The Senate approved a bill Wednesday that includes an extension of unemployment benefits and COBRA health benefits for unemployed workers through the end of the year, and a short-term extension of Medicaid funding for states and a Medicare "doc fix" (maintaining payments to doctors under Medicare).

The cost of this spending was not offset since it is considered emergency spending to stimulate the economy. But the costs of other provisions in the bill — extensions for $30 billion worth of business tax breaks often called the "tax extenders" — were offset. The biggest revenue-raiser used to offset this costs is a provision to close the "black liquor" loophole. This loophole allows paper-making companies using a carbon-rich by-product as fuel to use a tax credit that is supposed to encourage the use of environmentally-friendly alternative fuels.

But the "black liquor" provision may be used instead in the final health care reform bill. The health care reform bill approved by the House on November 7 of last year (H.R. 3962) included this revenue provision, and the President's recent proposal to bridge the differences between the House and Senate health bills also includes it.

There is another perfectly good revenue-raising provision that the Senate can use to offset most of the cost of the "tax extenders." The version of the tax extenders bill approved by the House on December 9 was supported by CTJ and several other progressive organizations because it included several good provisions, including one to close the infamous "carried interest" loophole. U.S. PIRG and CTJ issued a joint press release yesterday stating their disappointment that the Senate has not done the same.

The carried interest loophole allows billionaires managing hedge funds and buyout funds to pay taxes at a lower rate than middle-income workers. The House has passed legislation three separate times to close the carried interest loophole (including the recent House-passed extenders bill), and both of President Obama’s budget plans have proposed to close it. Senator Chuck Schumer (D-NY) was quoted in Congress Daily recently saying that closing the carried interest loophole is "on the table."

Until this loophole is closed, the compensation of these fund managers will continue to be taxed at a rate of 15 percent, the preferential rate for capital gains that is supposed to benefit people who invest their own money, not the people who manage it.

Senate Republicans blocked action on aid for millions of unemployed Americans this week, and threatened to continue to do so unless Congress acts on a completely unrelated matter: the federal tax on the estates of millionaires.

The Need for Help for the Unemployed

Congress has an opportunity to help families hardest hit by the recession while at the same time increasing consumer demand, which in turn will increase the number of businesses that are hiring. The Congressional Budget Office has found that extending unemployment benefits is one of the most effective ways to increase consumer demand (i.e., create jobs), making it attractive from the standpoint of economic policy as well as compassion for struggling Americans. (There are 6 job-seekers for every open position right now.)

By the end of February, 1.1 million people are scheduled to lose their UI benefits, and another 2.7 million are scheduled to lose them by the end of March. Senate Democrats hoped to move by unanimous consent to extend UI benefits and COBRA health care benefits for out-of-work Americans for 30 days, to tide them over until a longer-term extension can make its way through Congress.

Help for the Unemployed Held Hostage for Tax Cuts for Millionaires

Senate Republicans denied the unanimous consent request to pass an extension of UI and COBRA. The objection was raised by Senator Jim Bunning (R-KY) over the source of funding. But the measure is apparently also being held hostage by Senators wanting to give multi-millionaires a break on the estate tax.

The tax law passed under President Bush in 2001 gradually repealed the estate tax over several years until making it completely disappear this year. But, since the Bush tax cuts expire at the end of 2010, the estate tax will return in 2011 in its pre-Bush form (with the tax exempting the first $1 million in assets, per spouse, and a top estate tax rate of 55 percent).

House Democrats decided last year that a million dollars just isn't what it used to be, and passed a bill that would permanently increase the exemption and lower the rate, but not let the estate tax disappear in 2010. (Technically, they passed a permanent extension of the estate tax rules in effect in 2009, with a $3.5 million per-spouse exemption and a top rate of 45 percent.) But the Senate failed to act on the measure.
 
Under the proposal approved by the House, fewer than one percent of deaths would result in estate tax liability. Apparently that's too many for Senators Jon Kyl (R-AZ) and Senator Chuck Grassley (R-Iowa), who have wanted to repeal the estate tax for years and now hope that they can at least reduce it much further than the Democrats want. They have indicated that, until a deal is reached on the estate tax, they will block passage of the UI and COBRA extension. On Feb 24, Kyl, a long-time leader against the estate tax, said that Republicans will block consideration of the legislation unless they get "a path forward fairly soon" to voting on a measure to permanently weaken the estate tax.

Bizarrely, Senator Bunning blocked the unanimous consent motion for the $10.3 billion, 30-day UI and COBRA extension, saying he wanted the costs somehow offset, even while his Republican colleagues press for an estate tax measure that will cost hundreds of billions of dollars, with no hope of being offset.

Kyl and Grassley tried to cut a deal earlier this month with Senate Finance Committee Chairman Max Baucus (D-MT) to get a fast track for the estate tax vote in exchange for votes on a jobs bill, but Majority Leader Harry Reid (D-NV) rejected the package and put together a jobs bill of his own. That pared-down bill passed the Senate on Wednesday, including $16 billion in tax cuts for employers who hire new workers.
 
