CTJ's Tax Justice Digest, December 7, 2007

On Thursday, December 6, Republicans in the Senate voted en masse against consideration of a bill (H.R. 3996) passed last month by the House of Representatives to provide relief from the Alternative Minimum Tax (AMT) and offset the cost by closing loopholes for extremely wealthy financial managers. Instead, Republican leaders demanded that the federal government borrow the $50 billion. They got their way later in the evening, when the chamber passed a bill simply extending AMT relief without paying for it.

This sets the stage for a standoff with the House, where Democratic leaders are adamant that no laws be enacted to increase the federal deficit, in keeping with the pay-as-you-go (PAYGO) rules that were reinstated when the Democrats took control of Congress earlier this year. But in the Senate, because 60 votes are needed to pass most legislation, the Republicans were able to block the fiscally responsible approach even though it was supported by every member of the majority party.

"I'm willing to accept a tax cut for people making upwards of $100,000 a year, if we send the bill to people making millions," said CTJ director Robert S. McIntyre. "But I can't support cutting taxes for such well-off people and sending the bill to people who make $50,000. Yet sadly, it's exactly those ordinary taxpayers who will likely bear the cost of the increased debt -- through higher taxes or reduced public services in the future."

Republicans Manage to Preserve Loophole for "Carried Interest" -- for Now

In the AMT relief bill passed by the House last month, one of the revenue-raising provisions to offset the cost would have closed the loophole for "carried interest," a type of compensation paid to buyout fund managers. Republican leaders have demanded that this loophole allowing wealthy fund managers to pay taxes at a lower rate than middle-income families be preserved. They appear to have gotten their way for now, as House Ways and Means Committee Chairman Charles Rangel has said he would drop the carried interest provision and replace it with some potentially more palatable revenue-raising provision.

But the battle over carried interest is far from over. In September, CTJ sent to the House and Senate a letter signed by around 300 organizations from every state urging that the loophole be closed. Lobbyists for the industry have acknowledged that the issue is likely to come up again in the next couple of years as Congress considers broader tax reform.

CTJ would like to thank all those who helped begin the fight to close the carried interest loophole. As a result of these efforts, the majority party in both chambers has, after some initial hesitation, completely adopted the position that the loophole should be eliminated. We will continue to build on these efforts as Congress turns to broader tax reform.

President Bush Relied on Expanding Reach of AMT to Mask Cost of His Tax Cuts

Republican congressional leaders claim that Congress should eliminate the AMT without paying for it because no one ever intended to collect the AMT's revenues. But that's not true.

When George W. Bush proposed his tax cut plan, he and his tax advisors were well aware that, since the AMT is an alternative tax, lowering the regular tax rates without adjusting the AMT would push tens of millions of people into the AMT. But they needed the added AMT revenues to significantly reduce the projected cost of Bush's tax cut program. In fact, Bush's chief economic advisor was adamant that Bush's plan contemplated a huge increase in the AMT.

"Having created most of the AMT problem, Bush and his congressional allies are now trying to rewrite history so they can get away with loading even more debt on our children," said McIntyre. "They shouldn't be allowed to get away with it."

In Georgia, the radical plan to abolish property taxes and hike sales taxes, proposed earlier this fall by House Speaker Glenn Richardson, is shrinking by the day. Last week, Richardson pared back his proposal so that instead of repealing all property taxes, the plan would "only" repeal all homeowner property taxes for schools (plus the annual "car tax" Georgians pay on their motor vehicles), and would pay for the change by taxing personal services.

The plan still raises worrisome questions, however. Georgia already allows large state-funded (and local-option) homestead exemptions and other tax breaks for fixed-income families. If further residential property tax relief is necessary, a state-funded "circuit breaker" tax credit would be a better-targeted (and less expensive) option than outright repeal of all homeowner school property taxes. (Circuit breakers are provisions that prevent property taxes from exceeding a certain percentage of a family's income.) And expanding the sales tax base to include services, while a shot in the arm for a sustainable sales tax, would make Georgia taxes even more regressive unless accompanied by low-income tax breaks of some kind. As the Georgia Budget and Policy Institute has pointed out, a state Earned Income Tax Credit could be an important part of this mix.

