weeks, it does nothing to patch the AMT for tax year 2013.

It also returns  the estate tax to its 2001 levels, where the exemption is only $1 million and the tax rate is 55 percent. This provision alone seems anathema to Republicans, who’d be turning their back on Obama’s proposal to raise the exemption to $3.5 million and cut the rate to 45 percent. And it won’t make many Democrats happy either.

Overall, the Tax Policy Center estimates that relative to current law (that is, where all the 2001-2010 tax cuts expire), the Senate Democrat’s bill would cut taxes by an average of about $1,000 in 2013. Not surprisingly, nobody making less than $200,000 would pay more. Those making $75,000-$100,000 would pay about $1,400 less on average. Those making $1 million or more would enjoy a tax cut of about $26,000.

Relative to current policy, (where most of the 2001-2010 tax cuts are extended) the story looks very different, however. TPC figures the typical household would pay more. The average tax increase would be about $1,200 in 2013. But millionaires would pay substantially more—about $136,000 more than under today’s tax rules.  Those making between $100,000 and $200,000 would pay about $2,500 more.

Keep in mind that TPC’s policy baseline assumes the 2010 payroll tax cut expires and the rate returns to 2009 levels. Thus, it does not reflect higher payroll taxes that would be withheld from most paychecks  if the Congress adopts last summer’s Senate bill. On average, this will cost a worker about $700 next year.

These consequences suggest this option may generate a lot less enthusiasm than some suggest in the ongoing game of political chicken.

But the real reason the bill is so problematic is that it serves as nothing more than a can to be kicked down the proverbial road. It makes no effort to set permanent tax policy, and will leave taxpayers in exactly the same situation a year from now as today, except with somewhat lighter pockets.