On Friday, President Bush signed into law the financial rescue plan that had been approved by the House of Representatives just hours earlier. The House had rejected a similar financial rescue bill on Monday, but on Wednesday the Senate passed a version that was loaded with tax breaks in order to woo more votes in the House. The Senate bill combined the financial rescue plan with legislation to extend several temporary tax breaks (often called tax "extenders") as well as a measure to keep the Alternative Minimum Tax (AMT) from expanding to reach more taxpayers. The sweeteners added by the Senate were apparently enough to win over a majority of members in the House, who approved the bill on Friday and sent it on to the White House for Bush's signature.

The political dynamic was somewhat confusing throughout the debate over the bill. The financial rescue plan and the tax legislation were both bills that were opposed by the House, largely because of their costs. Counter-intuitively, the compromise was to pass both as one bill.

It almost sounded like a joke: What is bipartisanship? It's what happens when some lawmakers want new spending we cannot afford while other lawmakers want new tax cuts we cannot afford, and in the end Congress compromises by doing both and paying for none of it.

The Financial Rescue Plan

In all fairness, there are conservatives and progressives who supported and opposed the bailout legislation. Some argue that it is truly necessary to keep lines of credit open, and that its cost will be less than the widely-cited $700 billion figure. And there are surely some provisions among the tax cuts that we would all support. (One that comes to mind would make the child tax credit more accessible for low-income families.)

In theory, the government will eventually sell the assets it buys from financial institutions and recoup much of the costs (and it's possible, though unlikely, that the taxpayers could actually profit). And if the costs are not recouped after five years, the President is to propose legislation to Congress to recoup the money from the financial sector. (What shape this would take is unclear, but House Speaker Nancy Pelosi and others had earlier discussed a fee on financial institutions after the five-year period.) As discussed in last week's Digest article, Congressional leaders did win some concessions that improved the President's initial proposal. One involves limiting the deductibility of compensation to highly paid executives in the entities participating in the bailout. (However, some astute observers have pointed out that serious loopholes in that rule remain, including the fact that stock options are apparently not covered).

AMT Relief

The tax cut package has had a long and tortuous history. Generally speaking, the Democrats in the House have opposed passage of any type of tax cut legislation that will result in an increase in the budget deficit. This is entirely reasonable, especially given the massive deficits racked up throughout the Bush years, and in practice this means that any tax cuts must be accompanied by revenue-raising provisions or cuts in spending. In the Senate however, a minority of Republican Senators can block any legislation that has any sort of revenue-raising provision, and the result has been a long feud between the two chambers over whether to pay for AMT relief and other tax breaks.

The AMT is a backstop tax designed to ensure that well-off people pay some minimum tax no matter how proficient they are at finding loopholes to reduce or wipe out their tax liability. Tax liability is calculated under the regular rules and the AMT rules, and you only have to pay the AMT if your AMT liability exceeds your regular income tax liability.

For most middle-class taxpayers, this is usually not an issue. But the Bush administration chose to lower the regular income tax without making any permanent change to the AMT, so of course that means that more people are going have to pay the AMT. Another problem, albeit a less important one, is that inflation is eating away at the value of the exemptions that keep most of us from paying the AMT. The Clinton administration increased these exemptions, but no permanent increase in those exemptions has been made during the Bush years.

The adjustment in the AMT that was included in the bill will increase these exemptions so that most of us will continue to be unaffected by the AMT.

Earlier this year, the House approved AMT relief and the tax exenders, but included provisions in each that would offset the cost by closing tax loopholes. Republicans in the Senate objected to the offsets and vowed to block these bills.

More recently, the House actually relented somewhat and passed a bill that would provide AMT relief without paying for it, increasing the deficit by over $60 billion. Unfortunately, this was not enough for the Senate, which insisted on increasing the deficit even more by including the tax extenders without offsetting all of their costs.

Tax Extenders

The Senate had been insisting on the passage of a bill combining the AMT relief with the "tax extenders." The extenders include all sorts of handouts that either subsidize businesses that don't need subsidies (like the research credit), cut taxes in ways that are not particularly progressive (like the deduction for state sales taxes and the deduction for tuition which really only benefits fairly well-off families), or just offer very trivial benefits (like the provision allowing teachers to deduct $250 in classroom expenses, which yields a benefit of about $60 for teachers lucky enough to be in the 25 percent bracket).

The legislation includes one very wise provision to offset $25 billion of the cost by shutting down offshore tax schemes that help the already highly compensated avoid taxes on their deferred compensation. Generally, when a company pays into a deferred compensation plan for an employee, if that plan is "non-qualified" (meaning it exceeds certain limits that the super-compensated don't want to deal with) the company cannot take a tax deduction for the payment until it is actually received as income in later years by the employee. But some have figured out how to have their deferred compensation routed through an offshore entity in some tax haven so that there is no tax paid to the U.S. government or any other government, so not being able to deduct the payment is not an issue. This provision would make the deferred compensation in this situation immediately taxable to the individual, so that there would no longer be an incentive to use this scheme.

The passage of this reform is a positive development, but this still leaves a total $110 billion increase in the deficit as a result of the tax cuts.

As Isaiah Poole at the Campaign for America's Future observed this week,

"Whatever the merits of these tax measures -- and you can be sure that the merits of many of these provisions are highly questionable and exist only at the behest of lobbyists or lawmakers pandering for votes -- they certainly make a mockery of all the protestations of not turning the economic rescue effort into a "Christmas tree" of special-interest provisions. As it turns out, the "Christmas tree" concern only applies to provisions that would, for example, fund community organizations that have a track record of helping homeowners avoid foreclosure. You know, things that would help ordinary people directly affected by the financial crisis."

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