The graph below compares the impacts of the Democrats’ proposed payroll tax holiday with a tax policy that is more progressive (reviving the Making Work Pay Credit) and a policy that is far more regressive (the Bush tax cuts, which are already in effect through 2012). Senator Jon Kyl, the second highest ranking Republican in the U.S. Senate, now says he would agree to extend the payroll tax cut only if Democrats agreed to extend the far more regressive policy, the Bush tax cuts.

These figures disturbed us because even the Democrats’ proposal is not really all that progressive. If the 6.2 percent Social Security payroll tax paid by workers is reduced to 3.1 percent as Democratic leaders propose, the richest fifth of taxpayers will receive $83 billion in 2012 while the poorest fifth of taxpayers will receive just $7 billion.

Apparently that’s not regressive enough for Jon Kyl. The blog Think Progress notes that on Monday, Senator Kyl said on the Senate floor that when the payroll tax cut was enacted for one year at the end of 2010, that “was part of an overall agreement in which we said we will extend all of the existing tax rates — the so-called Bush tax cuts… we would extend this temporary tax holiday from the payroll tax cut, we would extend all of those. And I supported that… Now if we can do that again, I’m all for it. I’ll support the extension of the payroll tax holiday.” 

The graph shows that the Bush tax cuts in 2012 will provide the richest fifth of taxpayers with $231 billion and will provide the poorest fifth of taxpayers with just $3 billion. For more, read our short report on these figures.

On Sunday, the second highest ranking Republican in the U.S. Senate, Jon Kyl, said, “The payroll tax holiday has not stimulated job creation. We don’t think that is a good way to do it.” Asked why he opposes letting the Bush tax cuts end for the rich or imposing a surcharge on millionaires while also opposing this particular measure to keep taxes low, he replied, “The best way to hurt economic growth is to impose more taxes on the people who do the hiring. As a result, the Republicans have said, ‘Don’t raise the existing tax rates on those who do the hiring.’”

In other words, keep taxes low for the rich. A new report from CTJ shows that the Bush tax cuts supported by Senator Kyl will provide $231 billion in benefits to the richest fifth of taxpayers in 2012 and just $3 billion to the poorest fifth of taxpayers during that same year.

The payroll tax cut proposed by President Obama and Senate Democrats is more evenly distributed but is not particularly progressive. The CTJ report shows that it would provide $83 billion to the richest fifth of taxpayers and $7 billion to the poorest fifth of taxpayers.

Most economists agree that government spending measures are the most effective way to put more money in the hands of consumers to spend and thereby reduce unemployment. But if lawmakers insist on using tax policy instead, they should enact tax cuts that are targeted to those low- and middle-income consumers who are likely to immediately spend any new money they receive.

The Senate Democrats’ payroll tax cut proposal, which would be offset by a surcharge on millionaires ( see related story), won a majority of votes yesterday (50 Democrats and one Republican voted in favor) but was blocked by the remaining Senators. Republican leaders offered their own payroll tax cut that would be offset by cutting back federal government positions and pay, but this did not even receive support from a majority of Republicans in the chamber.

The CTJ report points out that a better option would be to revive the Making Work Pay Credit that expired at the end of last year, which has been discussed by some Senators but ignored by leaders of both parties.

The report finds that if the Making Work Pay Credit was in effect in 2012, the richest fifth of taxpayers would receive $11 billion while the poorest fifth of taxpayers would receive $7 billion, making it a less costly and more targeted tax cut.

State-by-State Figures Included

The millionaire surcharge that would have offset the cost of Senate Democrats’ proposed payroll tax cut would have affected only one-tenth of one percent of taxpayers in the majority of states, and in no state would those affected pay more than an average of 2.5 percent of their income under the surcharge, as explained in a new fact sheet from CTJ.

Nationally, just 0.2 percent of taxpayers would be affected by the surcharge and those affected would pay 2.1 percent of their income, on average under the proposal.

The surcharge would be 3.25 percent of the portion of any taxpayer’s adjusted gross income (AGI) in excess of $1 million starting in 2013. This means that a taxpayer with AGI of $1.1 million in a given year would pay a surcharge equal to 3.25 percent of $100,000, which is $3,250 (less than one-third of one percent of the taxpayers’ AGI). Taxpayers with AGI below $1 million would be unaffected by the surcharge.

