CTJ's Tax Justice Digest, March 9, 2007

Congress Begins to Consider Reform of the Alternative Minimum Tax

Earlier this week, the House Ways and Means Subcommittee on Special Revenue Measures held its first hearing this year on the Alternative Minimum Tax (AMT), which is supposed to ensure that extremely wealthy people pay some minimal amount of taxes regardless of what loopholes they enjoy. But unless Congress acts, the AMT will soon affect some households who are upper-middle income but not super-rich. This is because the exemptions that shield most people from the AMT have never been permanently indexed for inflation, and because the Bush tax breaks changed the regular income tax calculation but not the AMT. Congress has enacted temporary "patches" in recent years that extended the exemptions and increased them to keep up with inflation, but continuing this process would cost over $250 billion over the next four years. This cost would have to be offset if Congress is to stay within the PAYGO rules revived by the Democrats in the House shortly after they took control of Congress. The problem is that Republicans are responding to the situation by proposing to repeal the AMT entirely without paying for it, which could cost well over a trillion dollars over a decade.

Fingers Crossed for a Progressive, Budget-Neutral AMT Reform

Subcommittee Chairman Richard Neal (D-MA) indicated that a permanent reform will be proposed by the Democrats in a few weeks. It is not yet clear what that will look like, but Ways and Means chairman Charlie Rangel (D-NY) has hinted that a bill shielding more moderate-income families from the AMT could be paid for by redirecting some tax breaks away from the wealthiest taxpayers. Citizens for Tax Justice has proposed an AMT plan along those lines that would not change anything in the normal income tax rules, but other proposals have been suggested that would use new or higher regular income taxes on the wealthiest to pay for AMT reform.

Six Years Wasn't Long Enough for the Republicans to Fix the AMT

The subcommittee's ranking member, Phil English (R-PA), took the opportunity to argue that the AMT problem was the Democrats' fault. He pointed out that President Clinton vetoed an AMT repeal bill passed by the Republican Congress (that proposal would have repealed the AMT without offsetting the cost at a time when the administration was trying to balance the budget). Representative English did not explain how the Republicans managed to control every branch of government for six years without enacting a permanent solution in any of their six major tax bills. He also did not respond to the explanation that the Bush administration in 2001 intentionally chose to leave the AMT in place so as to make the cost of its first tax break appear less than it would really be after accounting for the AMT patches that Congress would inevitably enact. The AMT essentially threatens to take the Bush tax breaks away from many Americans but leave them in place for the very richest (who, ironically, are not as likely to be affected by the AMT). Nonetheless, Representative English argued that any plan that would close loopholes used by the wealthy or raise taxes on the wealthy to pay for AMT reform would be "class warfare" and would be opposed by the Republicans.

CTJ Tells Appropriation Subcommittee Bush's Tax Proposal Will Cost Over $5 Trillion in Second Decade

In testimony Monday before the House Appropriations Subcommittee on Financial Services and General Government, Citizens for Tax Justice Executive Director Bob McIntyre presented the latest CTJ data on the Bush tax cuts. He explained that the administration's proposal to make the tax cuts permanent will cost a total of $5 trillion dollars from 2011 through 2020. This total includes the added interest on the national debt accumulated as a result of the tax breaks. While the President's proposed budget does not include permanent AMT reform, this calculation assumes that Congress will be forced to change the AMT (either through consecutive "patches" or through legislation that permanently reforms the AMT).

Our Going-Away Present from the Republican-Controlled Congress:
An Unbelievably Confusing Tax Form

This year our federal tax forms are incredibly confusing, but it's not the IRS's fault, and it's not something that is going to be solved with the latest regressive "flat tax" plan. Rather, this year's tax filing confusion is caused by the previous Congress, which in the months before the Republicans lost power, procrastinated as long as possible before extending several tax deductions and credits. At that point it was too late for the IRS to include these deductions and credits on the tax forms, which were already printed and distributed. (To be honest, Citizens for Tax Justice has never been fond of these particular tax provisions, the "tax extenders," but we'd rather they be enacted permanently or not at all, as opposed to having Congress revisit them every couple years and spending endless amounts of time that could be applied to more pressing matters.)

Let's say you have kids in college. The general instructions say that the tuition deduction is expired but may have been extended and refers you to the IRS's web site. The 1040 (printed and on-line) has nothing about the tuition deduction. If you go to the website and look under "What's Hot" you find not a word about the tuition deduction. If you search further you can find information about changes in tax laws that apply and you discover that to take the tuition deduction, you go to line 35, which is for something called the "domestic production activities deduction" and write a "T" on the line if you're taking the tuition deduction. If you happen to be taking the domestic production activities deduction and the tuition deduction, you write "B" on the line for "both." Similar instructions are given for those taking the educator expenses deduction, the DC first-time homebuyer credit and the state and local sales tax deduction.

