What’s the Biggest Tax Mistake That Might Be Made This Year?

Policy makers have already made the biggest potential tax policy mistake they could have made this year. Ever since the tax cuts were enacted in 2001 and 2003, policy makers have known the law would expire at the end of 2010. That “drop dead” date offered an auspicious way to galvanize a systematic effort to reform a tax system that is badly in need of repair. Instead, policy makers pretty much ignored the issue until just before the 2010 Congressional recess, when politically tinged efforts to extend some or all of the tax cuts finally began — a “debate” that was too little, too narrow, and too late.

Our leaders’ procrastination goes beyond proactive broad-based reform and extends even to the most basic issues. Congress still needs to clarify the tax law for the current year. What is happening to the alternative minimum tax this year? Will the usual “patch” be enacted to cover tax year 2010? So far, it has not been, but we’ll see. Congress still needs to enact a budget for the fiscal year that just started on October 1.

In addition to those sins of omission, Congress could pursue some major sins of commission. Making any of the 2001 and 2003 tax cuts permanent this year would be a mistake — we can’t afford it and it would feed the dangerous notion that solving the fiscal problem is going to be easy. The tax cuts that benefit only high-income households should not be extended at all, even on a temporary basis. Extending them would be bad short-term economic stimulus: as the Congressional Budget Office and others have shown, the same amount of money could be used in better ways — for example, infrastructure investment or aid to the states — to boost the economy. Extending those cuts would also be bad long-term fiscal policy; if we don’t let those tax cuts die now, policy makers certainly won’t let them expire during a Presidential election in 2012 and so they will likely become permanent, which — again — we can’t afford.

What should policymakers actually do? Start with the essentials: clarify the 2010 tax treatment of the AMT and other provisions currently left hanging, pass a budget for the current fiscal year and enact a serious stimulus package. That would at least get the necessary work out of the way, so that next January they could get to the real problem — fixing the country’s massive and growing fiscal shortfall.