Of the 49 Senators who blocked the Democrats’ payroll tax proposal yesterday, the surcharge motivated many of them. Others blocked the proposal because they objected to the idea of a payroll tax cut in principle. Most Republican Senators actually voted against the version of the payroll tax brought to the floor by GOP leaders, which would have been offset with reductions in federal government jobs and compensation. ( See related story about CTJ’s figures on the payroll tax cut.)

Estimates provided by the White House show that the payroll tax cuts proposed last night by President Obama would cost $240 billion next year, just shy of the $245 billion cost of the Bush income tax cuts during the same year as estimated by Citizens for Tax Justice.

Republican lawmakers were the original proponents of a payroll tax holiday. But lately many of them have spoken out against it or are reluctant to endorse it because the President supports it. Apparently cost is not the reason for their objection, given their support of the Bush tax cuts.

The payroll tax cuts, which would go into effect in 2012 and which are the largest parts of the jobs plan announced by the President last night, have several components. The payroll tax cuts for workers would cost $175 billion, while the payroll tax cuts for employers would cost $65 billion, for a total of $240 billion.

Economists generally find that the most effective measures to mitigate a recession include programs that directly create jobs (such as Obama’s proposals to hire or retain school teachers and fix schools). Also at the top of the list are direct spending programs by the government on things like unemployment benefits (also included in Obama’s plan), since they go to the very people who are most likely to immediately spend any money or benefits they receive.

But some lawmakers oppose any and all new government spending, creating an obvious political constraint that the President has tried to navigate by proposing payroll tax cuts and other tax breaks that make up over half of the $447 billion cost of his jobs plan.

Payroll Tax Cuts for Workers: $175 Billion

As part of the tax compromise enacted at the end of last year, a one-year payroll tax cut is in effect for 2011, reducing the 6.2 percent Social Security payroll tax paid directly by workers to 4.2 percent. President Obama proposes to extend this break into 2012 and expand it by further reducing the tax paid by workers to 3.1 percent.

As we have explained before, cutting payroll taxes for workers is neither the best nor the worst possible tax measure. A tax credit that is more targeted to low- and middle-income people, like the Making Work Pay Credit, would be more effective because it would target money more towards people who are likely to spend it immediately and thereby give an immediate boost to the economy.

On the other hand, a payroll tax cut for workers is dramatically more targeted to low- and middle-income people than the other types of tax cuts that are usually debated (like the Bush tax cuts).

Payroll Tax Cuts for Employers: $65 Billion

The President’s plan would also reduce the Social Security payroll tax paid by employers to 3.1 percent for the first $5 million in wages paid in 2012. This break would go to all employers. The plan would also eliminate the entire 6.2 percent payroll tax paid by employers for any increase in a firm’s payroll up to $50 million.

Giving all companies a break for the first $5 million in wages is not likely to be effective because it gives employers a tax break regardless of whether or not they increase hiring. Economists have pointed out that many companies are stockpiling cash that they already could use to hire more workers, and a recent survey of business owners reveals that labor costs are nowhere near their main concern. In other words, only increased demand for goods and services can really prompt businesses to hire more workers. 

Some economists do believe that the payroll tax cut for businesses that expand their payroll will be more effective. But there are several reasons to be skeptical about the number of jobs that will be created as a result of this measure. First, most of this tax break will go to companies that would have expanded their payrolls anyway. Second, the payroll expansion in many cases will not mean new hires but could simply take the form of pay raises for existing employees. (This problem would be limited to a degree because the Social Security payroll tax does not apply to wages in excess of $106,800).

What businesses really need are customers. A payroll tax cut or a more targeted tax credit could help somewhat to produce more customers by putting cash in the hands of people who will spend it. But the other parts of the President’s plan, like transportation projects, extending unemployment insurance, modernizing schools, and rehiring teachers will almost certainly provide far more bang for the buck.

Republican House Majority Eric Cantor’s memo to his caucus laying out a new “jobs agenda” includes a tax break that would allow any “small business” to deduct 20 percent of its income for tax purposes. This idea is not new but was actually part of the House GOP’s proposal put forth during the debate over the economic recovery act in early 2009.

