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.

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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.