The Coming Tax Bomb

By JOHN F. COGAN and R. GLENN HUBBARD
April 8, 2008; WSJ Page A21

As the presidential campaign enters its final stages, there will be increased debate over budget priorities and how they will be paid for. Many commentators and political leaders, including Sens. Hillary Clinton and Barack Obama, believe that tax increases are needed to restore near-term budget balance and finance longer-term entitlement growth.

These claims fail budget arithmetic and economics. Worse, they raise serious questions about the nation's broad fiscal policies and its commitment to economic growth.

By historical standards, federal revenues relative to GDP, at 18.8% last year, are high. In the past 25 years, this level was only exceeded during the five years from 1996 to 2000. Still, we stand on the verge of a very large tax increase, one that will occur unless the next Congress and president agree to rescind it. Letting the Bush tax cuts expire will drive the personal income tax burden up by 25% – to its highest point relative to GDP in history.

This would be the largest increase in personal income taxes since World War II. It would be more than twice as large as President Lyndon Johnson's surcharge to finance the war in Vietnam and the war on poverty. It would be more than twice the combined personal income tax increases under Presidents George H. W. Bush and Bill Clinton. The increase would push total federal government revenues relative to GDP to 20%.

Why this large tax increase? The tax code changes enacted in 2001 and 2003 are scheduled to expire at the end of 2010. If they do, statutory marginal tax rates will rise across the board; ranging from a 13% increase for the highest income households to a 50% increase in tax rates faced by lower-income households. The marriage penalty will be reimposed and the child credit cut by $500 per child. The long-term capital gains tax rate will rise by one-third (to 20% from 15%) and the top tax rate on dividends will nearly triple (to 39.6% from 15%). The estate tax will roar back from extinction at the same time, with a top rate of 55% and an exempt amount of only $600,000. Finally, the Alternative Minimum Tax will reach far deeper into the middle class, ensnaring 25 million tax filers in its web.

Proponents of bigger government invariably argue that allowing all or some of President Bush's tax cuts to expire is necessary in the near term to balance the federal budget, and necessary in the longer term to finance the retirement and health-care promises made to the baby-boom generation. But a tax increase is neither wise nor necessary.

As has so often been true in the past, the economic damage caused by the tax increases and tax avoidance behavior will prevent the promised revenues from being realized. At the same time, the promise of higher revenues will encourage Congress to continue its profligate spending. As a result, a tax increase won't lower the budget deficit.

Moreover, current tax rates can be maintained and even reduced and still allow for necessary increases in national security appropriations and the balancing of the federal budget. Although budget balance may not be achieved overnight, a firm commitment by the next president to spending control will enable balance by the end of his or her first term.

Balancing the federal budget without a tax increase will require strong fiscal restraint. To achieve balance by the end of the next president's term in office, federal nondefense spending growth needs to be restrained to 2% per year instead of the currently projected 4.5%. This will be tough, but the federal government has been on a bipartisan spending binge for a decade. How large is this binge? Compared to the 1997 level adjusted for inflation and new homeland security spending, in 2007 actual nondefense appropriations were $125 billion higher, or cumulatively, a nearly $900 billion excess for the decade. If the next two congresses were to remove this excess gradually and shave 1% per year from projected entitlement growth, the budget could be balanced.

But what about national security? Certainly, balancing the budget without raising taxes requires that the wars in Iraq and Afghanistan be brought to a successful conclusion over the next five years. However, it does not require that the U.S. troop presence in either country be eliminated. Nor does balancing the budget preclude overdue and necessary increases in the defense budget.

The costs of needed improvements in our national security, though seemingly large, are small when measured in the context of the federal budget. According to the Congressional Budget Office, adding 100,000 active duty soldiers and 60,000 Army or National Guard members costs about $25 billion per year. Increasing the size of the Defense Department's procurement budget by 25% costs a similar amount. Each of these adds just 0.1% to annual federal spending – a small difference in the federal budget, but a powerful addition to our nation's security.

The current economic slowdown will increase the federal budget deficit this year and, in all likelihood, next year as well. But as the economy enters its recovery phase, raising taxes would choke off the recovery. The right policy, for both the economy and the budget, would be to make current tax rates permanent well before the scheduled increase. Giving investors greater certainty that current tax rates will be maintained will spur investment and aid the economic recovery, as it did in 2003. Federal budget balance will be achieved once the economy is again operating on all its cylinders.

This near-term budget debate foreshadows the more significant long-term budget debate the next president must lead. The CBO tells us that after a generation, Social Security and Medicare spending, left unchecked, will rise by 10 percentage points of GDP. Continuing the current hands-off entitlement policy will have severe consequences. The strategy of ratifying spending with higher taxes would require that all federal taxes rise by nearly 60%, bringing them to a European-level tax burden.

We still have time to prepare for the looming entitlement problem. Although baby boomers soon begin their retirement, the real impact of their numbers on the federal budget will not be felt for a decade. According to official budget forecasts, Social-Security costs will claim 4.5% of GDP in 2013, no higher than its claim on GDP during the first half of the 1990s.

