Tax cut costs billions more than expected

WASHINGTON -- Due to an error by congressional tax experts, a temporary suspension of taxes on dividends would cost billions more than senators thought when they voted last week to incorporate it into bill cutting taxes $350 billion over the coming decade.

Democrats said the mistake could complicate negotiations with Republicans over combining a Senate-passed tax bill with a version passed in the House

Senate Minority Leader Tom Daschle, D-S.D., said the estimate of the dividend provision's cost was off by tens of billions of dollars. The error technically boosts the cost of the tax cut beyond the $350 billion limit that senators had imposed on themselves while writing a $2.2 trillion budget governing tax and spending bills. Democrats opposed to the dividend tax cut lost their chance to object to the amendment based on its cost.

"They made a big mistake," said Max Baucus of Montana, the top Democrat on the Senate Finance Committee.

Senators had been told by congressional tax experts that the dividends policy, which halved taxes on dividends this year and suspended the taxes in 2004, 2005 and 2006, would cost $124 billion over the coming decade.

Tracking the error

A spokeswoman for Baucus said tax experts calculated the cost to the Treasury as if the policy applied to dividends paid out of current-year earnings and profits -- the intent of the amendment drafted by Sen. Don Nickles, R-Okla. Due to a drafting error, the tax cut actually covered dividends paid out of accumulated earnings and profits.

Separately, the top Democrat on the House's tax-writing Ways and Means Committee asked tax experts reviewing their calculations to factor in the cost to the Treasury if companies take advantage of tax-free dividends to avoid paying other taxes.

"The estimates for the Senate dividend tax cut were very close to the estimates provided for earlier proposals that had much more elaborate controls over potential tax avoidance," said Rep. Charles Rangel, D-N.Y.

While recalculating the cost of the dividends proposal, House and Senate tax writers started to discuss how to meld their tax cuts into a single bill.

House Majority Leader Tom DeLay, R-Texas, said negotiators agreed to a broad outline that would cut taxes $350 billion over the next decade and that the House would pass additional tax cuts later in the year.

"I think we can do a package that will actually end up being the third-largest tax cut in the history of the country," DeLay said.

Senate Majority Leader Bill Frist, R-Tenn., said GOP leaders have agreed to complete the bill before Memorial Day and continue to negotiate the size and structure of the bill. "None of those decisions have been made yet," he said.

House and Senate Republicans agree on most elements of the bill, which are included in some form in both tax cuts. Those items accelerate already scheduled cuts in income tax rates, cut taxes for married couples, increase the child tax credit from $600 to $1,000 and give tax breaks to small businesses.

The two chambers diverged most over how to treat investment income. While the Senate voted for a temporary suspension on dividend taxes, the House opted to cut the top rate on dividends and capital gains to 15 percent. Taxpayers pay as much as 38.6 percent tax on dividends and 20 percent on capital gains.

The House is not eager to accept provisions in the Senate bill that raised revenue to offset the cost of tax cuts exceeding $350 billion.

The negotiators must work under the $350 billion limit because Republican moderates in the Senate blocked bigger tax cuts. To give themselves a little extra room, GOP leaders have considered moving $20 billion in state aid and $30 billion in child credit refunds -- both items that count as spending in the congressional budget process -- outside their $350 billion limit.

Sen. Trent Lott, R-Miss., said the final form of the bill will ultimately bend to the wishes of three moderate senators who gave Republicans their winning edge in the Senate last week -- Republican George Voinovich of Ohio, and Democrats Evan Bayh of Indiana and Ben Nelson of Nebraska.

Nelson said Tuesday he expects to support the final tax cut if it retains the $20 billion in state aid.

A spokesman for Voinovich said the senator will vote an "easy no" if the combined tax and spending in the package exceeds $350 billion.

After voting for the bill in the Senate last week, Bayh said, "I will not support the gimmicks included in this bill, nor can I support a larger package that includes further raids on the Social Security trust fund."