Rangel-ing the Future

House Ways and Means Chair Charles Rangel (D.-N.Y.) introduced “the mother” of all tax reform bills last week. As the Financial Times says, Rangel’s bill cannot become law this year or next because of Bush’s certain veto. But it’s still significant, “because it is a portent of 2009” when it is presumed Hillary Clinton will be president, and will have a Democratic congress to work with.

So here’s a sampling of reactions, starting with FT‘s.

Its main elements are repeal of the alternative minimum tax (AMT); a new surtax on incomes of more than $150,000; a more generous earned income tax credit for low-paid workers; and a cut in the country’s anomalously high corporate tax rate. The distributional effect of the income-tax changes in 2008 would be somewhat higher taxes for those on very high incomes (more than $500,000 a year), and slightly lower taxes for everybody else (with those on incomes of between $200,000 and $500,000 doing best). This is not exactly raving socialism.

A permanent fix for the AMT is long overdue. This is a parallel tax code, originally meant to catch just a handful of super-rich taxpayers who were paying next to nothing. The need for this measure arose in the first place because of the bizarre complexities of the American tax rules and the myriad loopholes they create. But it was a badly designed palliative for the system’s underlying stupidity, which meanwhile went unaddressed – and thanks to that bad design, under current law 26m taxpayers will be caught in the AMT’s maw in 2008. Rather than make another temporary repair, the Rangel plan would scrap the AMT altogether and make up the revenue with the new surtax. This is an improvement over current law, and so, on balance, is the cut in corporate taxes, financed partly by repealing some deductions and broadening the base.

The problem is that the underlying complexity of the code is still, under this purportedly radical reform, untouched. In some ways, the reform adds to it. (The surtax is applied to “modified adjusted gross income”, not to taxable income: watch those tax bases proliferate.) One can have little quarrel with the plan’s distributional impact, except to wonder if it should have gone further, and the Republican attacks on this score are preposterous. But what America’s surreally complex tax system needs most is radical simplification, and this plan does not provide it.

Kevin Hassett of the American Enterprise Institute, a conservative think tank, is, well, a bit more critical:

In terms of revenue, Rangel’s reform would be the biggest tax increase in history. Compared to a baseline where President George W. Bush’s tax cuts are extended and the dreaded alternative minimum tax isn’t allowed to swallow millions of taxpayers whole, the bill raises taxes by a whopping $3.5 trillion over the next 10 years, according to the office of Representative Jim McCrery of Louisiana, the top Republican on the Ways and Means Committee.

To put that in perspective, that’s about $2 trillion more than the 10-year cost of the Bush tax cuts enacted back in 2001.

But the revenue grab isn’t the scariest part. That honor belongs to the increase in marginal tax rates, which is almost unfathomable in its scale. Rangel’s main objective is to repeal the alternative minimum tax, which was originally designed to capture taxes from wealthy individuals but over the years has taken in more and more middle-income families.

To accomplish that, and still collect the AMT revenue, he would enact a surtax on the adjusted gross incomes of wealthy taxpayers. If your family’s income is above $200,000, then your surtax is 4 percent. If it’s above $500,000, it’s 4.6 percent.

But the tax increase on the wealthy doesn’t stop there. When the Bush tax cuts expire in 2010, the top marginal rate goes back to 39.6 percent. In addition, Rangel would restore the phase-out of itemized deductions and personal exemptions that was repealed in Bush’s 2001 bill.

Adding it all up, and adjusting for the tax rate on Medicare, the Rangel bill would raise the federal marginal tax rate on incomes above $500,000 to close to 48 percent.

To put that tax rate in perspective, after adjusting for state and local income taxes, it would be about 13 percentage points higher than the average of U.S. trading partners in the Organization for Economic Cooperation and Development. And it would give the U.S. the fourth-highest combined top marginal tax rate in the OECD, behind only Denmark, Sweden and France.

Jessica Holzer, writing in The Hill, reports that business lobbyists will be divided on Rangel’s approach:

Many business groups swiftly denounced the bill. But others have held their fire, perhaps signaling support for portions of Rangel’s self-described “mother of all” tax reforms.

“The direction of the legislation that has been put forth by Chairman Rangel is one that we have traditionally approved of,” Rachelle Bernstein, vice president and tax counsel for the National Retail Federation (NRF), said.

The corporate tax reduction was “very attractive” to NRF’s members because they are “very high-effective tax rate payers,” Bernstein said.

Although the corporate tax rate is 35 percent, many businesses pay much less thanks to various loopholes uncovered by their tax lawyers and deductions put in by the tax lobbyists. But retailers remain one of the highest-taxed segments of the economy.

Dorothy Coleman, the vice president for tax policy at the National Association of Manufacturers, said that giving up the so-called “section 199” tax break for manufacturers could be a “good deal” for her members if it is paired with a significant corporate rate cut.