Having time is no excuse for inaction, but a near-term tax increase is the wrong way to prepare. Higher revenues will encourage Congress to raise spending, compounding the long-term budget problem. And, the long-term tax increase required to fund unchecked long-term spending would likely reduce annual GDP growth by a full percentage point.

The proper way to prepare to meet the entitlement challenge consists of three essential elements: Change entitlements to slow their cost growth; eliminate all nonessential spending in the remainder of the budget; and, most important but often overlooked, adopt policies that promote economic growth. The greater the economic growth, the larger the economic pie, and the greater the public and private resources available to finance entitlement obligations and other national priorities.

Last year's federal budget illustrates the importance of economic growth to the federal budget's overall health. The federal budget deficit was recorded as 1.2% of GDP, half its average level over the past four decades. This modest deficit occurred despite the fact that Congress has been on a decade-long spending binge; despite the fact that not a single entitlement program has been significantly reduced since the late 1990s and two entitlements, Medicare and farm support payments, have been significantly increased; and despite the fact that we are in the midst of costly but necessary wars in Iraq and Afghanistan.

The consensus that tax increases are needed for fiscal balance is wrong. The next president can fund our defense priorities, maintain tax cuts, and balance the budget. A tax-increase consensus blurs the basic debates over our budget priorities in 2008 – and severely limits our choices in 2028.

Mr. Cogan, a senior fellow at the Hoover Institution, was deputy director of the Office of Management and Budget under President Reagan. Mr. Hubbard, dean of Columbia Business School, was chairman of the Council of Economic Advisers under President George W. Bush.

Obama talks cap-gains rate with CNBC

n an interview in conjunction with his big economic speech in New York, Senator Obama tells CNBC’s Maria Bartiromo he favors increasing the capital-gains tax rate.

Bartiromo reported after her interview: “Right now, as you know, the cap gains tax is at 15 percent. He has yet to give us a specific number. How high he wants that number to go? He has said, and he told me today, that he won't go above 28 percent. So we are talking about the possibility of a doubling in the capital gains tax. He was averaging at about 25 percent.”

Here is her exchange with the senator:

BARTIROMO: "How do you plan to change the tax code when it comes to capital gains? How high will that 15 percent rate go?"

Sen. OBAMA: "Well, you know, I haven't given a firm number. Here's my belief, that we can't go back to some of the, you know, confiscatory rates that existed in the past that distorted sound economics. And I certainly would not go above what existed under Bill Clinton, which was the 28 percent. I would--and my guess would be it would be significantly lower than that. I think that we can have a capital gains rate that is higher than 15 percent. If it--and if it, you know--when I talk to people like Warren Buffet or others and I ask them, you know, what's--how much of a difference is it going to be if it's 20 or 25 percent, they say, look, if it's within that range then it's not going to distort, I think, economic decision making. On the other hand, what it will also do is first of all help out the federal treasury, which is running a credit card up with the bank of China and other countries. What it will also do, I think, is allow us to make investments in basic scientific research, in infrastructure, in broadband lines, in green energy and will allow us to give us--give some relief to middle class and working class families who have been driving this economy as consumers but have been doing it through credit cards and home equity loans. They're not going to be able to do that. And if we want the economy to continue to go strong, then we've got to make sure that they're getting a little relief as well."

Obama's 'Patriot' Act

Wall Street Journal
February 27, 2008; Page A16

No, we're not talking about Barack Obama's opposition to the post-9/11 antiterror law. We're referring to the Senator's support for something called the Patriot Employer Act, which deserves more attention as an indicator of his economic agenda.

Along with Democratic co-sponsors Sherrod Brown and Dick Durbin, Mr. Obama introduced the bill in the Senate in August 2007. Recently in Janesville, Wis., he repeated his intention to make it a priority as President: "We will end the tax breaks for companies who ship our jobs overseas, and we will give those breaks to companies who create good jobs with decent wages right here in America."
[Barack Obama]

Mr. Obama's proposal would designate certain companies as "patriot employers" and favor them over other, presumably not so patriotic, businesses.

The legislation takes four pages to define "patriotic" companies as those that: "pay at least 60 percent of each employee's health care premiums"; have a position of "neutrality in employee [union] organizing drives"; "maintain or increase the number of full-time workers in the United States relative to the number of full-time workers outside of the United States"; pay a salary to each employee "not less than an amount equal to the federal poverty level"; and provide a pension plan.

In other words, a patriotic employer is one which fulfills the fondest Big Labor agenda, regardless of the competitive implications. The proposal ignores the marketplace reality that businesses hire a work force they can afford to pay and still make money. Coercing companies into raising wages and benefits above market rates may only lead to fewer workers getting hired in the first place.

Under Mr. Obama's plan, "patriot employers" qualify for a 1% tax credit on their profits. To finance this tax break, American companies with subsidiaries abroad would have to pay the U.S. corporate tax on profits earned abroad, rather than the corporate tax of the host country where they are earned. Since the U.S. corporate tax rate is 35%, while most of the world has a lower rate, this amounts to a big tax increase on earnings owned abroad.