Here’s what CTJ said about this part of the House GOP plan in January 2009:

Provisions in the House GOP Plan to Help “Small Business”

The Republican plan proposes to allow a “small business” to take a tax deduction of 20 percent of its pretax income, whether the small business is a corporation or a sole proprietor. The plan defines a “small business” as one with 500 or fewer employees. It makes no distinction based on income. A “small business” making $100 million would get to deduct $20 million of its income right off the top. (Apparently, a company with slightly more than 500 employees would have an incentive to lay off staff to qualify for the tax break!)

The Republican leadership notes that “small businesses can pay up to 35% of their income in taxes to the federal government.” But for a sole proprietor to be in the 35% income tax bracket, she would need taxable income (after deducting all expenses) in excess of $372,950. And because of the graduated tax brackets, her effective rate would be much less. For a corporation to be in a 35% tax bracket, taxable income must exceed $10 million. The architects of this proposal have an expansive definition of the word “small” to say the very least.

The plan description also states that the United States corporate tax rate ranks the 29th highest (out of 30) among the major economies of the world. Corporations currently pay federal income taxes at a statutory rate of 35 percent. But the effective rate paid by corporations (the percentage of income paid in taxes after taking into account the deductions and credits and other breaks that lower their tax liability) is far lower than 35 percent. Comparing corporate taxes as a share of gross domestic product (as a share of the overall economy), the United States actually ranks low compared to other developed nations.

It’s also worth pointing out that a 20% deduction unnecessarily complicates the tax code. Congress could simply amend code sections that are already in the law (like the corporate or individual tax rates). Anti-tax lawmakers may be afraid that a simple corporate income tax rate cut might not go over too well with a public that believes large corporations got us into the current economic downturn.

Last, but not least, a business tax cut is just about the least effective stimulus measure Congress could possibly enact. The tax cuts put more money in the hands of business. But there is very little correlation between a corporation’s cash position and its plans for investment—whether expanding capacity or hiring new employees. Businesses invest in expansion when they believe there will be an increase in the demand for the goods and services they provide. If they don’t anticipate a sales increase, they won’t expand no matter how many tax breaks the federal government gives them.

Read CTJ’s full report on the 2009 House GOP economic plan here.

(Includes state-by-state figures)

A new report from CTJ finds that the compromise tax plan agreed to by President Obama and congressional Republicans would provide more than a quarter of its tax cuts to the best-off one percent of all Americans. That’s almost double the share of the tax cut that the President proposed to give the highest earners.

At the same time, the new tax plan would reduce taxes, and increase the budget deficit, by $424 billion in 2011 alone. That’s 40 percent more in tax cuts than the $301 billion tax cut the President had earlier proposed.

Read the report.

House Democrats voted in a closed-door caucus meeting on Thursday to not take up the compromise deal, which also includes a 13-month extension of expanded unemployment benefits, until changes are made to the tax provisions. Meanwhile, the Senate is debating the compromise today.

Under the compromise plan:

- The wealthiest one percent would get an average tax cut in 2011 of almost $77,000 compared to current law (under which all of the tax cuts enacted since 2001 are scheduled to expire). That’s almost triple the $29,000 tax cut that President Obama proposed to provide to the top one percent.

- Meanwhile, the lowest-income fifth of all taxpayers, those making less than $20,000 a year, would get a smaller tax cut than the President earlier proposed. This is because the GOP-inspired, 2 percent temporary reduction in the payroll tax in the compromise plan offers low-income workers a considerably smaller payroll tax reduction than the President’s proposal to extend his “Making Work Pay” payroll tax cut. The Making Work Pay payroll tax cut entirely eliminated the 6.2 percent worker payroll tax on the first $6,450 in earnings ($12,900 for couples).

The payroll tax cut agreed to by the President and GOP leaders would also provide considerably less economic stimulus “bang for the buck” than the President’s earlier proposal, because it is largest for high earners, who are less likely to spend their payroll tax savings. The compromise payroll tax cut would cost an estimated $112 billion in 2011, double the $57 billion dollar cost of the President’s earlier proposal. But we estimate that $112 billion in added borrowing would stimulate only an extra $18 billion in consumer spending compared to the President’s earlier payroll tax cut plan.

The tax bill passed by the House yesterday (H.R. 4853) would make permanent two provisions that were included in the economic recovery act and which would otherwise expire at the end of this year. One makes the child tax credit more accessible to low-income working parents. The other reduces the marriage penalty in the EITC.

