Forget about the World Series for just a moment — the enormous tax reform plan announced by Ways and Means Committee Chairman Charlie Rangel (D-NY) this week has to be the biggest bean-ball ever thrown. Not only does it travel far and wide from the tax reform Americans had hoped for, more taxpayers will wind up taking their lumps than initially advertised.
The impetus for the massive reform plan is a mistake made by Congress more than 35 years ago called the Alternative Minimum Tax (AMT). This complex scheme requires the filer to complete a second tax return and pay steep tax rates on income when, under the government’s definitions, an individual is taking “too many” legal tax deductions. Initially aimed at ensnaring 155 high-income-earners who weren’t paying income taxes, the threshold for the AMT wasn’t indexed for inflation when instituted and will hit 21 million families in 2007 if not fixed (compared to 4 million in 2006).
But even in its early years, the AMT snagged far more taxpayers than Congress ever intended. In the AMT’s fifth year of existence, 20,000 taxpayers were caught in the trap, far more than the 155 that were targeted at its inception. This flat-out fluke of tax policy has been getting worse for some time, and will become America’s biggest financial nightmare in the near future if not dealt with comprehensively. Some estimates have as many as 33 million taxpayers falling into the jaws of the AMT just three years from now.
Unfortunately, Congress has shrunk from the fight, opting instead to enact patches that re-index the AMT thresholds one year at a time. Calls for repeal have been strong and getting stronger now that the true scope of the debacle is known. Being primarily a “blue state” problem, Democrats are attempting to tackle the AMT once and for all … while still clinging to the flawed “PAYGO” rules they reinstated this year.
PAYGO treats the economically vital tax cuts enacted in 2001 and 2003 as revenue-losing, temporary provisions that must be “paid for” with spending reductions or tax hikes elsewhere. Given Congress’ pathological aversion to controlling expenditures, pulling the tax lever becomes a near-certainty.
And so from this swamp sprang Rangel’s “mother of all tax reforms” bill. In it, the AMT is patched for 2007 and eliminated entirely afterwards. But instead of simply correcting the AMT mistake, Rangel would offset every dollar in “lost” receipts with new kinds of misery sprinkled throughout the Tax Code.
Though the plan repeals the AMT, it simply reconstitutes the tax under another name. It starts with a 4 percent “surcharge” on taxpayers with income in excess of $200,000 and 4.6 percent for those over $500,000. This change alone more than offsets the AMT repeal and means that families who would qualify as middle-class in many metro areas would see their tax rates go as high as 44 percent, a 25 percent increase from the current top rate.
Rangel claims that “91 million families” will benefit from the scheme, but that includes millions of households receiving the Earned Income Tax Credit (EITC) – households who don’t pay taxes anyway. Meanwhile, families who would qualify as upper-middle-class in many metro areas, along with many small business owners, could see their tax rates soar past 40%. That’s because Rangel’s proposal is virtually silent on the question of retaining the Bush tax cuts. By failing to renew the tax reductions that have fueled America’s economic recovery, and throwing a new surtax into the mix, Rangel would effectively raise tax rates twice.
Chairman Rangel’s plan isn’t just robbing Peter to pay Paul – its robbing Peter and Paul while convincing both of them that the other guy is the one paying the higher taxes. The plan includes a cut in the corporate tax rate from 35 percent to 30.5 percent, which would be a positive step to improve the competitiveness of American companies. But it claws back virtually all of that supposedly “lost” corporate revenue by eliminating sensible tax rules that other countries allow for their own home-grown companies. The scheme would let small businesses continue to take tax-favorable expensing, but then force some of them to shoulder higher self-employment taxes. It would also take the wrong-headed step of taxing so-called “carried interest,” the share of profits that an investment fund manager receives, at ordinary income tax rates rather than the lower capital gains rates it has always been subject to.
This bill doesn’t just rob Peter and Paul; it panders to them both as well. It increases the standard deduction slightly, modifies the EITC to make it easier for childless individuals to qualify, and increases the refundable portion of the child tax credit – all attempts to make the plan politically appealing to those on the lower end of the income ladder. Meanwhile, it includes the extension of a string of popular and sometimes arcane tax credits frequently used by large corporations. Aside from the reasonably effective research and development credit, there are breaks for activities such as “motorsports entertainment complexes.”
The reality is simple: eventually, all taxpayers will suffer if this so-called tax reform act becomes law, because on balance it is likely to extract more money from our economy and small businesses. That means fewer jobs, less income growth, and bigger government. This plan swings and misses at making the Tax Code fairer, simpler, and less burdensome — three strikes and you’re out Mr. Chairman.