Put another way, U.S. companies would suddenly have to pay a higher tax rate than their Chinese, Japanese and European competitors. According to research by Peter Merrill, an international tax expert at PriceWaterhouseCoopers, this change would "raise the cost of capital of U.S. multinationals and cause them to lose market share to foreign rivals." Apparently Mr. Obama believes that by making U.S. companies less profitable and less competitive world-wide, they will somehow be able to create more jobs in America.

He has it backwards: The offshore activities of U.S. companies tend to increase rather than reduce domestic business. A 2005 National Bureau of Economic Research study by economists from Harvard and the University of Michigan found that more foreign investment by U.S. companies leads to greater domestic investment, and that U.S. firms' hiring of more offshore workers is positively, not negatively, associated with the number of American workers they hire. That's in part because often what is produced overseas by subsidiaries are component parts to final, higher-value-added products manufactured here.

Mr. Obama is also proposing to raise tax rates on affluent individuals, as well as on capital gains and dividends. This would also lead to more capital and jobs leaving the U.S. The after-tax return on U.S. investment would fall appreciably if these tax hikes were adopted, and no amount of tax-credit subsidy will keep capital from fleeing to lower tax jurisdictions.

If the U.S. didn't impose the second highest corporate income tax rate in the world, companies would have less incentive to move jobs overseas. Rather than giving politically correct companies a 1% tax credit, it makes more sense to reduce the U.S. corporate tax rate for everyone -- by at least 10 percentage points to the global average.

Economists have long understood that companies don't really pay taxes; they merely collect them. A study by the American Enterprise Institute has shown that U.S. workers bear the cost of the corporate income tax in lower wages and salaries. To borrow Mr. Obama's language, what's really unpatriotic is the 35% U.S. corporate tax rate.

Inflation and the Tax Man

By RICHARD W. RAHN
January 17, 2008; WSJ Page A17

Rudy Giuliani's tax-reform proposal includes indexing capital-gains taxes for inflation -- that is, putting the original price of the asset in today's dollars. All of the Republican candidates have called for low or lower taxes on capital gains, while the Democrats favor higher capital-gains taxes. But inflation-indexing of capital gains should be part of every candidate's "economic stimulus" package, regardless of party affiliation.

Accounting for inflation in this way has the advantages of producing more short-term revenue to the Treasury as long-term gains are "unlocked." Furthermore, lowering the cost of capital would stimulate investment and the stock markets, and would increase the fairness of the tax system by not taxing phantom gains for people at all income levels. It would also square capital-gains taxation with the U.S. Constitution.

Assume you purchased a common stock in a company in 1984 for $100 a share and sold it in 2007 for $200 a share. Have you received any "income" from the sale of the shares of stock? The IRS would say "yes," but this is clearly wrong. The IRS will claim that you had a $100 per share capital gain on the stock in the above example, yet actually the increase was solely a result of inflation. Because you cannot buy more goods and services with $200 now than you could have with $100 in 1984, you have had no "income" or wealth accretion.

Over the years numerous economists, lawyers and others have tried to fix this problem and have gotten nowhere with Congress. But now, due to increased concerns about inflation, economic growth and judicial salaries, the time may be right to move forward.

Chief Justice John Roberts has just renewed his call for an increase in pay for federal judges. He, his predecessor William Rehnquist and other judges have complained about the "steady erosion" of judicial salaries over the past 20 years. According to Article III, Section I of the U.S. Constitution, compensation of federal judges "shall not be diminished during their Continuance in Office."

As inflation has outstripped the increase in judicial salaries, the judges have clearly had "diminished compensation" in real terms. Chief Justice Roberts currently makes $212,000 per year, yet all but five of his predecessors in the past 200 years made more in inflation-adjusted dollars (Warren Burger's 1969-1986 income averaged about $250,000 per year in 2006 dollars).

The debate centers on the definition of income. The 16th Amendment to the Constitution states, "The Congress shall have the power to lay and collect taxes on incomes," and the Fifth Amendment clearly states, "No person shall . . . be deprived of life, liberty, or property, without due process of law; nor shall private property be taken for public use without just compensation."

If the portion of a capital gain due solely to inflation is not income, then taxation without inflation-indexing is an unconstitutional taking of property. Income is commonly defined as, "the amount of money or its equivalent received during a period of time in exchange for labor or services from the sale of goods or property, or as profit from financial investments."

To be money or its equivalent, the payment must have the power to command goods or services produced in the economy. Thus, if the money received from the sale of an asset cannot command more goods and services than the original capital invested, there clearly has been no income.

Too few judges and members of Congress have a basic understanding of economics. As a result, they do not readily see how small but steady losses in value over long periods (except when it comes to their own salaries) is damaging. Inflation of 2%, 3% or 4% per year may seem trivial, but over time it causes great distortions -- the U.S. dollar is now worth less than 1/20th of what it was worth in 1913 when the Fed was established. If the 12% inflation the U.S. experienced in 1979 had continued, the price level would have doubled every six years.