Another wrinkle is that Grassley and Kyl have reportedly been in discussions with Senator Maria Cantwell (D-WA) who has proposed to allow multi-millionaires to prepay their estate tax at a lower rate. This is clearly a accounting gimmick designed to mask the true cost of the estate tax change. It would bring some money into the Treasury during the 10-year budget window that Congress focuses on, but lose huge amounts of revenue in years after that. United for a Fair Economy has objected to the proposal in a letter to Senator Cantwell. Washington residents are urged to sign on to the letter.

Coalition Calls for More Robust Estate Tax than Approved by House Democrats

Congress needs to move in a different direction on the estate tax. Americans for a Fair Estate Tax, a coalition of organizations including Citizens for Tax Justice, has issued a call for an estate tax that exempts no more than $2 million in assets per spouse, and taxes the taxable portion of estates at a rate of at least 45 percent, with an additional 10 percent on assets in excess of $10 million. Only about 0.7 percent of deaths resulted in estate tax liability in recent years when the per-spouse exemption was set at $2 million.

Cutting the estate tax any more than this — particularly when Congress seems to have so much trouble helping the Americans who are struggling the most — would prove that Congress really does have its priorities completely backwards.

A new report from Citizens for Tax Justice explores the tax proposals included in the federal budget outline that President Obama submitted to Congress on February 1. Like the budget he submitted last year, it is a vast improvement over the policies of the Bush years and continues to outline a progressive reform agenda.

But, also similar to last year, the President’s budget could be greatly improved with more aggressive policies to raise revenue. Over the coming decade, the President proposes to cut taxes by $3.5 trillion. We include in this figure the cost of extending most of the Bush tax cuts and relief from the Alternative Minimum Tax (AMT) as well as additional tax cuts that President Obama proposes.

His budget would offset a portion of this cost with provisions that would raise $760 billion over a decade by limiting the benefits of itemized deductions for the wealthy, reforming the U.S. international tax system and enacting other reforms and loophole-closing measures.

The report concludes that the federal government should collect at least as much revenue as the President proposes in order to avoid larger budget deficits. There are two bare minimum requirements for Congress to achieve this. First, Congress must not extend any more of the Bush tax cuts than President Obama proposes to extend. Second, Congress must raise at least as much revenue as President Obama has proposed ($760 billion over ten years) through loophole-closers and new revenue measures.

Read the full report.

"From some on the right, I expect we'll hear a different argument -– that if we just make fewer investments in our people, extend tax cuts including those for the wealthier Americans, eliminate more regulations, maintain the status quo on health care, our deficits will go away.  The problem is that's what we did for eight years."  (Applause.)  "That's what helped us into this crisis.  It's what helped lead to these deficits.  We can't do it again."

President Obama spoke these words in his State of the Union address on Wednesday night, after pledging to enact an agenda that will create jobs and tackle our long-term budget deficit. He did a good job of explaining that the budget deficits that exist today are the result of deficit-financed tax cuts, two deficit-financed wars, and a major recession all occurring before he entered the White House.

But one has to wonder if President Obama is gently bearing left at a time when any sensible directions would call for a sharp left turn.

The Bush Tax Cuts

He remains committed to extending the Bush income tax cuts for the 98 percent of taxpayers who have adjusted gross income (AGI) below $250,000 (or below $200,000 for an unmarried taxpayer). The budget document released by the administration last year showed, in a convoluted way, that this would cost $1.88 trillion between now and 2019. His proposal to partially extend the Bush cut in the estate tax (making permanent the estate tax rules in effect in 2009) would cost another $576 billion over the same period, for a total of about $2.45 trillion.

The estimated costs of these proposals may be different in the budget to be released next week (since all the projections change at least somewhat in response to developments in the economy). But make no mistake, the cost of extending most of the Bush tax cuts far exceeds the savings the President hopes to achieve with his proposed spending freeze (which will actually cut spending if one accounts for inflation and other factors).

Cutting Non-Security Discretionary Programs

The administration is reported to believe $250 billion can be saved from the spending freeze, which would last three years but would not apply to national security, Medicare, Medicaid, or Social Security. The first problem is that these exempt categories of spending, along with interest payments on the national debt that cannot be avoided, make up 70 percent of the federal budget. Americans love to complain about wasteful government spending, but few realize that, once you eliminate those categories of spending that are very popular with the public, there's not a whole lot left to cut. The non-security discretionary spending that is left has come under increasing pressure in recent years since it's the only part of the budget lawmakers feel comfortable attacking.

The second problem is that cutting back spending when the economy may still be weak could prolong our downturn. Progressive observers have warned that the Roosevelt administration's decision to stop stimulating the economy and focus on deficit-reduction plunged the country back into a deeper depression in 1937.

For their part, administration officials have explained that they are not proposing an across-the-board freeze. Rather, they will identify particular types of spending that represent wasteful giveaways to special interests rather than public services that people depend upon.

Even if that's true (and the jury is still out on that), it's still peculiar that taxes aren't getting more attention. This is the third problem with the President's approach. The need for higher taxes is like an 800 pound elephant in the room that everyone is trying to ignore, even if they vaguely acknowledge that Bush's tax cuts got us into this mess. Does a family with an income of $190,000 really need every cent of their Bush tax cuts? Do families with $7 million in assets really need to be fully exempt from the estate tax? The President's tax proposals would have us believe so.

