Setting Up Wall Street's Next Tax Trade

This week's tax compromise between the White House and congressional Republicans is a big win for Wall Street.

The deal extends the lower tax rates on dividends and capital gains. That should provide investors incentive to stay in the market —or get in if they were uncertain. Big bonuses and compensation packages are safe for at least two years, with the extension of the Bush-era cuts on high-income earners.

That is the short-term outlook. A long-term part of the agreement also is good for Wall Street. The compromise takes baby steps toward two end-game goals: One is obvious, and the other has been dormant since the early part of Bush's second term.

If Republicans compromised at all, it was with the sacrifice of permanent tax cuts: income taxes and the capital gains and dividend cuts that now set to expire in two years. That concession was almost a given considering the political pressure on President Barack Obama. A permanent extension was just not going to happen.

But a two-year extension may be just as welcome. Republicans hope that by reviving the tax cut question in an election year will be a winning issue. The impact during the next two years almost doesn't matter. If the economy is in full recovery mode, tax cutters can take credit. If we're in a stall or worse they can argue that raising taxes in such a climate is a bad idea.

Either argument will put President Obama in a corner.

In other words, if the Republican House victory in November gave the GOP leverage to extend the cuts, the climate in 2012 almost certainly will give Republicans stronger leverage toward extending them permanently.

The less obvious impact of the tax compromise is its impact on Social Security. As part of the deal, Democrats insisted on a one-year 2% payroll tax cut aimed at giving Americans more money to spend and stimulate the economy.

It isn't free money, of course. The payroll taxes in question will be trimmed from Social Security, costing the program roughly $120 billion. Relative to revenue, that isn't a deal breaker, since the program's annual receipts are around $2.6 trillion. Still, the cut definitely makes a bad situation worse.

Recession and high unemployment have hit Social Security hard. More people are claiming benefits. Social Security is expected to run a $41 billion deficit this year, something that wasn't supposed to happen until later in the decade.

By the 2030 or sooner, the U.S. government will either have to borrow heavily to meet the demands of baby boomers or cut benefits. During the next 75 years, there is a $5.3 trillion gap that needs to be filled.

So what is a nation to do? How about privatizing Social Security? Past defeats aside, the idea hasn't died and probably won't until an airtight plan to fix the system is enacted. Consider that in recent weeks, the privatization idea ( in which participants would be allowed to invest some or all of the money they pay into the system) has been percolating.

Rick Crawford, a Republican from Arkansas, won a Congressional seat after advocating during his campaign Social Security "private accounts." John Boozman, an Arkansas Republican who defeated Democratic incumbent Blanche Lincoln in her Senate re-election race, also supports private accounts. Marco Rubio, another Republican who was elected to the Senate from Florida, championed the idea before constituents in the retiree-heavy state complained.

"It is a mathematical fact that the least expensive way to provide for an almost certain future liability is to save and invest in capital markets prior to the onset of the liability," wrote William Shipman, a former mutual-fund executive, and Peter Ferrara, a former Reagan policy adviser, on the Journal's Opinion page Oct. 27.

Wall Street has long coveted the trillions of dollars pumped into the government-run retirement plan. Time and expense are on the side of securities and asset-management firms. The more Social Security's financial picture gets more dire, the more radical alternatives are considered.

That is why dipping into Social Security for a short-term tax benefit helps the cause. Even if the payroll tax expires—and that is hardly a given considering how hard it is to roll back tax cuts—the money lost for the program isn't coming back.

That is why Wall Street should see the compromise not only as a short-term win, but a step toward the bigger victor of bringing in fresh investor cash and the fees that come with it.

The boon might not happen immediately, partly because the public's mistrust of Wall Street is too high.

But as any retiree can tell you, memory is one of the first things that goes.