Congress, in order to prevent unlegislated tax-rate increases, has indexed the tax brackets and some other parts of the income-tax code for inflation, which recognizes that a dollar of income in 1998 is not the same as one in 2008. Yet they have failed to do this for capital gains or the AMT, which is now creating great heartache for them as well as for taxpayers. For the code to be logically consistent and to avoid an unconstitutional taking of property -- and for the word "income" to have the same meaning throughout the code -- any capital gain necessarily needs to be indexed for inflation.

The reasons capital gains have not been indexed for inflation (in addition to some members of Congress and judges who do not understand the proper definition of income) are that some argue it would be too complex, and that, since capital gains are taxed at a lower rate than regular income, the problem has already been addressed. Some claim it would result in a big revenue loss. But in the age of advanced tax software, indexing of capital gains is no more complex than many other provisions of the tax code. (The whole code needs to be simplified, but that is another issue.)

Taxing capital gains at a lower rate is done for a number of good economic reasons, and only offsets inflation for assets that have appreciated rapidly in a short time period. Adjusting capital gains for inflation would clearly increase revenues in the short run because of the "unlocking" effect, and probably over the long run because of the higher levels of investment it would stimulate. Over the past 30 years, the Joint Tax Committee, using largely static models, has consistently erred grossly -- at times even getting the direction of the plus or minus sign wrong -- in forecasting capital-gains tax revenues as a result of tax-rate changes.

The Bush administration ought to make inflation indexing part of its "stimulus package." If properly explained, considerable bipartisan congressional and judicial support should be obtained. A number of legal scholars have argued that the executive branch could unilaterally make the change by requiring the IRS to correctly define the words "cost" and "income," given that it was the IRS that originally incorrectly defined them.

It is not likely that many judges or members of Congress would find it in their personal, political, or the national interest to argue that phantom gains are "income." After all, most Americans do understand the meaning of income, even if some in Washington do not.

Mr. Rahn is the chairman of the Institute for Global Economic Growth and an adjunct scholar at the Cato Institute.

URL for this article: http://online.wsj.com/article/SB120053175732296095.html

Another Bush Tax Cut

Wall Street Journal December 20, 2007; Page A16

Nancy Pelosi and her fellow House Democrats surrendered to reality yesterday, grudgingly handing President Bush and taxpayers another victory. They finally passed a one-year "patch" that will prevent the Alternative Minimum Tax from hitting some 22 million middle-class Americans when they file their 2007 tax returns next year.

Congress passed the AMT in 1969 to hit a handful of millionaires who were said to be exploiting too many loopholes also passed by Congress. But because it isn't indexed for inflation, and because Democrats raised AMT rates in 1993 to 26% and 28% from a single rate of 24%, the AMT has turned into a blob that sucks in ever more taxpayers earning between $75,000 and $200,000 a year.

Now back in the majority, Democrats have found themselves hoist on their own 2006 campaign pledge for "pay as you go budgeting," which meant offsetting any AMT tax "cut" with $50 billion in other tax increases or spending cuts. Mr. Bush and Republicans sensibly argued that, because it was never intended to hit so many people, the AMT shouldn't be used as an excuse to raise taxes on other Americans. And with an election year coming, Senate Democrats didn't want to raise taxes on their rich hedge-fund donors. So House Democrats had little choice but to abandon "paygo" as well and pass AMT relief without any offsetting tax increases.

This is good news for the economy, which is struggling enough without a new tax on private equity or other risk takers. Even better for the longer term, this Democratic decision to abandon paygo may foretell less damaging economic policy in 2009. The main goal of paygo is to make cutting taxes all but impossible, and in particular to prevent any extension of the lower Bush tax rates that expire after 2010. This year's AMT fight has exposed paygo for the political fraud it is, and sets a precedent for abandoning it in 2009 in order to avoid walloping the economy with an even bigger, and more damaging, tax increase.

Democrats will of course have to come up with another one-year "patch" in 2008 before the election, and already they're promising that this time they really will stick to paygo. Right. Our own advice is that Democrats could avoid these annual acts of political masochism if they'd merely repeal their own 1993 AMT tax-rate increases, which would stop the tax from snaring so many voters in their own "blue" states. Meantime, who would have guessed that a Democratic Congress would continue Mr. Bush's streak of cutting taxes in some form in every year of his Presidency. Congratulations, Madam Speaker.

Dems Call for Taxes on Wealthy at Debate

What else is new? Tax the wealthy-tax big corporations. Tax relief for the middle class and the poor. . The rhetoric to the uninitiated is high-minded and seems to make sense. But change it a bit and you get the the reality.

Tax the successful, tax the winners, reward the mediocrity...reward the losers. If you think this is the future success story for America, than by all means vote for your favorite Democrat. I pray Americans are smarter than that, but when they get a chance to vote for a 'free lunch'..all bets are off.

New Iowa Pumpkin Tax Puts Damper on Growers' Halloween Spirit

Renee Mulvey

The Iowa Department of Revenue is taxing jack-o'-lanterns this Halloween.

