Deficits & politics to drive 2011 tax policy: with deficit and budget concerns, legislators and policymakers in Washington are grappling with difficult decisions regarding deficit reduction and tax reform. Balancing the desire for some additional short-term fiscal stimulus and targeted tax reductions with long-term deficit reduction goals will make this year challenging for lawmakers.

• Author: Neubig, Tom
• Position: TAX

Growing concern about the federal deficit will shape tax policy this year. However, the political reality of a divided government and the politically difficult decisions required for deficit reduction and tax reform may limit lawmakers' ability to come together around meaningful tax legislation.

With the arrival of 2011, the economic situation is sobering. Large deficits, a recovering but sluggish economy and unemployment remaining close to 10 percent provide a stark backdrop for potential legislative activity in 2011. Balancing the desire for some additional short-term fiscal stimulus and targeted tax reductions with long-term deficit reduction goals and pay-as-you-go (PAYGO) requirements will be a challenge for lawmakers.

The timing and size of future deficit reduction will be a major political issue this year. Political gridlock caused tax legislation to languish for much of 2010, creating tremendous uncertainty for taxpayers, employers and planners.

In early December, with just a few weeks left to the congressional session, President Barack Obama announced the framework of a deal with lawmakers that would extend tax cuts enacted under President George W. Bush for two years for all taxpayers, provide a seamless extension of certain expired tax provisions, "patch" the alternative minimum tax for two years and establish an estate tax regime for 2011 with a 35-percent maximum rate and $5-million exemption per individual.

The tentative deal included 100-percent expensing of capital investments for 2011, as well as a two-year extension of the research and development tax credit. It also included economic stimulus measures, notably a 13-month extension of unemployment benefits and a one-year payroll tax cut for employees in 2011.

The deal immediately drew criticism from some congressional Democrats, and at press time it was unclear whether the tax package would become law. But the proposal appeared to reflect a possible shift from the stalemate over tax legislation that had characterized much of last year.

The Political Landscape

What is ultimately accomplished will depend on the personalities and politics involved and whether lawmakers opt for continued partisan dueling or legislative pragmatism. In the midterm elections, the Republicans gained more than 60 seats and a majority in the House of Representatives, picking up six seats but remaining in the minority in the Senate.

As the initiator of tax legislation, the House is likely to focus on spending reductions, with a reluctance to raise revenues. The Republican House is likely to find the Senate, with its budget rules, a continuing roadblock for tax legislation.

The Senate's 60-vote requirement to avoid a filibuster may be even more difficult to obtain with only 53 Democratic votes. Potential compromises may be stalled by Senate Republicans insisting on no tax increases and further spending reductions and by Democrats displeased with particular spending reductions.

Although the Democrats no longer hold the majority in both houses of Congress...