The McConnell Tax-Rate Freeze

Sen. Mitch McConnell’s excellent floor speech Monday unleashed a political thunderbolt: The Obama plan for higher tax rates on the wealthy — including successful earners, investors, and profitable small businesses — is dead. At least before the election.

Mr. McConnell is submitting legislation to freeze all tax rates for a year. With the latest defection by independent Joe Lieberman, along with Democrats James Webb, Ben Nelson, Evan Bayh, and probably Kent Conrad, the Republican leader more than likely has the votes to block Obama. Harry Reid hasn’t even submitted legislation, nor has he scheduled any floor votes. So McConnell has the whip hand.

And the Republican leader nailed the president’s inner big spender by quoting an Obama remark that the so-called “savings” from taxing the rich would be spent on “better things.” So it would never be used for deficit reduction; it would be the government’s money, not the taxpayers. That’s the Obama philosophy.

But the abnormally high level of uncertainty that has plagued investors and businesses will continue. Where is tax policy really going?

Before and after the elections, the Senate GOP caucus and pro-growth Democrats can block any tax hikes. But can they pass an extension of the 2003 Bush tax cuts? The clock is ticking. The tax-cut program expires in 117 days (just about). Then the top tax rate goes up to 39.6 percent (actually 41 percent without exemptions). Capital gains go to 20 percent while the estate tax reverts to 55 percent. And dividends will rise back to 39.6 percent from 15 percent.

This is all harsh medicine, especially for investors.

Year-end tax selling is more likely as the tax cost of capital goes up and after-tax investment returns go down. The profits-driven stock rally, accompanied by incredibly low interest rates, has a ceiling.

Republicans are right to draw a line in the sand on tax hikes of any kind. They are also drawing a second line in the sand for government spending.

Should a Republican November landslide include both the Senate and the House, the odds of extending the tax cuts would improve, but the outcome might still depend on overturning an Obama veto. That’s tough to do if the president stays on the left rather than embarking on a Clintonesque trip to the center.

Mitch McConnell’s tax freeze is good politics and good economics. Legislatively, perhaps he’s thinking one step at a time. But the fate of the Bush tax rates is still very much in doubt until some big-bang spending-and-tax-limitation package can be worked out.