Reactions to H.R. 3970
Chairman Rangel’s
“Tax Reduction and Reform Act of 2007”
Veterans of tax legislative battles see the introduction of Chairman Charles Rangel’s “Mother of All Tax Bills” as the first salvo in what will ultimately become the battle to reform the federal tax code in the next few years. Clearly, there is no way that President Bush will approve of the tax rearrangements Mr. Rangel has concluded are necessary while he remains in office. With 49 Republicans in the Senate, the President likely has the numbers to keep Democrats there (assuming they would support the Rangel measure in sufficient numbers) from prevailing.
Indeed, the Chairman has as much as acknowledged this by inserting a one-year Alternative Minimum Tax (AMT) relief measure into the bill astride his permanent repeal provision. Permanent repeal of the AMT would cost nearly $800 billion, while another year of staving it off would (only) cost $50 billion. “Mother”, i.e., a bill to permanently fix the AMT, would require and does include revenue-raisers that would offset that $800 billion. Not going to happen now. Instead, what the Chairman has done is to lay down an interesting marker of his vision of, as his Committee’s press release says is the “most comprehensive overhaul of the U.S. tax code introduced since the Tax Reform Act of 1986.”
What is interesting about it? For starters, he offers corporate America a 4.5% reduction in the top marginal tax rate (from 35% to 30.5%). He indicates that corporate executives with whom he has spoken would rather give up some favored credits and beneficial provisions in order to get the top rate reduced. He has taken that to heart, proposing after next year to eliminate the Research and Development Tax Credit, deferral of active business income, the worldwide allocation of interest expense provisions, using foreign tax havens to avoid tax, the “last-in, first-out” accounting method--the list goes on and on. In doing this, he has signaled to that part of the corporate community that can live with such changes, that he expects their support in the battle to come, knowing that there will be a split among corporations over these proposals.
Next, Chairman Rangel has made it clear that for individuals and couples with high incomes the “party is over”. “Hard working” families (we used to just call them “working families--implying lower incomes) get some relief through an increase in the standard deduction (almost $50 billions worth over 10 years), an expansion of the earned income tax credit (almost $30 billion), and $9 billion for an increase in the refundable credit for children.
The changes for higher income Americans would be substantial: the AMT relief would be at least partially denied to those couples earning somewhere in excess of $200,000 (to be determined by the Secretary of the Treasury) for they would have to pay a 4% “replacement tax” (replacing some of the AMT revenue lost by permanent repeal) and on top of this for those earning in excess of $500,000, and additional 4.6% on the excess. This will raise nearly $35 billion more than permanent repeal over 10 years.
Perhaps the poster children for those with higher incomes in this package are investment fund and hedge fund managers. Chairman Rangel takes aim at some of them with the end of so-called “carried interest” capital gains treatment. Under his bill (actually, as a pay-for for the one-year AMT relief provision), they will now have to pay regular income tax rates for portions of their income deemed to be compensation for services. The provision raises over $25 billion in 10 years. Adding insult to injury, he prevents hedge fund managers from deferring compensation by using offshore tax havens ($23 billion). And in an effort to quell the desire for lucrative offshore fund returns for investment on the part of pension plans, universities and other tax-exempts, the Chairman relaxes the unrelated business income tax (UBIT) rules to permit direct investment in such funds.
Subchapter S corporations’ shareholder/employees will now be subject to self-employment taxes on the portion of their distributed share that relates to the service business of the corporation, and makes similar changes apply to limited partner/employees of partnerships engaged in service businesses (raises nearly $9.5 billion).
There are other provisions, as well. However, the outlines of the next tax reform, as Chairman Rangel sees it, have been drawn. He would lower corporate rates, but broaden the corporate tax base by getting rid of a substantial portion of the special provisions added since 1986. He would make wealthier Americans shoulder much more of the load, while giving the lowest income earners more relief from taxes. In his outline for reform, everything is paid for.
This Congress, instead of tax reform on this scale, there will be a series of one-year measures. A long list of “extenders” will be reenacted. The AMT won’t bite new taxpayers for another year. Congress will fight over the pay-fors, with some arguing that the one-year AMT provision isn’t a tax reduction, but rather a measure to prevent a tax increase. That distinction, they will argue, is sufficient to justify not paying for it. It is unlikely that view will prevail, but it is at least possible. The Senate appears increasingly skittish about enacting tax increases, but may, in the end, be forced to pay for protecting voters from the AMT, if only for a year.
Whatever happens, the real message in the “Mother of all Bills” is contained in what won’t happen until after the present occupant departs the White House. As an opening position, it is both bold and predictable. It makes no bones about who will now pay for necessary changes, and unequivocally says that change is coming. At the same time, it is not a radical policy or structural departure from the expectations of many who anticipated its introduction. The question is, can the Congress find within itself the discipline to deal with the cancer that the AMT has become and to deal with assorted other tax system imperatives, carefully select out some of “Mother’s” provisions and replace them with provisions that either cost or raise revenues proportionately, and set the country on a responsible path financially? Or, is there a completely new approach just waiting to substitute for all of this after the next election and capture the public’s support?
Don’t change that channel.