Steps in the Right Direction

The President certainly wants to move in the right direction, as was evident in various parts of his speech. He reiterated his proposal to charge a fee on risk-taking by the largest banks, which would raise $90 billion over a decade according to the administration. We've argued before that this is entirely reasonable. The institutions affected know they have an implicit guarantee from the government and are prone to put the entire economy at risk as a result. It makes sense to demand that they pay up in proportion to their risk-taking.

The President also reaffirmed his desire to do something about offshore profit-shifting by corporations. The proposals he made last year along these lines would raise $200 billion over a decade and would be extremely important, as we have explained in detail, in preventing U.S. corporations from shifting their profits to other countries.

Sometimes this shifting means companies actually move jobs and operations offshore, but other times it involves accounting gimmicks and transactions that exist only on paper. Either way, Americans lose tax revenue for no good reason other than that Congress is afraid to take on the lobbying power of multinational corporations.

America has a budget problem that is long-term in nature. The money we spend this year or next year to stimulate the economy has little impact on the long-term deficit. Reforming our tax system permanently, however, is an important part of the long-term solution.

President Obama has proposed a fee of 0.15 percent on the riskier assets held by the roughly 50 financial institutions that have more than $50 billion in holdings. The fee would be in place for at least ten years and the Administration estimates that it would collect around $90 billion over a decade. If the $700 billion distributed through the financial bailout (the Troubled Asset Relief Program, or TARP) is not entirely paid back by that time, then the fee would continue to be in effect for additional years.

The proposal might kill a whole flock of birds with one stone. Excessive risk-taking by the financial industry as a whole lead to a systemic meltdown. As a result, the banking system as a whole was failing, meaning businesses were unable to obtain credit, making it impossible for them to function. The bailout propped the banking system back up to avoid a deeper recession, but the distasteful side-effect is that the largest banks know full well that they are now considered "too big to fail."

So now the biggest banks have little incentive to avoid the sort of risk-taking that lead to the collapse. The implicit government guarantee gives them a special advantage that smaller banks don't have. The proposed fee would seem to address these problems at least to some extent, by reducing the incentive for risk-taking as well as the advantage that the largest banks have over smaller banks.

The bailout legislation (which was signed into law by George W. Bush, in case anyone forgot) includes a provision requiring the President to offer a proposal by 2013 for recouping any losses from the program.

Of course, Washington would not be Washington if special interests weren't ready to oppose any new tax or regulation. Jamie Dimon, chief executive of J.P. Morgan Chase said, "Using tax policy to punish people is a bad idea." He added, "All businesses tend to pass their costs on to customers."

Would banks really pass this fee on to their customers? Wouldn't they be constrained by the fact that customers could just go to a smaller bank that is not subject to the fee? And even if that happened, the worst imaginable result would be that the financial industry would be less dominated by institutions that are "too big to fail." What would be so terrible about that?

More to the point, the fee looks more like a regulation than a punishment. From this perspective, the only problem is that it's temporary. Why not permanently charge a fee on risk-taking by the large institutions that now seem to have an implicit guarantee that they'll be bailed out by the government if need be? From this perspective, it also becomes clear that the haggling over which banks have paid back their TARP funds is largely beside the point. The entire industry traded in explosives that blew up the economy when they stopped being careful.  

At the end of the day, it's hard to imagine that this fee would hurt banks at all. As one writer for the Wall Street Journal put it, "Paying out $10 billion a year is no sweat for an industry that, according to Goldman Sachs, made $250 billion in earnings before taxes and loan-loss provisions last year."

The U.S. House of Representatives adjourned for the year on Wednesday while the Senate hustles to finish legislation on health care. As of this writing, an array of major tax issues are still to be resolved in the next several days or when Congress returns in 2010:

Health Care Reform

On November 7, the House passed its health care bill, (H.R. 3962), which includes a public option. The largest revenue-raising provision in the House health bill is a surcharge of 5.4 percent on adjusted gross incomes over $1 million (or over $500,000 for unmarried individuals).

(See CTJ's previous analysis and state-by-state estimates of the surcharge in the House health care bill.)

The Senate is still working to pass a health care bill, and some reports claim that the chamber could be working on Christmas Eve to accomplish it. While there is a clear majority of Senators willing to support a public option, the rules allowing 41 Senators to filibuster legislation have encouraged a few conservative Democrats to join Republicans in blocking a public option.

While some details remain to be worked out, a majority of Senators seems to have settled on certain revenue-raising provisions to help pay for health care reform. The largest revenue-raiser in the still-developing Senate bill is an excise tax on high-cost health insurance plans. This excise tax is controversial because many analysts conclude that these plans are not particularly generous in the benefits they provide and they are not necessarily enjoyed by high-income workers. Rather, the high costs are often the result of insurers charging more to cover a work force that is older than average or that has high health risks.

(See CTJ's previous analysis concluding that the Senate's proposed excise tax on high-cost health insurance is less progressive than the surcharge in the House health care bill.)

