The Tax Deal is Done, So Now What?


There’s an analogy going around that compares the tax deal that just got through Congress to giving a few aspirin to a guy with a broken arm: the aspirin will help with the pain, but once it wears off that arm is still going to be broken.

“I think the two-year extension is political, and I think in two years we’re going to be having the same conversation we’re having right now,” said Kelly Phillips Erb, a tax attorney in Philadelphia.

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The U.S. House of Representatives passed a compromise tax plan in the wee hours Friday morning that had been worked out between President Barack Obama and Republican Congressional leaders. It extends for two years sweeping tax cuts for all Americans enacted under former-President George W. Bush.

The Senate approved the plan overwhelmingly on Wednesday.

In exchange for the temporary across-the-board extension (Democrats, including Obama, wanted the cuts to expire for the wealthiest U.S. taxpayers), Republicans agreed to extend jobless benefits for the long-term unemployed and to give a one-year tax break to employees that would put about $800 into the hands of workers who make $40,000 a year.

Politicians and business leaders who supported the compromise say the agreement removes nagging uncertainty that has stifled economic growth, arguing that if businesses are unsure of their tax obligations they’re not likely to invest in expansion or hire new employees.

But does a two-year reprieve provide the sort of security blanket that will induce companies to grow their businesses?

Not necessarily.

Of course, nearly everyone agrees that this deal is better than no deal, even if it merely postpones the hard decisions that need to be made about the labyrinthine U.S. tax code, while setting the foundation for another battle royale over taxes in 2012.

Erb, whose clients include numerous small and mid-sized business owners, said she doesn’t believe the temporary nature of the deal is “paralyzing the economy. But I think it’s causing people to have hiccups. I know people who are making decisions on a wait-and-see basis, and that’s not good for the economy.”

Erb said the uncertainty that will linger despite the approval will almost certainly have a greater impact on smaller businesses than big ones. Huge firms such Coca-Cola (NYSE:KO) can better navigate uncertainty than small ‘mom and pop’ businesses, she said.

“For a small-business person, the question of whether I hire another person, or do I order more product in a slower economy … I don’t know that you can make these types of decisions” as questions linger over how potential changes to the tax code might affect the economy, she said.

The tax debate will undoubtedly be revived during the 2012 election, at which point another brouhaha is certain to erupt.

As it stands, according to The Wall Street Journal, the tax deal set to emerge from Congress just days ahead of a Jan. 1 deadline -- when the Bush tax cuts are scheduled to expire -- leaves unsettled an array of tax rates tied to salaries, capital gains and dividends, and Social Security deductions taken from pay checks. (The bill still needs Obama's signature, a foregone conclusion.)

In addition, the status of numerous tax breaks that benefit families, students and low-income workers will remain up in the air for at least another two years.

But all of that lingering uncertainty was far more preferable to what would have happened if Congress had failed to act, said Cliff Waldman, an economist for the Manufacturers Alliance/MAPI, a public policy and economics research organization in Arlington, Va.

“There is one thing unequivocally clear and that is if nothing had happened, and there had been an economy-wide tax hike on Jan.1, it would have been a mess. There could have been a double-dip recession. For the moment the tax deal, as imperfect as it is, removes a key source of short-term uncertainty,” said Waldman.

Waldman said the approval of the temporary compromise gives lawmakers an opportunity to consider broad changes to U.S. tax policy.

“In the long-term, we have enormous challenges facing us,” the economist said. “The financial crisis awakened us to a lot of problems” that are imperiling America’s long-term status as an economic superpower.

Waldman said a common plea of big and small companies alike is for Congress to simplify the tax code. In fact, some business executives have said they would go as far as trading a higher tax rate for a simplified code.

“It takes a lot of time and a lot of money for corporations to prepare their taxes,” he said.

For the time being, political horse trading means uncertainty is being postponed until 2012, and Americans won’t be getting a tax increase next month.

Erb said most business owners understand that the business environment in the U.S. is subject to constant change the result of our democratic form of government and a fickle electorate. She said she hopes the two-year deferral on taxes gives lawmakers time “to do some forward thinking proactive tax policy, rather than reactive policy.”

But she’s not holding her breath.

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