The new department policy was implemented after officials decided that pumpkins are used primarily for Halloween decorations, not food, and should be taxed, said Renee Mulvey, the department's spokeswoman

"We made the change because we wanted the sales tax law to match what we thought the predominant use was," Mulvey said. "We thought the predominant use was for decorations or jack-o'-lanterns."

Methinks, Renee must be a Democrat...

Read it all.....

Inconvenient Tax Truths

Charlie Rangel and other liberal leaders want to raise tax rates even if it means lower tax revenues.

BY PETE DU PONT
Tuesday, October 30, 2007 12:01 a.m.

Nobel Peace laureate Al Gore believes global warming is "an inconvenient truth." Here are some economic truths that America's liberal leadership finds too inconvenient to support.

Tax rate reductions increase tax revenues. This truth has been proved at both state and federal levels, including by President Bush's 2003 tax cuts on income, capital gains and dividends. Those reductions have raised federal tax receipts by $785 billion, the largest four-year revenue increase in U.S. history. In fiscal 2007, which ended last month, the government took in 6.7% more tax revenues than in 2006.

These increases in tax revenue have substantially reduced the federal budget deficits. In 2004 the deficit was $413 billion, or 3.5% of gross domestic product. It narrowed to $318 billion in 2005, $248 billion in 2006 and $163 billion in 2007. That last figure is just 1.2% of GDP, which is half of the average of the past 50 years.

Lower tax rates have be so successful in spurring growth that the percentage of federal income taxes paid by the very wealthy has increased. According to the Treasury Department, the top 1% of income tax filers paid just 19% of income taxes in 1980 (when the top tax rate was 70%), and 36% in 2003, the year the Bush tax cuts took effect (when the top rate became 35%). The top 5% of income taxpayers went from 37% of taxes paid to 56%, and the top 10% from 49% to 68% of taxes paid. And the amount of taxes paid by those earning more than $1 million a year rose to $236 billion in 2005 from $132 billion in 2003, a 78% increase.

Finally, another inconvenient truth is that there have been 49 consecutive months of job growth as a result of the economic expansion induced by President Bush's 2003 tax rate reductions.

One would think that this positive economic performance would inspire Congress to continue the successful policies that caused it. But the liberal establishment takes a negative view of tax rate reductions and embraces the opposite approach: ensure expiration of the Bush tax cuts in 2011 and in the meantime enact substantial tax increases.

Rep. Charles Rangel of New York, chairman of the tax-writing House Ways and Means Committee, last week introduced an estimated $3.5 trillion tax increase that would raise the capital gains tax rate from to 19.6% from 15% and places a surtax of as much as 4.6% on people making more than $150,000 a year. Mr. Rangel applies it not to current taxable income but to adjusted gross income, thus phasing down itemized deductions such as charitable contributions, home mortgage deductions, and state and local tax deductions. Together with the end of the Bush tax cuts, Mr. Rangel's plan would increase the top income tax rate to 44% from 35% for individuals, small-business owners and farmers, who make up about three-fourths of taxpayers in the highest bracket.

While raising taxes on individuals, the Rangel bill would reduce corporate tax rates to 30.5% from 35% and eliminate the alternative minimum tax. That would be "paid for" by increasing taxes on hedge funds and buyout firms by about $48 billion.

Federal tax revenues have been rising between 6.7% and 14.5% in each of the past three years, but the proposed tax increases, by slowing rather than stimulating the economy, would ensure that these percentages decline. Hillary Clinton defines the liberal tax policy as "we are going to take things away from you on behalf of the common good," but in the unlikely event that the tax bill passes Congress next year, President Bush's veto pen will surely take away from the liberal leadership things that will do harm to the common good.

On the other hand, the 2008 elections could lead to a very different outcome, for the Rangel bill shows in which direction tax policy will proceed if there is a Democratic president and Congress in 2009.

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.
Mr. du Pont, a former governor of Delaware, is chairman of the Dallas-based National Center for Policy Analysis. His column appears once a month.

Copyright © 2007 Dow Jones & Company, Inc. All Rights Reserved.

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The Mother of All Tax Hikes - Part Deux

From the Online WSJ

By DICK ARMEY
October 29, 2007; Page A19 Wall Street Journal

The great philosopher Waylon Jennings once said, "There ain't no right way to do the wrong thing." Congress should take this to heart when it comes to fixing the Alternative Minimum Tax (AMT).

Both Republicans and Democrats agree that the exploding AMT is bad news for taxpayers and the economy, and its growing burden creates a political constituency for tax reform. This is especially true in high-tax blue states like California and Connecticut, where a growing number of Democrats have a serious AMT problem. That's a bit of irony, since the AMT was their 1969 scheme to raise taxes on a handful of "super-wealthy" by creating a parallel tax system. Because the AMT was not indexed to inflation then, this year it will raise taxes for 24 million Americans unless Congress acts quickly.

That's the leverage House Ways and Means Chairman Charlie Rangel (D., N.Y.) wants to use to force a sweeping tax increase and income redistribution plan through Congress. The legislation is misleadingly titled the "Tax Reduction and Reform Act of 2007." Its informal moniker, "the mother of all tax reform," gives us a better sense of the profound impact it will have on American taxpayers and the economy.