One revenue-raiser in the Senate proposal that is progressive is an increase in the Medicare payroll tax rate on earnings over $250,000 (or over $200,000 for an unmarried individual).

While this tax increase would only affect those who can afford to pay more, an even better proposal would reform the Medicare tax so that it no longer exempts investment income. This idea was included in an amendment that was filed by Senator Debbie Stabenow during the Finance Committee markup, but was not acted on. Such an amendment may be offered when health care reform is debated on the Senate floor.

Job Creation

On December 8, President Obama announced several proposals to create jobs. His best ideas involve direct spending by the federal government (including extending aid to unemployed and low-income people and aid to state and local governments, among other things). His worst ideas involve tax cuts (including eliminating capital gains taxes on small business investment and providing a tax credit for payroll expansion).

(See CTJ's previous discussion of President Obama's job creation proposals and ways to stimulate the economy.)

The House approved a $154 billion jobs bill, as part of a regular appropriations bill (H.R. 2847), before adjourning this week, and thankfully, it focuses on direct spending. One of the few tax cuts included is a provision to remove the earnings requirement (currently set at $3,000) for the refundable portion of the Child Tax Credit, ensuring that low-income families with children can benefit from it. The Senate is not expected to take up jobs legislation until sometime next year.

Estate Tax

The tax cut legislation enacted by President Bush and his allies in Congress in 2001 set the estate tax to gradually shrink until disappearing altogether in 2010. But, like all the Bush tax cuts, this estate tax cut expires at the end of 2010, meaning the estate tax will reappear in 2011 at the pre-Bush levels if Congress simply does nothing.

Families who have several million dollars to leave to the next generation have benefited the most from the infrastructure, educated workforce, stability and other public goods that taxes make possible. So it's entirely reasonable that these families pay a tax on the transfer of their enormous estates from one generation to the next, particularly since the majority of the value in these estates is capital gains income that has never been taxed.

One might be tempted to think that allowing the estate tax to disappear would be fine if it reappears at the pre-Bush levels in 2010. Unfortunately, the one-year repeal of the estate tax could tempt some lawmakers to make that repeal permanent, or might tempt them to allow only a very scaled back version of the estate tax to reappear in 2011.

So the House of Representatives approved a compromise that would make permanent the estate tax rules in effect in 2009. This would partially preserve the Bush cut in the estate tax, but prevent the tax from disappearing in 2010.

(See CTJ's previous analysis of the estate tax legislation, along with state-by-state figures showing how few estates are actually subject to the tax.)

Key Democratic Senators indicated that they did not want to make permanent the 2009 rules because -- incredibly -- they were interested in reducing the estate tax even more. Democratic leaders in the Senate attempted but failed to get agreement in the chamber to pass a one-year extension of the 2009 rules, which would prevent the estate tax from disappearing in 2010 and allow Congress to debate a permanent solution as part of the broader tax debate that must happen before the Bush tax cuts expire at the end of next year.

Pathetically, the Senate failed last week to prevent the one-year repeal, which they had known was coming ever since the Bush cut in the estate tax was enacted back in 2001. Democratic leaders in the Senate say they will enact the one-year extension of the 2009 estate tax rules retroactively in 2010. While retroactive tax increases may not be the ideal way to do things, this approach should not cause any problems since tax planners have known for years that Congress was likely to act to prevent this one-year disappearance of the estate tax.

Corporate Tax Breaks (aka "Tax Extenders")

On December 9, the House approved H.R. 4213, which would extend a series of tax cuts (mostly breaks for business) but would offset the costs by closing the infamous "carried interest" loophole for buyout fund managers and by cracking down on offshore tax cheats.

The bill would also require the Joint Committee on Taxation (JCT) to issue reports evaluating these tax cuts before the end of next year, when Congress is likely to act on them again.

CTJ joined the AFL-CIO, SEIU, AFSCME and eight national non-profits in signing a letter in support of H.R. 4213 for these reasons.

The provisions extending the tax cuts (often called the "tax extenders") are enacted by Congress every year or so. CTJ and other analysts have often criticized the tax extenders as corporate pork routed through the tax code.

But H.R. 4213 is a major step in the right direction for the reasons spelled out in the letter to Congress.

(See our previous article on H.R. 4213 explaining the points made in the letter.)

Democratic leaders in the Senate want to pass the tax extenders retroactively early in 2010. One problem is that the chairman of the Senate tax-writing committee, Max Baucus (D-MT) believes that the carried interest issue is “best dealt with in the context of an overall tax reform,” according to a spokesman. As we've explained before, this is an all-purpose excuse for legislators who want to avoid closing even the most unfair and outrageous loopholes.

In a move that helps the banking giant Citigroup, the IRS issued a notice last Friday granting TARP recipients an exception to the restrictions on using losses of acquired companies to reduce future taxes.

The limitations (known as Sec. 382 limitations) are meant to restrict a company from using the Net Operating Losses (NOLs) of companies it buys to reduce its own taxable income in the future. Sec. 382 was clearly never meant to apply to a situation in which the government acquires and then sells stock in a company, but rather was meant to prevent taxpayers from buying companies purely as tax shelters.
 