The bill introduced by Senate Finance Chairman Max Baucus, which Democratic leaders plan to vote on Saturday, would make these changes permanent as well as a third change in the recovery act that expands the EITC for families with three or more children.

For more information, see CTJ's recent state-by-state figures showing how each of these provisions impacts families with children.

Call your members of Congress.

Send an email to your members of Congress.

Republicans in Congress oppose extending the augmented unemployment insurance program for even three months — unless the $12.5 billion cost is offset with cuts in spending from the economic recovery act that was passed last year, which is keeping unemployment significantly lower than it would otherwise be.

Meanwhile, Congressional Republicans are demanding that the Bush tax cuts for the richest 2 percent of Americans be made permanent, at a cost of $700 billion over a decade — and they want this to be deficit-financed.

In other words, the party that will take over the House of Representatives next year believes that $12.5 billion for the unemployed is unaffordable but $700 billion for the richest two percent is absolutely vital.

Call and email your members of Congress NOW to tell them this is outrageous and unbelievable.

The Congressional Budget Office has found that extending income tax cuts, particularly for the rich, is the least effective of all the economic recovery measures Congress has debated, while unemployment insurance is the most effective because it puts money in the hands of people who will spend it immediately.

Economists expect unemployment to remain high for a lot longer than 3 months, so Congress needs to extend the augmented UI program for a full year. Congress has always provided  augmented UI during economic downturns, and has never cut off the extra help with unemployment as high as it is today.

There is reason for hope. Reports are trickling in that Democratic leaders will force a vote on a tax bill along the lines of what President Obama has proposed: Making permanent the Bush tax cuts for the first $250,000 of a married couple's income (the first $200,000 of a single person's income). The tax cuts for income over those amounts would expire, which means the richest two percent of taxpayers would continue to enjoy some, but not all, of the tax cuts enacted under President Bush.

This proposal hardly sounds like a progressive dream, but it's the best chance for the President and his allies in Congress to take a stand against continuing tax cuts that only benefit the very richest taxpayers. See CTJ's figures comparing the President's tax plan to the Republican plan (including state-by-state figures).

Hold the Vote!

Congress needs to vote on this tax plan. If lawmakers who support tax cuts for the very rich oppose this plan, then they need to go on record opposing tax cuts for 98 percent of Americans because they are trying to protect tax cuts for the richest two percent. When Americans see how their lawmakers vote on this bill and on unemployment insurance, they will finally have a clear idea of who is represented in Congress.

Putting lawmakers on the spot in this manner is one way — perhaps the only way — to get them to do the right thing.

Speaking in Cleveland on Wednesday, President Obama reaffirmed his commitment to making the Bush tax cuts permanent for 98 percent of taxpayers and allowing them to expire at the end of this year for the richest two percent. Responding to reports that Republicans will try to block his proposal, the President said,

"So let me be clear to Mr. Boehner and everyone else:  we should not hold middle class tax cuts hostage any longer.  We are ready, this week, to give tax cuts to every American making $250,000 or less."

This is an accurate description of the situation. Republicans are threatening to vote against a bill to extend tax cuts for 98 percent of taxpayers in order to secure tax cuts for the richest 2 percent. We would not call everyone among the bottom 98 percent of taxpayers "middle class," but we certainly agree that tax cuts should not be extended for any more people.

As CTJ has noted, the Bush tax cuts were disproportionately aimed at the richest taxpayers, who happen to be the only taxpayers whose income grew wildly over the past several years. Data from the non-partisan Congressional Budget Office indicates that nearly 39 percent of the income growth from 1979 to 2007 went to the richest one percent. That's more than went to the bottom 90 percent.

The Congressional Budget Office has also studied several different measures to create jobs and found that every measure it analyzed would create more jobs per dollar of cost than income tax cuts for the rich.

And yet, some members of Congress are determined to extend the tax cuts for the rich and will even block any bill that extends the tax cuts for everyone else.

The argument Republicans most often make is that many small business owners are among the richest two percent, and ending the tax cuts for these people will mean less job creation.

This argument is a red herring. Only 3 percent of taxpayers with business income (and only 5 percent of taxpayers who rely on business income for over half of their income) are rich enough to lose any of their income tax cuts under Obama's plan. These include many partners in law firms, accounting firms, hedge funds and other businesses we don't generally think of as "small" businesses. And even for those who do create jobs, there is no connection between income tax rates and hiring decisions. Businesses are not taxed on money they pay to their employees as wages, and small business owners are not taxed on income they reinvest in their businesses.