Mr. Rangel's bill starts simply enough with a one-year extension of AMT relief provisions. However, the Democrats have sown the seeds for additional taxes with their "paygo" rules, which require all tax cuts to be offset by revenue increases elsewhere. For a temporary $40 billion AMT fix, Mr. Rangel has targeted one of the more productive and dynamic sectors of our economy -- the financial-services industry -- with several new provisions that will increase taxes, including higher taxes on so-called "carried interest," which will affect hedge funds and possibly other partnerships.

Beyond this year's temporary AMT patch, Mr. Rangel's bill would permanently end the AMT in 2008. That's a good idea, but the static price tag for this "relief" is where the trouble starts. Mr. Rangel's bill increases tax rates by 4% on individuals earning above $150,000 and couples earning over $200,000. This increase will come on top of the rollback of the 2001 and 2003 Bush tax cuts. The combined result: America's top income-tax rate will skyrocket from the current 35% rate to a top rate of 44%. Let's be clear -- that's a 25% tax hike.

So much for low-tax America and high-tax Europe; this would put the nation's top rates among the highest of all developed nations. This is an especially heavy burden for American farmers and small businessmen who pay taxes as individuals. According to an Oct. 25 memo from Ways and Means Committee Ranking Member Jim McCrery (R., La.), the net result will be the biggest tax increase in U.S. history, totaling $3.5 trillion in higher taxes over the next 10 years.

Mr. Rangel does shuffle the corporate-tax code, dropping the top rate to 30.5% from the current 35%. It's rather refreshing to see that he recognizes that America's corporate-tax rate is too high and hurts our competitiveness. But this glimmer of progress is swamped by the plan's range of new taxes on capital investment and punitive measures towards American companies that operate globally.

Contrary to its deceptive name, Mr. Rangel's bill is not tax relief, but a breathtaking tax increase. And it is not tax reform, but just another round of new complexity layered on top of the existing tax code, with tweaked provisions, changed definitions and redistributed income to favored groups through carefully crafted new subsections. Compliance with the 60,000-page tax code costs Americans seven billion man-hours and over $140 billion in fees to accountants and consultants, all before a single check is cut to the government. While the AMT may be repealed by this bill, the inefficiencies and burdens that keep Washington lobbyists employed full time remain.

Thankfully, there's an alternative to Mr. Rangel's redistributive approach, and it's being offered by a group of pro-growth tax reformers in the House of Representatives. "The Taxpayer Choice Act," is being offered by Reps. Paul Ryan (R., Wis.), Michele Bachmann (R., Minn.), Jeb Hensarling (R., Texas), and John Campbell (R., Calif.) that repeals the AMT while fundamentally reforming the tax code.

These young Republican legislative entrepreneurs offer taxpayers the choice of remaining in the current system with its itemized deductions, charts and schedules, or moving into a greatly simplified system that eliminates all deductions and loopholes while offering only two simple rates. All taxpayers would have a standard individual deduction of $12,500, and individuals earning below $100,000 would pay a flat 10% of income, while individuals earning above that would pay 25%. Calculating taxes would take less time than brewing a pot of coffee. [QA: Republicans should jump all over this idea!]

Last year I observed on this page that, on fiscal policy, voters could not see a dime's worth of difference between the two political parties. How things have changed. Mr. Rangel's mother-of-all tax increases is another of the same, tired, "tax-the-rich" revenue-raising schemes of past Democratic Congresses. It focuses on redistributing income through the tax code at the expense of economic growth and tax simplicity. Such tax schemes have a high political-demagogy coefficient that can temporarily satisfy liberal constituencies, but they always backfire in practice.

In the early 1990s, I remember watching Sen. George Mitchell sing the praises of a new luxury tax that would "tax the rich." But as any Economics 101 student might have predicted, the immediate effect of this luxury tax was a sharp decline in sales of "luxuries," particularly new boats, and a dramatic loss of boat-related manufacturing and service jobs. It was less than a year before Sen. Mitchell was working to lift the tax so his constituents in boatyards in Maine could get back to work.

The Taxpayer Choice Act, on the other hand, is based on the belief that the only legitimate purpose of the tax code is to raise the revenue necessary to fund the legitimate expense of government; it is not a place for social engineering or rewarding favored political constituencies. It treats taxpayers with dignity, and moves us in the direction of eliminating double taxation, which encourages capital formation, savings and investment.

I have long advocated a tax code that is simple, fair, flat and honest. Income should be taxed once, and only once, thereby promoting economic growth through increased savings and investment. Sadly, Mr. Rangel's Democratic vision for tax policy takes giant steps away from that ideal. Republicans have a competing vision that offers taxpayers an escape from both the AMT and many of the heavy compliance costs of today's tax code.

This small step may still be too big for the income redistributors in our nation's capital. Until American citizens beat Washington bureaucrats and special interests, taxpayers will remain trapped in a tax code built by and for special interests. Finally, at least, they have a choice between two fundamentally different visions. Let's hope the taxpayer wins this debate.

