Last week House Ways and Means chairman Charlie Rangel rolled out a massive tax bill, best known by its informal name, “the mother of all tax reforms.” The good news is that the bill cuts the corporate income-tax rate. It also repeals the dreaded alternative minimum tax (sort of). The bad news is that the tax hikes and new spending included in the bill make for a package that would do more harm than good.
The bill takes aim at the AMT, a parallel tax system established in 1969 in response to about 150 wealthy families that were paying little or no federal income tax. The AMT brackets were not indexed for inflation, and since Clinton raised AMT rates and Bush cut regular income-tax rates, the tax now threatens to ensnare 23 million families this year, mostly among the middle-class.
Under Rangel’s bill the AMT would be repealed and replaced by a new surtax. This tax would apply to married couples making over $200,000 and single taxpayers making over $150,000. The bill also would allow the Secretary of the Treasury to set the threshold at a higher amount, but only if the higher amount would still tax at least 90 percent of taxpayers who would have had to pay the AMT. The tax would start at 4 percent of adjusted gross income, not taxable income, and increase to 4.6 percent for married couples earning more than $500,000 and single taxpayers earning more than $250,000.
This new surtax projects to raise $831.7 billion over ten years, $36 billion more than the AMT is expected to collect over the same period. In other words, Rangel would restructure the AMT, not repeal it, and his restructuring would amount to a tax hike, not a tax cut.
There is much more in the bill, including one-year extensions of dozens of popular tax breaks and $38 billion in new social spending in the form of expanded earned-income and refundable-child credits. There are more significant tax hikes, too, including a capital-gains tax increase on general partners in investment partnerships (such as private equity and real estate investment partnerships), a tax on the deferred compensation of hedge-fund managers, and a tax hike on S Corp. shareholders (who would be required to pay self-employment tax).
The thrust of the bill, on the individual side at least, seems to be tax reform in reverse — a number of breaks, exemptions, credits, and spending schemes all paid for with higher tax rates. And because the bill does nothing to prevent the Bush tax cuts from expiring in 2011, the top individual income-tax rate, under this law, would go from 35 percent this year to 44.2 percent in 2011, which would do serious damage to the economy.
There is better news on the corporate front. Rangel’s bill does lead with a lower corporate tax rate, in this case a welcome reduction from 35 percent to 30.5 percent. This is still higher than some of our international rivals, but it’s much more competitive. The bill also would make the accelerated small-business expensing provisions of the Bush tax cuts permanent. (These, incidentally, are the only Bush tax cuts made permanent by this bill.) The corporate tax on domestic manufacturing would be cut from 32.85 percent to 30.5 percent, eliminating the preference for manufacturing income under current law.
The bill also would repeal the last-in, first-out accounting method over eight years. This method is both valid and time-tested, and has been recognized by the IRS as appropriate for many industries since the 1930s. But the purpose of the repeal is to force oil companies to inflate their profits and pay higher taxes at a time when higher energy prices are already squeezing many consumers.
On the whole, however, the corporate piece of the bill would be economically beneficial and has the character of true tax reform: lower rates with fewer preferences.
That said, if this bill seems too complex to pass this year, that’s because it is. The bill was written to be modular, so that the one-year AMT provisions could be pulled out and packaged with some of the revenue-raisers in a smaller vehicle that can pass this year. Allowing 23 million families to be slammed with the AMT is not an option, politically or economically.
The big question is which of the tax hikes from the larger bill will be included in this one-year AMT patch. The tax hikes on private equity and hedge-fund managers add up to about the cost of the patch, which may be the direction Rangel is leaning. But that would be a big mistake. Alternative investments have been the strongest, most competitive segment of our financial markets in recent years, particularly as the costs of excessive litigation and overregulation under Sarbanes-Oxley have hamstrung public capital markets. We have been losing capital to foreign competitors, and these tax hikes would only accelerate that trend. At the same time, capital flight and other avoidance strategies would prevent these taxes from raising nearly as much revenue as estimates suggest.
Tax reform is very difficult business, and Rangel does deserve credit for starting a conversation. But if we’re going to go through the political paroxysms tax reform requires, it should be for a more worthy product than the Rangel bill — such as the FairTax or a flat tax. In the meantime, rather than walloping middle-class taxpayers with more taxes, Congress should pass a one-year AMT patch without tax hikes and move on to the business of genuine tax reform.