As President Obama pointed out, the only change that the richest taxpayers face is that income in the top two tax brackets will be taxed as it was at the end of the Clinton years.

"And for those who claim that this is bad for growth and bad for small businesses," the President said, "let me remind you that with those tax rates in place, this country created 22 million jobs, raised incomes, and had the largest surplus in history."

As a previous CTJ report (with state-by-state figures) explains, low- and middle-income taxpayers actually get a better deal on average under the President's proposal than under the Republican approach, because Obama would also make permanent the improvements in the Earned Income Tax Credit and Child Tax Credit that were part of the economic recovery act.

The President's speech Wednesday was partially a response to the one made in Cleveland two weeks earlier by House Republican Leader John Boehner, whose five-point "plan" to help the economy mainly consisted of continuing George W. Bush's tax and spending policies, not enacting any new reforms, and firing President Obama's economic advisers.

As CTJ previously reported, Boehner attacked loophole-closing provisions in the recently enacted $26 billion jobs bill (H.R. 1586) by describing them as exactly the opposite of what they really are. The provisions end abuses of the foreign tax credit. These abuses allow U.S. corporations to enjoy a negative tax rate on offshore investment income, which creates an obvious incentive to shift operations, jobs and profits offshore.

Boehner wrongly claimed that H.R. 1586 "is funded by a new tax hike that makes it more expensive to create jobs in the United States and less expensive to create jobs overseas."

On Wednesday, Boehner offered what some media outlets described as a "concession," which would be to freeze in place, for two years, all the Bush tax cuts and the spending levels in effect in 2008.

This would, of course, repeal several measures meant to address the economic crisis, including the economic recovery act enacted last year. The Congressional Budget Office recently concluded that the recovery act has created between 1.4 million and 3.3 million jobs, and increased the number of full-time-equivalent jobs by between 2.0 million and 4.8 million.

In one sense, Boehner's offer really is a concession, since the Republican position has until now been that the Bush tax cuts should be made permanent for all taxpayers, rather than extended temporarily. It's possible that Boehner made this move because he knows that his position on taxes is far more precarious than media reports suggest. Plenty of polls show that the majority of Americans want the tax cuts to expire for the richest two percent of taxpayers.

There's another problem for lawmakers who want to extend tax cuts for the rich. To get their way, they will have to vote against (or even filibuster, in the case of the Senate) a bill extending the tax cuts for 98 percent of taxpayers. President Obama was right when he described his opponents as holding tax cuts for most Americans "hostage" to protect tax cuts for the rich.

President Obama wants to sign a jobs bill into law. The majority of members of the House and Senate want the same thing. So do the two million out-of-work Americans who will have lost their unemployment benefits by July because of Congress's inaction. Not to mention the millions of Americans who will see public services like education and public safety slashed because their states have to make up shortfalls in Medicaid funding. And then there are the mainstream economists who conclude that some deficit-spending on measures that pump money immediately into the economy and create jobs are entirely justified when unemployment is hovering around ten percent. In the face of all this, a minority of 42 Senators has managed to block legislative action.

Congress has fought a months-long battle over the bill, H.R. 4213, which includes an extension of emergency unemployment benefits and Medicaid funding to states, two spending measures that economist Mark Zandi has argued are the most effective way to stimulate the economy. These measures result in immediate spending, which leads to a boost in consumer demand, and the retention or creation of jobs to produce the goods and services needed to meet that demand.

The bill also includes a collection of provisions that extend short-term tax breaks for business that Congress enacts every year or so. Members of Congress and Hill staffers often call these the "tax extenders." CTJ has criticized the tax extenders for years. But, we support them this year because they are coupled with provisions that would offset their costs by clamping down on unfair tax loopholes. This is a major step forward for Congress. See CTJ's many reports on these loophole-closing provisions.

To their credit, Democratic leaders have tried every conceivable tactic to win over the so-called "moderates" who are blocking the bill.