Mr. Armey, Republican majority leader of the U.S. House of Representatives from 1995 to 2001, is chairman of FreedomWorks Foundation.

URL

Web Tax Triumph

Trust me , folks. This is a huge victory against those in local, state and federal government who are constantly looking to pick your pocket. Taxing your internet use has been a gleam in their eyes, adding to the already onerous over-taxation of basic phone and cable tv.

Tax creep is insidious, but understandable. When income is based solely on revenue from taxpayers as that of politicians, bureaucrats, most liberals is, then they are highly motivated to seek tax increases. Of course there are many reasons why redistribution of wealth is the touchstone of American liberals, but they are fighting an uphill battle as long as we all stay informed. The internet and the blogosphere have been awesome weapons in the fight.

For now, one battle has been won. From today's Wall Street Journal:

October 26, 2007; Page A16

Internet consumers scored a victory in Washington last night, thanks to Senator John Sununu (R., N.H.), with big assists from Minority Leader Mitch McConnell (R., Ky.) and Oregon Democrat Ron Wyden. The Senate passed a seven-year extension of the Internet tax moratorium, with robust language that should stiff-arm even the most voracious state and local governments looking for loopholes to tax your email.

Mr. McConnell created negotiating leverage by forcing on to the Senate schedule a vote on Mr. Sununu's permanent Net tax ban. The last thing moratorium opponents wanted was to face an up-or-down vote on a permanent ban, which is why they recently cancelled a committee vote when it became clear they had underestimated the popularity of the tax moratorium. That's also why you can now ignore the letter on the preceding page, in which Senators Tom Carper (D., Del.) and Lamar Alexander (R., Tenn.) sing the praises of their short, loophole-ridden "moratorium" bill. They junked it last night and scrambled aboard the Sununu steamroller.

While accepting less than a permanent ban, Mr. Sununu and his pro-Internet allies won additional provisions authored by Mr. Wyden to protect consumers. A report yesterday from the Congressional Research Service revealed that the House had botched the drafting of its four-year extension by leaving open the possibility of new taxes on email services if they weren't marketed along with Internet access service. Kudos to Senators Sununu, McConnell and Wyden. If the House, as expected, passes the Senate bill early next week, President Bush can sign it into law before the current ban expires November 1.

“Mother of All Tax Hikes” Bill

Press Release

Memo: McCrery on "Mother of All Tax Hikes"

October 25, 2007

By Ways and Means Republican Press Office

MEMO

RE: “Mother of All Tax Hikes” Bill

TO: Republican Members, Republican Staff

FROM: Ways and Means Committee Ranking Member Jim McCrery

My Friends,

At a bipartisan Ways and Means caucus last night, Chairman Rangel outlined his long-awaited “Mother of All Tax Hikes” legislation. The basics of the package are simple: This is the largest individual income tax increase in history.

The bill will add a 4% surtax on Americans earning more than $150,000 a year ($200,000 for couples). That is on top of the scheduled expiration of the 2001 and 2003 tax cuts. So, under Democrats’ plan, over the next few years, the individual income top tax rate in the United States will rise from 35% to 44%. By way of comparison, the other 29 Organization for Economic Co-operation and Development countries – basically other developed nations - have an average top marginal tax rate of 35.7%. In fact, only five OECD countries would have higher top marginal tax rates in 2011 than the United States if the Democrats’ bill is enacted.

This crushingly high tax rate will affect approximately 10 million taxpayers directly - including those who report business income, like small business owners and farmers - but the damage will ripple throughout our economy. Because small businesses and family farms often pay their income taxes as individuals, this is a massive tax hike on the engine that drives job growth in this country.

In addition, the surtax is on adjusted gross income, not taxable income. This sounds like a technical issue, but it means that Rangel’s bill will erode the value of a series of tax deductions – including for mortgage interest, charitable giving, medical expenses, state and local taxes, and the standard deduction. And, because the surtax kicks in at $150,000 for individuals and $200,000 for couples, the bill creates a monster of a marriage penalty.

Chairman Rangel will claim that these tax increases go to provide tax cuts to 90 million Americans, but he is selling pure snake-oil. Many if not most of those taxpayers are getting a purely imaginary “tax cut.” Some of them are the roughly 20 million people that Republicans shielded with the Alternative Minimum Tax patch. Millions more are people who have benefited from the 2001 and 2003 tax cuts, and only get “tax cuts” if you assume that the 10% bracket, marriage penalty, and $1,000 per child tax credit will expire. Others, like single people who will now be eligible for the Earned Income Tax Credit, are getting a tax refund from the government even though they don’t actually pay income taxes.

It will take time to analyze this bill and sort through the data, but we know from the start that the 90 million figure is pure hokum. In fact, before you know it more taxpayers may wind up paying higher taxes – and fewer paying less - under Rangel’s plan than they did last year.