Sec. 382 generally limits the use of NOLs when there is a more-than-50% change in the ownership of a company. The IRS issued a ruling last May that any ownership by the government would not count towards an ownership change. Last Friday's notice expanded that exception to include any shares sold to the public by the government.
 
This notice particularly helps Citigroup since Treasury is planning to sell its stake in Citigroup to the public. This exception will allow Citigroup to avoid the Sec. 382 limitations and be able to use its NOLs against future taxable income.
 
Some commentators have noted that this will increase the cost of the federal bailout for TARP recipients, taking additional money out of the pockets of ordinary taxpayers. But if the government's bailout has, as most economists believe, avoided a much more serious recession, most Americans are probably still better off.
 
Unlike the previous administration's infamous "Wells Fargo ruling," the IRS has the authority to issue this notice under the provisions of the 2008 Emergency Economic Stability Act and the 2009 American Recovery and Reinvestment  Act. One of lawmakers' objections to the Wells Fargo ruling was that it applied only to a specific industry, but this new notice applies to all TARP recipients.

On Tuesday, President Obama put forth ideas, some good and some not as good, to create jobs. The more misguided proposals involve using the tax code to reward businesses, while the best ideas involve direct spending.

For example, he proposed the elimination of capital gains taxes for small business investment and an extension of the break that lets small businesses immediately deduct (expense) a larger amount of their capital investments.

The capital gains break is particularly problematic. If this provision works as existing similar capital gains breaks work, it would mean that anyone who buys an interest in a company that qualifies as a "small business" within a certain time period can hold onto that interest for as long as they like -- say, 20 years or longer -- and then sell it without paying any tax on the gain.

Of course, no investor knows whether or not a small company will grow and last that long. The company could go out of business in a couple years. Or the company could be Microsoft.

But, more to the point, it's not obvious that this would help a small business today to create jobs. Investors don't want to put their money in a venture unless they think there is some demand for the goods or services that would be produced. So, what's needed now to create jobs is a boost in demand for goods and services. Investors would respond by creating or expanding business, meaning they would hire more people to work more hours. Business owners only expand like this if they can profit, and that resulting profit is what causes stocks to become more valuable, which is what causes shareholders to have capital gains.  

The President's capital gains proposal gets this all backwards by aiming a tax cut at the very end of that process, at the capital gains, and assuming that demand will materialize on its own as long as a tax cut encourages an increase in the supply of capital. At risk of drawing an alarming comparison, the proposal is, well, supply-side in its logic.

The President also says he wants to work with Congress to "create a tax incentive to encourage small businesses to add and keep employees."  This could be a mediocre idea or a bad idea, depending on exactly what he's thinking.

If he's thinking of a payroll tax holiday, this could, in theory, produce some increase in demand if it means that workers who pay less in payroll taxes will spend the increase in their take-home pay. But to the extent that they save the extra money, it doesn't produce the boost in demand that is needed right now.

If the "tax incentive" the President is thinking about is a tax credit that goes to businesses for creating jobs, that could be even more problematic. There has been a lot of talk about giving businesses a credit for the amount by which they expand their payroll, and even making the credit refundable so that companies that are not currently profitable can benefit from it. Like the capital gains tax break, this proposal would do little to boost demand. But that's only the beginning of the problems.

Another problem is that it raises the question of how to treat new companies. Would they get the credit, and how would it be calculated since all their jobs are new? If they get the credit, what's to stop someone from liquidating their existing company and starting a new company that is different in name only?  Perhaps more alarming is the fact that a lot of companies will create more jobs anyway, so a lot of the revenue would be a reward to firms for doing something they would have done even without the tax break.

A proposal that has been recently promoted by the Economic Policy Institute argues that even if one takes these problems into account, a well-designed tax credit can create jobs in a cost-effective way. Even if only a fraction of the jobs created are the result of the credit, the authors figure that five million jobs could be created over two years, at a total cost of about $5,400 per full-time job (or full-time job equivalent) created as a result of the credit.

Given the many questionable assumptions needed to come to this conclusion, we think a much surer bet for job creation would be plain old government spending. Thankfully, direct spending by the government was also included in the proposals the President discussed.

For example, he mentioned extending aid to unemployed and low-income people as well aid to states. This type of government spending would result in increased consumption (and therefore increased demand for goods and services) almost immediately.

As a recent report from the Center on Budget and Policy Priorities explains, aid to states is particularly important right now, because state governments are already planning their budgets for fiscal year 2011, when most of the aid they received in the recovery act is supposed to end. There's usually a lag between an economic recovery and state governments' recovery of their revenue streams, so a lot of states will be cutting services and staff even if the economy is expected to improve in 2011.

Federal aid to state and local governments that allows them to save jobs that they are about the eliminate provides an immediate and clear benefit. It maintains the income that the otherwise eliminated state and local government employees will spend, which boosts demand for goods and services above where it would be if the federal government did not provide this aid.

The President is right that Congress cannot improve our economy by focusing single-mindedly on the budget deficit. The federal government needs to provide the conditions for job creation. Let's hope that this effort doesn't get diverted into a tax-cutting spree that makes good sound bites without addressing our underlying economic problems.