Snatching Defeat from the Jaws of Victory

Not content to allow the state's Supreme Court to restore some degree of sanity to the state's property tax system, legislators in Washington last week voted to reinstate a property tax cap that the Court had recently found to be unconstitutional. The cap, initially imposed as a result of a 2001 ballot initiative, had prevented - and, now, will continue to prevent - certain property taxes from growing by more than 1 percent per year, a rate less than the rate of inflation and well below the rate of growth necessary to maintain public services. In fact, the Legislature's vote occurred during a special one-day session hastily called by Governor Chris Gregoire, a move that seems at least partially motivated by a desire to keep localities from doing something rash, like taking the opportunity to increase property taxes and spend them on such luxuries as police or fire departments.

During the session, the Legislature also approved a change in law that will allow homeowners with incomes under $57,000 to defer payment of as much as half of their property taxes until they sell their homes. The Washington State Budget and Policy Center has produced a series of short papers examining property tax caps, deferrals, and other related issues; read them here.

A Word from the Wise

A state cannot improve the lives of its residents by becoming the "discount store of the U.S." warned Dr. William Fox, the respected Director of the Center for Business and Economic Research at the University of Tennessee, in a speech at the Annual Economic Outlook Conference in South Carolina this week. Fox said of South Carolina's tax structure, "If you want to be the discount store of the U.S. that certainly is an option. But it is not the way to create a rising income relative to the U.S. and the rest of the world."

According to The State, Fox reportedly said that South Carolina "needs to put in place a tax system that grows with the need for education and infrastructure, "so that you can invest in yourself." Fox and other colleagues are consulting with the Palmetto Institute (a South Carolina based think-tank) regarding ways to improve the state's tax structure. Let's hope that in the coming legislative sessions South Carolina follows Fox's advice instead of attempting to become the tax policy equivalent of K-Mart.

Budget Shortfall Projected in Minnesota

Late week few in Minnesota were surprised to learn of the state's forecasted $373 million shortfall for the FY08-09 biennium. Policymakers must find a way to fill this gap by the end of the 2009 fiscal year. The Minnesota Budget Project says, "These forecast results are further evidence that Minnesota's experiment in this decade to respond to fiscal troubles with budget gimmicks, short-term fixes and reduced investments in the state's physical and human capital has failed. The promised benefits -- a stronger economy and continued high quality of life -- have not materialized." In a November 30 press release Governor Tim Pawlenty said, "that state government should hold the line on spending and not raise taxes on Minnesotans." The Governor's release says that he "will propose tax cuts for individuals" that would be paid for by eliminating corporate tax loopholes which relate to how business income is defined.

Michigan Resolution: Repeal and Replace

The Michigan service tax, a six-percent tax on select services, was repealed by the Michigan Legislature only hours after it look effect last weekend. The service tax was initially passed by the legislature because it was billed (and correctly so) as a way to modernize the state's tax structure; it was also intended to help to fill a multi-million dollar shortfall in the state's 2007-08 budget.

A number of issues led to the tax's untimely demise. The enacting legislation was passed very quickly without the planning necessary to ensure a quality bill; there were inconsistencies regarding which services were taxed (for example, skiing was taxed, but golf was not); and business-to-business services were included in the legislation (something most economists recommend against). The revenue hole from repealing the service tax will be filled by a surcharge on the Michigan Business Tax. Many state business interests preferred the business tax surcharge over the sales tax base expansion proposal. Clearly Michigan's path to sales tax base expansion was rocky, but as the bases for state economies continue to change from goods to services, it's inevitable that states looking for revenue will turn to expanding their sales tax base. There are important lessons to be learned from Michigan's attempt. For more read ITEP's policy brief.