Video: Obama on economic challenges

By Tom Curry National affairs writer
updated 1/8/2009 6:28:24 PM ET 2009-01-08T23:28:24

While tax cuts are an integral part of President-elect Barack Obama’s stimulus plan, the newly convened Congress and the incoming commander in chief are nonetheless preparing for a tax hike.

House Majority Leader Steny Hoyer announced Wednesday that the House will vote next week on expanding the State Children’s Health Insurance Program, which will be funded by an increased excise tax on cigarettes and cigars.

A tax increase may seem counterintuitive in a recession — especially since Obama and congressional Democrats are simultaneously touting tax cuts as part of the cure for the ailing economy.

But its likely to be down played as a tax increase only on smokers, who, according to the Centers for Disease Control and Prevention, comprise roughly one-fifth of the population.

A spokesman for the House Ways and Means Committee said this bill mirrors the one passed by Congress in 2007, and subsequently vetoed by President George W. Bush.

A 156 percent tax increase
The legislation would impose a 156 percent tax increase on smokers, raising the 39-cents per pack federal cigarette tax to one dollar.

The Congressional Budget Office estimated that the bill passed in 2007 would have raised about $53 billion in revenue over ten years.

But it will be a relatively small tax increase compared to the tax cuts that Obama has proposed — those may end up amounting to more than $300 billion over two years.

The tax increase is also tiny compared to the projected $1.2 trillion deficit in the 2009 fiscal year.

But will Democrats also raise taxes on other demographic groups? They've yet to say if non-smokers will be targeted.

In an interview with CNBC’s John Harwood on Wednesday, Obama said that he had not made a decision yet as to whether he will ask Congress to raise taxes this year on people making more than $250,000. He's also pondering waiting until the end of 2010 when the current income tax rates expire.

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Declining budget deficit in 2012
The CBO budget outlook released Wednesday assumes that the federal deficit will fall to a quite modest 1.6 percent of GDP in 2012, down from the staggering 8.3 percent in 2009.

Video: Obama’s fight over economic plans But that CBO forecast assumes that Congress will let the income tax rates revert to their higher pre-Bush levels of 2000.

If Congress does nothing before the end of next year, income tax rates will go up and most Americans will face tax increases — and for some, they'll be significant.

Next year is an election year for a third of the Senate and all House members, so Congress could potentially be voting on a large tax increase right before, or perhaps just after, the 2010 election.

“That issue is going to have to be addressed sometime over the next year,” said House Minority Leader John Boehner on Thursday. “The first thing we have to do is get through this next month in determining what this economic rescue package is going to look like, how big it is, and what’s its made up of. The president has his budget submission in early February — and so we’ll have plenty of time to deal with that (2010 tax) question.”

But the 2010 ball is in the Democrats’ court.

House Speaker Nancy Pelosi opened her briefing Thursday with a pledge of “fiscal discipline.”

Raise taxes on those over $250,000
In response to a question about the tough tax decision she and the Democrats face next year on taxes, Pelosi quite forcibly said, “Put me down as clearly as you possibly can as one who wants to have those tax cuts for the wealthiest in America repealed.”

When asked at what income level she’d repeal the 2001 and 2003 tax cuts she said, “That number will be determined. But we have talked in the $250,000, $300,000 range.”

She added, “Put me down as one in favor for repeal as soon as possible.”

The CBO forecast about the shrinking size of the deficit in future years assumes that Congress does not “fix” the Alternative Minimum Tax, as it's been doing recently to prevent a biting of the middle class.

Harsh bite of the AMT
The AMT is a parallel tax system originally designed to ensure that high-income people did not escape taxation. But since the AMT is not indexed to inflation, each year it affects more and more people who think of themselves as middle class.

And the AMT has an especially harsh bite in states such as New York and California with high state income taxes.

Democrats will need to decide what to do about income tax rates and AMT.

Hoyer vowed Wednesday that “we are going to pursue… getting us back to a place of fiscal balance by executing fiscally responsible policies. That obviously will not be possible in the short term, given the deep distress our economy is in…”

He added, "Republicans proceeded over the last eight years as if deficits didn't matter. They didn't want to pay for AMT, they didn't want to pay for the war, they didn't want to pay for other things they pursued...Deficits matter."

Financial markets willingness to believe in credibility of Democrats commitment to fiscal balance depends on the Democrats’ answers to those tax questions.

But the cigarette tax points to one way to raise revenue without broad hikes on middle-income workers — increase duties on undesirable activities and products.

How about, for instance, a federal excise tax on sugar-sweetened beverages? A recent CBO study of various health care policy options says there is more than $50 billion in revenue over ten years to be gained from taxing soft drinks.

The problem, of course, is that cola drinkers can shift to non-taxed liquids, such as apple juice or ice water.

And while $50 billion in revenue may seem like a large amount, it is really quite small compared to the $3 trillion in deficits which the CBO forecasts from now until 2019.

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