The National Association of Realtors (NAR) and other groups representing the real estate industry have been a case study in special interest politics for some time. A quick glance a the Congressional Joint Committee on Taxation's tax expenditure report reveals that tax breaks related to housing cost over $100 billion a year, but that's not enough to satisfy NAR and its followers.

The Battles Over the "Carried Interest" Loophole

Two years ago, the Real Estate Roundtable (of which NAR is a member) hired Douglas Holtz-Eakin to defend the "carried interest" loophole, which basically allows those investing other people's money to pretend that they put up their own money, thus entitling them to pay taxes at the low capital gains rate of 15 percent rather than the regular rate of 35 percent that other highly compensated workers pay. (CTJ released a fact sheet debunking Holtz-Eakin's arguments.) The Obama administration continues to support closing the carried interest loophole.

The Homebuyer's Credit

In the last year of the Bush administration, the real estate industry managed to get Congress to adopt, as part of the economic stimulus law enacted in 2008, a $7,500 homebuyer credit that taxpayers would have to pay back to the IRS. This, year, they persuaded Congress to upgrade that to a $8,000 homebuyer credit that does not have to be paid back and that is available to taxpayers under certain income limits if they purchase a home before the end of November of this year.  

The homebuyer tax credit was estimated at the time of enactment to have a cost of $6.6 billion, but is actually on track to cost more than twice that.

Since the economic crisis was caused by inflated home prices, it is not at all clear how subsidies provided through the tax code to boost home prices could possibly be good policy. 

Ted Gayer at the Brookings Institution has written that:

"The tax credit is very poorly targeted. Approximately 1.9 million buyers are expected to receive the credit, but more than 85 percent of these would have bought a home without the credit. This suggests a price tag of about $15 billion – which is twice what Congress intended – for approximately 350,000 additional home sales. At $43,000 per new home sale, this is a very expensive subsidy."

Perhaps most alarming is the possibility that the homebuyer credit could become another "tax extender," the term used by Congressional staff and lobbyists to describe tax breaks that are ostensibly in effect for only a year or two, but which everyone believes Congress will extend again and again. NAR is, of course, pushing for Congress to extend the homebuyer credit.

Health Care

Perhaps the worst example of special interests fighting to block the common good is the real estate industry's interference in Congress's attempts to reform health care. Early this year, the Obama administration proposed to limit the value of itemized deductions for wealthy taxpayers to 28 percent as a way to raise revenue that would partially fund health care reform. CTJ found that this would affect only the richest 1.3 percent of taxpayers and would merely reduce some of the unfairness that occurs when Congress subsidizes certain activities (like home ownership and charitable giving) through the tax code. NAR, naturally, would have none of it, since this proposal would curtail the savings received by high-income taxpayers when they claim the itemized deduction for home mortgage interest.

In fact, NAR recently has come out against a much more scaled back version of this proposal, which would merely cap itemized deductions at 35 percent.

Currently, the top income tax rate is 35 percent, so the richest Americans can save, at most, 35 cents for each dollar of itemized deductions they claim. But the Bush tax cuts, which lowered the top income tax rate from 39.6 percent to 35 percent, will expire at the end of 2010. That means that in 2011, under current law, each dollar of itemized deductions claimed by a very wealthy person could result in almost 40 cents of savings. Capping itemized deductions at 35 percent would therefore merely freeze in place their current value after the Bush tax cuts expire and rates go back up.

NAR recently issued a statement saying that it opposes even this scaled back proposal to limit itemized deductions and that it "rejects in the strongest possible terms any proposal that would limit the deductions for mortgage interest and real property taxes." NAR is unabashed in its defense of subsidies provided through the tax code for families in the top income tax bracket.

Do the Realtors Oppose the Bush Tax Cuts?

But if the realtors believe that the very rich should receive 39.6 cents for each dollar of itemized deductions they claim, that seems to imply that they think the top income tax rate should revert back to the pre-Bush level of 39.6 percent. Their position seems to be that it is unacceptable for the richest Americans to only save 35 cents for each dollar they claim in itemized deductions. The only way for that number to go back up from 35 to 39.6 is for President Bush's reduction in the top rate to expire. Surprisingly, NAR and CTJ seem to have one position in common, albeit for vastly different reasons.

As the current recession pulls revenues down in states across the country, legislatures find themselves between a rock and a hard place, or at least that's how the situation is often presented. Sometimes budget crises are portrayed as a choice between several horrific alternatives. (Cut healthcare for low income children or programs for the elderly?)

So you would think that every state facing such cuts would use federal stimulus funds to avoid them, right? Wrong. Federal stimulus aid to states is explicitly intended to protect essential services such as health care and education, but a recent article in Business Week explains that some states are using this money to indirectly finance tax incentives for businesses. In some cases it has been suggested that tax cuts for corporations may actually threaten states' eligibility for these funds!

In an interview for the article, Greg LeRoy of Good Jobs First notes that, "When a cash-strapped state is giving out an enormous tax package and also getting federal money, the left hand, in this case the incentives, is connected to the right."