Which brings us to the larger fallacy of the Democrats’ “paygo” system. There is no need to “pay for” protecting taxpayers from a massive AMT tax hike. The government never meant for the AMT to affect middle-class Americans, and we have a responsibility to make sure it doesn’t. By arguing that preventing this tax increase requires us to raise taxes elsewhere, Democrats are trying to lock Congress into a system where we are guaranteed to raise taxes by $3.5 trillion over ten years.

That’s right. $3.5 trillion. The baseline that the Democrats are using for “paygo” includes revenue from an “un-patched” AMT and from the tax increases that occur when the 2001 and 2003 tax laws expire after 2010. Together they total $3.5 trillion over ten years. If we play by the Democrats “paygo” rules, that is the size of the tax increase we are imposing on the American people. That will hurt our nation’s competitiveness and cost us American jobs. The Rangel bill is the first step down a road none of us want to follow, and I urge you to oppose it strongly.

###

A Capital Gains Primer

A Capital Gains Primer
October 15, 2007; Page A22

'The tax on capital gains directly affects investment decisions, the mobility and flow of risk capital . . . the ease or difficulty experienced by new ventures in obtaining capital, and thereby the strength and potential for growth in the economy."

John F. Kennedy, 1963

When it comes to taxes, Barack Obama is no Jack Kennedy. The Illinois Senator recently announced that he wants to raise the capital gains tax to restore "fairness" to the tax code.

That makes it a three-peat: All of the leading Democratic contenders for President have endorsed higher taxes on stock ownership. Hillary Clinton is the "moderate" in that so far she'd merely raise the tax to 20% from the current 15% -- a 33% increase. John Edwards and Mr. Obama want to nearly double it, to 28%.

This would repeal not only the Bush capital gains tax cut of 2003 but also the 1997 bipartisan tax cut signed by Bill Clinton, which cut the rate to 20% from 28%. In explaining his proposal, Mr. Obama ignores JFK's arguments about economic growth and instead plays the envy card: "For decades, we've seen successful strategies to ride antitax sentiment in this country toward tax cuts that favor wealth, not work."

But it's not only the wealthy who will take a hit from higher capital gains taxes. Recent surveys indicate that roughly 52% of American adults own stock in some form, and last year 8.5 million of these investors paid a capital gains tax. The value of those assets will decline if capital gains taxes go up because financial markets instantly capitalize higher taxes on stock profits into lower stock prices.

We saw this effect in May of 2003 after the passage of President Bush's investment tax cuts. An analysis by the investment advisory firm Strategas shows that stock values rose by 10.3% in the following weeks, and over the last four years the net worth of Americans's stock holdings has increased by some $6.2 trillion. Economic growth was the largest driver of stock prices, to be sure, but a higher after-tax return on capital also played a role.

Taxing capital gains at a lower rate than ordinary income is a long-established policy to encourage risk taking and investment. Since we already tax corporate earnings at 35% through the corporate income tax, taxing those profits again when the stock is sold imposes a double tax on risk capital. That's why 12 industrialized nations, including Hong Kong and Korea, impose a zero capital gains rate.

The differential rate also compensates for the fact that the tax applies to the value of inflated capital gains, rather than the real gains. Former Federal Reserve Board member Wayne Angell discovered that between 1973-1993 the majority of gains from stock sales were a result of "phantom gains due to inflation." The tax code also taxes people fully on their gains, but only allows a $3,000 deduction each year on losses. The lower capital gains rate makes up in part for that failure to deduct losses from risk-taking investments.

Mr. Obama is wrong when he assumes that the returns to capital accrue exclusively to rich investors. A study by former Treasury Department economist Gary Robbins has found that from 1946-1998, about 90% of the returns to capital investment accrued to workers in the form of higher wages, because when workers have more tools like computers, forklifts and robotic equipment, they produce more.

Ah, but won't the Treasury benefit from a revenue windfall? Almost certainly not. For the past 40 years, capital gains tax increases have been associated with a decline in tax revenues. Rate cuts have generated more tax collections. One reason is that higher rates give investors an incentive to hold their assets to avoid paying the tax. The capital gains rate was last raised in 1986. Revenues from the tax tripled in the year before the increase, as investors cashed out of assets before the window of the lower tax rate slammed shut. But in each of the five years after the rate jumped to 28% from 20%, capital gains revenues remained below the pre-1986 level, according to a study by the National Chamber of Commerce Foundation.

Conversely, the 1997 capital gains tax cut had a stock market unlocking effect. Congress's consistently mistaken Joint Committee on Taxation predicted that the government would collect $195 billion from 1997 to 1999 from capital gains payments. The actual amount was $279 billion. In other words, the lower tax rate raised $84 billion more than expected -- which is one reason the late 1990s produced budget surpluses. Most recently, as the nearby chart shows, the 2003 tax cut produced a doubling of tax receipts to $97 billion in 2005 from $47 billion in 2002. That's twice what Congress predicted.

* * *

Every generation or so, it seems that the American political class has to re-learn these tax policy lessons the hard way. What's especially striking about this year's Democratic economic proposals is how little any of them mention economic growth. Their message is "fairness," inequality and income redistribution. They seem to think taxes can be raised with ease, and no one's behavior or investment choices will change. Jack Kennedy knew better.