She emphasized that she would strongly oppose certain provisions if they were enacted alone, but regarded the overall proposal as “the beginning of a debate.”

“We’ll take a look at it and see where it goes,” Coleman said….

“Looking at my industry, if you have a tax cut on the middle class, that’s going to be good for retailers,” Bernstein said.

But for now, many in the business community remain leery of the plan, which Republicans have dubbed the “mother of all tax hikes.” Business groups say Rangel’s tax overhaul barely offers any crumbs to offset provisions they deem harmful to their members and the economy.

“It’s a tax change and a tax shift, but it’s not a tax cut and it’s not a tax reform,” the chief economist for the U.S. Chamber of Commerce, Martin Regalia, said.

Some segments of the economy will be unequivocally hurt by the legislation. Businesses that file as S-corporations would lose the manufacturing tax break but wouldn’t benefit from a reduction in the overall corporate tax rate.

The private equity and hedge fund industries would get hit by a doubling of their tax rate.

Meanwhile, the oil industry and large wholesalers, including auto dealers, would be hurt by a provision to repeal the last-in, first-out (LIFO) accounting method.

Jade West, the senior vice president of the National Association of Wholesaler-Distributors, argued that the business community would be remiss if it were to praise certain attractive provisions of what she views as an overall problematic bill: “We have no choice but to react strongly.”

The National Venture Capital Association, which lobbies for VCs, said “the proposals would mean an effective 100% tax increase on venture capitalists’ carried interest, and raise a significant barrier to investment in start-up companies and new technologies,” according to Tax-News.com. Quoting NVCA President Mark Heesen,

“The US has built an entrepreneurial ecosystem that is the envy of the world and we believe that the consequences of this legislation will be to penalize the very investors who are committed to growing our most critical innovative industries. We believe that seriously jeopardizing an investment model that works so well to create US jobs and foster innovation is not the answer.”

Rep. Rangel himself stressed the scuttling of the AMT in today’s Wall Street Journal (link to free site.)

Fundamental tax reform must begin with a repeal of a tax that is now hitting middle-class families and is threatening to grab back the benefits promised under the 2001 and 2003 tax cuts. I’m talking about the alternative minimum tax (AMT), and I’ve just introduced legislation to strike it from the tax code before it ensnares millions of middle-class Americans.

The AMT was first put in place in 1969 to ensure that the wealthiest among us weren’t able to find enough loopholes in the tax code to avoid paying taxes entirely. But it has grown in the years since. This year alone, it is threatening 23 million taxpayers, including firefighters, teachers and others who were never intended to fall under its grasp.

The Bush administration is calling for permanent repeal of the AMT and has outlined plans for doing so as part of a comprehensive tax-reform package that won’t cost the Treasury any revenue. My proposal meets the president’s goal of a “revenue-neutral” reform and more….

In order to achieve broad tax relief without increasing the national debt, this legislation restructures benefits provided at the upper income levels. The bill would also end the preferential and lucrative tax treatment currently enjoyed by private equity and hedge fund managers.

There is no justification for fund managers to continue receiving a lower, 15% tax rate on “carried interest,” which is essentially compensation paid for the services they provide. By adjusting the top rates and reducing windfalls paid out to some of the wealthiest individuals in the nation, we can help restore a sense of equity and fairness that is critical to the success of our voluntary tax system.

Tireless supply-sider Pete DuPont counters with a parallel tax system that gives taxpayers a choice between paying a “flat tax” with no deductions, or the status quo, with the AMT included.

A much more interesting approach was introduced in the House three weeks ago by Rep. Paul Ryan, a Wisconsin Republican: elimination of the Alternative Minimum Tax, extension of the 15% capital gains and dividend rates that expire in 2010, and giving taxpayers a choice between filing under the current tax system or a new option with just two income tax brackets, 10% for joint filers with incomes less than $100,000 and 25% for those with higher incomes. It includes a $25,000 standard deduction plus a $3,500-a-person exemption, which comes to $39,000 for a family of four. The new option would be a flat-tax choice, with no other exemptions or loopholes, and the AMT would be gone.

Every taxpayer would be able to make a choice between the current tax system with the AMT burden, tax rates from 10% to 35%, and many complex deduction options, or the Taxpayer Choice Act. Mr. Ryan estimates that the federal government’s revenues–excluding AMT revenues, the elimination of which would cost the government only about 2.4% of revenues over 10 years–would be about the same as under the current system, and the top 5% and 1% of taxpayers would pay slightly higher taxes than they do today.

Such a system would stimulate the economy, increase economic growth and job opportunities, and simplify a very complex and frustrating current tax system. But for the liberal establishment a flat tax with lower rates would be a very inconvenient truth. Much better in their view are the substantial Rangel tax increases.

Rangel’s move has pushed tax reform into the 2008 race, which looks like it won’t just be about Iraq and homeland security anymore.

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