The good news is that this confusion could create support for tax reform and simplication. The bad news is that a lot of the plans peddled as "tax simplification" do not focus on simplification, but rather remove the progressive rates which have nothing to do with this confusion. (Tax tables are provided to tell you how much you actually owe after you work through all these deductions and credits). Our current President has persuaded Congress to enact six tax break bills in six years — but none have simplified our tax code. Broad tax reform might be a good idea — in 2009.

Is a "No Income Tax Floor" the Best Approach to Tax Fairness?
Lessons from North Carolina

"People in poverty should not pay income tax in this state." It was North Carolina Governor Mike Easley who said it last week in his "State of the State" speech, but it's a sentiment that is widely shared by policymakers of all stripes around the nation. However, Easley's proposed remedy — a tax credit that eliminates all state income tax for some low-income families, and cuts the income tax bill in half for others — shows both the power and the limitations of this sentiment. A new report by the North Carolina Budget and Tax Center (BTC) highlights the flaws in Easley's "no-tax floor". The main problem is that the proposed tax credit is non-refundable, which means it can be used to reduce income taxes to zero but can't be used to offset regressive sales and property taxes. As ITEP's Who Pays report has documented, these non-income taxes hit poor families far more heavily, on average, than does the income tax.

This fact may have been unclear to many initially when the proposal was presented. The governor's projections of the number who would be taken off the income tax rolls by his plan erroneously included the hundreds of thousands of North Carolinians who already pay no income taxes because of the standard deduction and personal exemption already in place.

As the BTC has also documented, there's a better answer for policymakers who are truly concerned about not taxing low-income families further into poverty: a refundable state Earned Income Tax Credit. The goal of eliminating income taxes on poor families has gained heightened visibility in recent years, largely due to the Center on Budget and Policy Priorities' terrific annual report on this topic. Now, the BTC's work is prompting a healthy debate on how best to redress the inequities highlighted in the CBPP report.

Illinois Proposal Would Go Two Steps Backward

In his State of the State address this week, Illinois Governor Rod Blagojevich declared that his state's tax system is "one of the most regressive … in the nation" and proposed sweeping changes in response. The Governor's diagnosis is correct, but his prescription would likely make the situation worse. As ITEP's 2003 report Who Pays demonstrates, Illinois' tax system is the 6^th most regressive in the nation. The poorest fifth of taxpayers pay around 13 percent of their incomes in taxes, while the richest 1 percent pays just around 6 percent. Yet, the Governor's "Tax Fairness Plan" would replace a comparatively progressive source of revenue — Illinois' corporate income tax — with a gross receipts tax, which generally hits low-income taxpayers the hardest. ITEP's latest Talking Taxes policy brief reviews the advantages and disadvantages associated with this type of tax. It observes that a gross receipts tax could be used as an alternative minimum tax that enhances the basic corporate income tax, but policymakers should not throw out the corporate income tax altogether. Both Voices for Illinois' Children and the Center for Tax and Budget Accountability have detailed sets of policies that would improve both the adequacy and the equity of Illinois' tax system.

The Benefits of Closing the Tax Gap

Congressmen Rahm Emanuel (D-IL) and Ray Lahood (R-IL) have put forward a bipartisan proposal to use revenues collected through better enforcement of capital gains taxes to double the funding of the State Children's Health Insurance Program (SCHIP) over the next 5 years to $60 billion. Ten billion dollars of this increase would go to children not currently covered by SCHIP. Families whose income is between 200% and 350% of the federal poverty level ($20,000 for a family of 4) would receive an advanceable and refundable tax credit to purchase health insurance for children.

The proposal to improve capital gains enforcement has already been presented as a bill by Representative Emanuel (H.R. 878) that would require securities brokers to report a customer's basis (generally the purchase price) in securities transactions to prevent understating the capital gains on such transactions. This step was one the suggestions offered by Citizens for Tax Justice to the Senate Budget Committee in January. The President included a similar proposal in his budget for fiscal year 2008. As reported in last week's Tax Justice Digest, another proposal to expand SCHIP would use revenue from an increased federal cigarette tax. The Center on Budget and Policy Priorities has a new report that outlines various ways of paying for an SCHIP expansion.

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