For example, the House passed legislation three times to completely eliminate the infamous "carried interest" loophole that allows certain wealthy investment fund managers to treat their compensation as capital gains and thus enjoy a lower tax rate. This time, the House scaled back its provision to close this loophole, and Democratic leaders in the Senate scaled the provision back multiple times in their versions of the bill. Eliminating this loophole, which was proposed by the Obama administration, was estimated to raise about $24 billion over a decade. Democratic leaders in the Senate whittled that down to $13.6 billion. The provision is not so much a loophole-closer any more as a loophole-reducer.

Other compromises made to secure votes were even more alarming. The most recent proposal would have taken over $9 billion of unspent funds from the recovery act that are supposed to be used for food stamps to help offset the costs of this bill. This is preposterous. Food stamps are one of the most effective types of stimulus, along with unemployment insurance benefits and fiscal aid to states, according to Mark Zandi.

The country needs the Senate to pass, some way or another, a jobs bill. Sadly, Democrat Ben Nelson and the 41 Republican Senators have the ability, under the Senate's bizarre rules, to stop that from happening.

As the Senate continues a seemingly endless debate over H.R. 4213, the jobs and "tax extenders" bill, business lobbyists, right-leaning economists and politicians have had more time to shape their arguments in defense of the tax loopholes that the bill would pare back.

To offset the costs of the tax breaks included in the bill, three types of loopholes would be restricted. They include the "carried interest" loophole that allows certain investment fund managers to treat their compensation as capital gains and thus enjoy a lower tax rate, the "John Edwards" loophole allowing people with "S corporations" to avoid payroll taxes, and abuses of the foreign tax credit by U.S.-based multinational corporations.

The debate over the "carried interest" loophole has received the most attention, and CTJ has responded to some of the outlandish arguments made in its defense.

More recently, Senator Olympia Snowe (R-ME) has voiced her opposition to the provisions regarding "S corporations," and filed an amendment to strip them from the bill. A recent report from CTJ explains that this amendment should be rejected because the loophole in question allows people to underestimate the extent to which their income is wages, meaning they avoid payroll taxes.

The report also explains that the main effect of the provisions in H.R. 4213 regarding S corporations would probably be on Medicare taxes. The new health care reform law actually applies Medicare taxes to most non-retirement income, but there is a bizarre exception left for certain non-wage income from S corporations. H.R. 4213 would not even eliminate this exception entirely but would merely target those taxpayers who are most obviously manipulating the tax rules to avoid paying the Medicare tax. This seems like the least Congress could do.

The provisions in H.R. 4213 that prevent abuses of the foreign tax credit have also received more attention lately. A new report from CTJ responds to criticisms of these provisions made by the Peterson Institute's Gary Hufbauer and Theodore Moran.

The purpose of the foreign tax credit is to ensure that American individuals and corporations are not double-taxed on income that they earn in other countries. Hufbauer and Moran seem to acknowledge — and endorse — the common practice of corporations using credits in excess of what is necessary to avoid double-taxation. In these instances, corporations are really using the credit to lower their U.S. taxes on their U.S. income. Or, put another way, it means the credit is being used to subsidize foreign countries by helping U.S. corporations pay their foreign taxes.

Surely, everyone should agree that this is not the purpose of the foreign tax credit. But without the reforms included in H.R. 4213, these practices will continue, and we will have missed an important opportunity to make our tax system fairer and more rational.

Federal benefits for the long-term unemployed have been expired for over a week and the Senate still has not approved a bill (H.R. 4213) that would extend these and other vital measures. The bill also includes badly needed Medicaid funding for states and other provisions that would stimulate the economy. (See CTJ's recent reports on this legislation).

Call your Senators and urge them to vote for H.R. 4213.

Use this toll-free number provided by AFSCME to make your call: 888-340-6521

Part of the consternation among some Senators is that the spending provisions in the bill would add (modestly) to the deficit. Economists have explained that short-term deficit-financed spending measures can be used to effectively boost consumer demand, and thus job creation, during a recession, without adding to the long-term budget crisis.

Many of the Senators who have supported tax cuts that created long-term deficits (the kind of deficits that actually do lead away from fiscal sustainability) now oppose this bill out of their concern about "fiscal responsibility." Other Senators are more genuine in their concern about deficits but have wildly misplaced fears about a bill that has little, if anything, to do with our long-term budget situation.

A number of Senators are still concerned about the tax provisions in the bill. It includes an assortment of small tax cuts (mostly for business), which are often called the "tax extenders" by members of Congress and their staffs. While these tax breaks probably accomplish very little, the good news is that their cost would be offset with provisions that close unfair tax loopholes.