Economic research has shown that if tax incentives to businesses are financed by cuts in spending on essential services and infrastructure, the costs may far outweigh the benefits. Corporate tax breaks (like this one in North Carolina, worth almost $70 million) don't produce anywhere near enough economic benefits to offset their costs. Even worse, most are simply handouts to companies who would have invested anyway.

These giveaways are expensive and clearly contribute to declining revenues. On the other hand, research suggests that the benefits of public services are likely more important than tax costs as determinants of business location. Instead of lining the pockets of large corporations, states should be engaging in pro-growth policies that ensure low- and middle-income families don't bear the full brunt of the current economic storm.

For more on costly corporate subsidies, check out Good Jobs First.

The Treasury Department has recently issued rulings that to allow a newly bailed out General Motors to avoid part of the 1986 tax reform that is supposed to prevent abusive tax shelters.

Many years ago, Congress enacted rules to keep companies from trafficking in net operating losses (NOLs). Profitable companies were buying companies with NOLs and using the NOLs to offset their income, reducing or completely eliminating their tax liability. In many cases ability to use the NOLs was the only valuable asset the loss company owned. So Congress added Internal Revenue Code Section 382 to limit the amount of NOL "carryforwards" that companies can use when there is a change in ownership of more than 50 percent.

Under the General Motors restructuring, the federal government will own about 60 percent of the stock of the new GM. Generally that would mean that the ability to use the NOLs would be strictly limited (a small portion would be allowable each year). But the Treasury Department has issued a series of rulings that will allow GM to use the NOLs. The rulings basically treat the U.S. government as never having been a shareholder. So if things start looking up for the troubled automaker and the government is able to share some of its stake in the company, the GM stock will be significantly more valuable to a potential investor because of the NOLs that will save GM taxes in the future. Net operating losses can be carried forward 20 years to offset taxable income. They can also be carried back two years, but GM has not posted a profit since 2004.

When anti-tax activists and lawmakers complain that Congress and the President are pursuing policies that will cause taxes to be too high, the first question anyone should ask is: Compared to what? What exactly is the alternative to allowing the Bush tax cuts to end (at least for the rich) and finding new ways to raise revenue?

This week the House GOP showed us what the alternative is and it's frightening. On Wednesday, the ranking Republican on the U.S. House of Representatives' Budget Committee, Congressman Paul Ryan (R-Wisc.), released a budget plan which he argues is a more fiscally responsible alternative to the budget outline proposed by President Obama and the similar budget resolutions approved by both chambers last night. His proposal is apparently an update of the plan that House GOP leaders introduced last week and is different in some key respects.

The revised House GOP budget plan would move towards cutting and privatizing Medicare, convert Medicaid into limited block grants to states, and even cut Social Security benefits for some retirees. The plan would deeply cut the relatively small amount of government spending devoted to non-military, non-mandatory programs by refusing to adjust the budgets of these programs for inflation and population growth for five years. The House GOP plan would repeal the recently enacted economic stimulus law (the American Recovery and Reinvestment Act of 2009, or ARRA) a year before its expiration at the end of 2010.

A report from Citizens for Tax Justice compares the income tax proposals in the House GOP plan to the income tax proposals in the House Democratic plan in 2010, and finds that:

• Over a third of taxpayers, mostly low- and middle-income families, would pay more in taxes under the House GOP plan than they would under the House Democratic plan in 2010.
• The richest one percent of taxpayers would pay $75,000 less, on average, in income taxes under the House GOP plan than they would under the Democratic plan in 2010.
• The income tax proposals in the House GOP plan, which is presented as a fiscally responsible alternative to the Democratic plan, would cost over $225 billion more than the Democratic plan's income tax policies in 2010 alone.

Read the report.

Yesterday, the ranking Republican on the U.S. House of Representatives' Budget Committee, Congressman Paul Ryan (R-Wisc.), released a budget plan which he argues is a more fiscally responsible alternative to the budget outline proposed by President Obama and the similar budget resolutions working their way through the House and Senate right now. His proposal is apparently an update on the plan that House GOP leaders introduced last week and is different in some key respects.

A new report from Citizens for Tax Justice compares the income tax proposals in the House GOP plan to the income tax proposals in the House Democratic plan in 2010, and finds that:

• Over a third of taxpayers, mostly low- and middle-income families, would pay more in taxes under the House GOP plan than they would under the House Democratic plan in 2010.
• The richest one percent of taxpayers would pay $75,000 less, on average, in income taxes under the House GOP plan than they would under the Democratic plan in 2010.
• The income tax proposals in the House GOP plan, which is presented as a fiscally responsible alternative to the Democratic plan, would cost over $225 billion more than the Democratic plan's income tax policies in 2010 alone.

Read the report.

Americans are not very permissive when it comes to folks who are on the dole. Poor families receiving welfare in the United States are subject to a long list of work requirements and time limits and they can be sanctioned (that is, they can have their tiny benefit checks cut off) for failure to comply with the rules.

