Fighting the Liberal Impulse to Increase Taxes

If all you have is a hammer, they say, everything looks like a nail. For liberal lawmakers, the hammer is a tax hike. No matter what the proposal, the liberal impulse is to attach a tax increase.

Consider the proposal by Defense Appropriations Subcommittee Chairman John Murtha (D-Penn.), House Appropriations Committee Chairman David Obey (D-Wisc.) and others to hit taxpayers with a $150 billion surtax to fund the war in Iraq. Decrying the lack of “shared sacrifice,” they want to impose a 2% surtax on low- and moderate-income taxpayers and a massive 12% to 15% surcharge on — who else? — the rich.

Democratic leaders quickly dismissed this zany idea because it touched the invisible third rail of politics — individual income tax hikes. While little political harm comes from hiking taxes on smokers or Big Oil, these so-called “niche” tax increases yield precious little new revenue compared to the $1 trillion or so the new congressional leadership will require to extend expiring tax provisions such as the current cap on the Alternative Minimum Tax (AMT). Yet the only way lawmakers can raise this sort of revenue is to not only touch, but become downright intimate with, notorious third rails such as income tax rates, the popular tax credit for children, and taxes on investment and savings.

The immediate reason for this political conundrum: the “pay-as-you-go” budget rule adopted in January. Under pay-go, legislation that tinkers with the tax code or entitlement programs must be deficit neutral. Any proposal that cuts taxes or increases spending must identify corresponding “offsets” (either a tax increase, a cut to entitlement programs, or some combination). Because the new majority would sooner patrol Anbar Province without body armor than cut Social Security benefits, pay-go becomes the rationale to justify a stream of tax increases.

That brings us to the coming tax showdown over whether to make an AMT extension compliant with pay-go and, if so, how. AMT is a parallel tax code that now surprises about 4 million taxpayers each year with a tax surcharge that averages several thousand dollars. Because it wasn’t indexed to inflation, each year it potentially strikes an ever increasing number of middle-income taxpayers. To prevent this, Congress has enacted annual “patches” that maintain AMT-inflicted pain at its recent, politically tolerable level. The latest patch sheltered 20 million taxpayers from approximately $50 billion in AMT liability.

But now Congress will have to either waive pay-go or move a one-year $50 billion tax increase, or an unfathomable $800 billion hike to cover the next decade. Majority Leader Steny Hoyer says that waiving pay-go “is not an option” and that the House will be “closing tax loopholes and cracking down on special tax breaks.”

But in January, House Speaker Nancy Pelosi spoke not of loopholes but trotted out the time-honored tactic of class-warfare. She proposed “tax cuts for middle income families” and large tax increases for those making over $500,000. Indeed, Rep. Richard Neal (D-Mass.) has floated a proposal to lower or eliminate all AMT liability for taxpayers with incomes below $500,000 while increasing the tax burden dramatically for the miniscule number of taxpayers earning more than that.

The technical problem the tax raisers encounter is that there aren’t enough “rich” taxpayers to sate their appetite for tax revenue. Their political conundrum is that most of the rich live in the “blue” states the tax raisers tend to represent.

In 2004, the latest year for which IRS data is available, only 3% of taxpayers were either non-married with an income over $100,000 or married with an income in excess of $200,000. The largest concentrations of these taxpayers are found in blue states such as Connecticut (6%), New Jersey (5.6%), Massachusetts (5%), California (4.9%), New York (4.7%) and Maryland (4.5%). Red state residents — Mississippi (0.9%), Kentucky (1.8%), Oklahoma (1.8%), Nebraska (1.9%), and Alabama (2.0%) — are much less likely to fall into this category.

The pain any tax increase will inflict on taxpayers in these states and districts is even worse, considering that, as the Tax Foundation found, “state and local taxes will consume a record-setting 11% of the nation’s income in 2007,” up almost a full percentage point in only 5 years.

Exactly when will this ever-increasing tax burden turn taxpayers in blue states red with anger and, perhaps, red politically as well?