So it is not remotely surprising that taxpayers also want to establish some strict rules for large institutions that are on the dole. The taxpayers have handed over spectacular sums to bail out financial institutions, which amounts to corporate welfare on an epic scale. They obviously want to know that their money is being put to the use intended (i.e., saving us from another Great Depression) rather than just funding a third or fourth vacation home for a bank executive.

The delicate little problem for Congress is that lawmakers have a tendency to be awfully lax on the recipients of corporate welfare -- until their permissiveness is brought to light in some scandalous display. That's pretty much what happened recently as reports surfaced that American International Group (AIG) had paid out $165 million in bonuses after receiving $170 billion in federal TARP funds.

In the hurried butt-covering that followed, the House of Representatives grabbed the nearest tool (the U.S. tax code) and tried to use it to hammer a defect out of their bailout program to make it more acceptable to the newly attentive public. On March 19, they approved a bill that we are not exactly impressed with.

The House bill would impose a 90% tax on bonuses paid to employees of Troubled Asset Relief Program (TARP) recipients, as well as the mortgage giants Freddie Mac and Fannie Mae. The tax would apply to bonuses paid to employees of companies who have received $5 billion or more in government aid since the beginning of 2008. The tax would no longer apply when bailout-fund recipients have paid back enough to the federal government to fall below the $5 billion mark. The tax would only be imposed on employees whose adjusted gross income exceeds $250,000.

Much of the AIG bonus money was reportedly paid to the financial services group that got the firm in so much trouble with credit default swaps. Besides AIG, the bill would affect bonuses paid by eight other companies, including Goldman Sachs, J.P. Morgan, and Citigroup because the tax would apply to all bonuses paid after December 31, 2008.

As appalling as the AIG bonuses are, it's important to remember that the tax code exists to raise revenue to fund public services. Tax policy should be thoughtfully designed and carefully implemented to raise sufficient funds for services in a fair and equitable manner. Just as tax subsidies for business unnecessarily complicate the tax code, tax penalties that correct mistakes Congress made in crafting programs unrelated to tax policy are ill-advised.

Finally, taxpayers (even the least deserving) should be able to predict in advance the tax effects of their transactions. Changing tax rules or the rules of any program mid-stream seems unfair. After all, even the poor families who get the meager welfare benefits provided in most states are told about the program's rules before they receive their benefits.

On February 13, Rep. Peter DeFazio (D-OR) and seven co-sponsors introduced a bill that would impose a tax on securities transactions. The 0.25 percent tax would be imposed on the value of the securities traded. Rep. DeFazio proposes the measure as a way to pay for the various Wall Street bailouts.

This proposal would, in theory, raise revenue from the folks who benefitted from the bailouts. But there's another proposal we like better. Congress should simply eliminate the loophole in the income tax for long-term capital gains and corporate stock dividends, which subjects these forms of income to a top rate of just 15 percent.

People who earn wages must pay income taxes at progressive rates as high as 35 percent, and the first $102,000 a person earns in a year is, in addition, subject to payroll taxes of around 15 percent. So allowing people who live off their investments to pay a tax rate of only 15 percent is grossly unfair. As Warren Buffet recently pointed out, he pays a lower tax rate that his secretary, thanks largely to the loophole in the federal income tax for capital gains and dividends.

And it truly is the wealthy who primarily benefit. A report issued by CTJ in May of last year found that 70 percent of the benefits of President Bush's tax cut for capital gains and dividends goes to the richest one percent of taxpayers. The report also cited IRS data showing that in 2005, this loophole cost the Treasury $91.7 billion.

So getting back to Congressman DeFazio's proposal, we find several advantages of a higher capital gain rate over a securities transaction tax:

• Taxing capital gains at a higher rate would tax only those transactions that resulted in a gain, while a securities transaction tax would be imposed on every trade, whether or not there was a profit.
• A higher capital gains tax rate would be imposed on all capital gain transactions, not just those that arise from exchange-traded securities transactions. (Many derivative transactions are not traded on an exchange.)
• Taxing capital gains at ordinary tax rates would make the tax system much more fair and progressive. Taxpayers in the lower rate brackets would pay a lower rate on their capital gains while taxpayers in the higher brackets would pay a higher rate.
• Taxing capital gains at the same rate as ordinary income would eliminate the many, many tax avoidance schemes that taxpayers use to convert ordinary income to capital gains.
• Taxpayers would make decisions based on economics -- not on the tax treatment of different investments -- eliminating a lot of market distortion.

Unfortunately, many lawmakers feel a strong urge to expand the most egregious loophole in the federal income tax rather than repeal it. On the same day that the DeFazio proposal was introduced, Rep. Walter Jones (R-NC) introduced a bill to raise the capital loss limitation from the current $3,000 per year to $10,000 per year. This would provide another tax break for the wealthy. Generally, taxpayers can use capital losses to offset capital gains, and if they have net capital losses, they can deduct $3,000 of that against ordinary income. The rest is carried over to future years. If there were no limit, investors could choose to sell only assets that have a loss and offset other types of income, even though they might have unrealized gains in other capital assets. An October, 2008 CTJ report analyzed a similar proposal made by Senator John McCain (R-AZ) during his presidential campaign and criticized the idea for the same reason.