It's the Senators' devotion to maintaining these loopholes that is another factor slowing down progress on this bill.

Battle Continues Over "Carried Interest" Loophole for Investment Fund Managers

The most controversial tax provision would clamp down on the "carried interest" loophole, which allows investment fund managers to treat their earned income as capital gains and thus benefit from a much lower income tax rate. Over the past few weeks, some honest investment fund managers have spoken up to tell Congress that their loophole really is unjustified, and it was also reported that two Republican Senators favor closing the loophole.

The draft of the bill proposed by Senate Majority Leader Reid already watered down this reform a great deal (compared to the version that passed the House) by allowing the lower capital gains rate to continue to apply to a larger portion of carried interest. As a new report from the Center on Budget and Policy Priorities explains, the last thing Congress should do is weaken this provision any further.

Senators Defend the "John Edwards" Loophole

Another controversial reform would close the "John Edwards" loophole for "S corporations." Payroll taxes apply to wage income, but not other types of income. So, some people want to disguise their wage income as non-wage investment income to avoid payroll taxes. People who own S corporations have to determine (and tell the IRS) how much of their income is wage income and how much of it is other income, and of course there is a huge incentive to underestimate the amount that is wage income.

John Edwards famously played this trick by saying that his name was an asset and this asset, rather than his work, was generating most of the income of his S corporation.

Some Senators have expressed concern about the effect this reform would have on small businesses. But none have explained coherently why we should allow this type of scheme to continue.

Call your Senators and tell them to stop putting multi-millionaire investment fund managers ahead of struggling families.

Call the Capitol switchboard at 202-224-3121 and ask to be connected to the Senators for your state.

Democrats in Congress are rushing to pass the jobs and "extenders" bill before the end of the week. This bill includes extensions of badly needed unemployment insurance and COBRA health benefits, TANF jobs and emergency funding, Medicaid funding for states and several other important measures. These are the type of measures that many economists, like Mark Zandi of Moody's Economy.com, believe will help stimulate the economy and speed up the recovery. The bill may be passed in the House this week.

Even if the bill passes the House, there may be a serious roadblock in the Senate. Some Democrats in the Senate may oppose or slow down this bill because it includes a provision to clamp down on a loophole allowing investment fund managers to earn hundreds of millions of dollars each year and yet pay taxes at a lower rate than their secretaries.

In other words, some Senate Democrats (and all or most Republicans) would allow unemployment and health benefits to expire for out-of-work families, and would allow jobs funding and Medicaid funding to expire, all to protect a loophole that allows multi-millionaires to pay taxes at lower rates than middle-income people. With every (or nearly every) Republican Senator guaranteed to vote against the bill, the Democrats are struggling to remain unified.

(See CTJ's recent report about the tax loophole-closers in the bill.)

If there was ever a time to call your Senators and give them hell, this is it.

The bill in question is H.R. 4213, the jobs and "extenders" bill. The loophole in question is the infamous "carried interest" loophole that allows wealthy fund managers to pretend that some of the compensation they receive in return for managing other people's money is capital gains. ( See CTJ's recent report about carried interest.)

Compensation for work is almost always taxed at ordinary rates as high as 35 percent and subject to payroll taxes of around 15 percent. But this loophole allows the investment fund managers (who can earn hundreds of millions of dollars a year) to pretend that some of their compensation is capital gains, which is subject to an income tax rate of just 15 percent and is not subject to payroll taxes at all.

After the Bush tax cuts expire at the end of this year, the top tax rate for "ordinary" income (meaning income subject to ordinary income tax rates) will go from 35 percent to 39.6 percent and the top rate for capital gains will go from 15 percent to 20 percent. That means that if this loophole is not closed, investment fund managers will be able to cut their income taxes roughly in half from what they should be paying, and will still avoid payroll taxes.

Democratic leaders have already compromised on this issue. Instead of treating all carried interest as "ordinary" income (i.e. not capital gains) as previous House-passed bills would do, the current proposal would treat 75 percent of it as ordinary income.

Incredibly, this has not been enough for some Senators who want to further weaken the provision.

Keep in mind that this has nothing to do with changing the taxation of anything that can honestly be called investment income. The idea behind the tax preference for capital gains is that it encourages people to invest. This is nonsense for reasons we'll get into on another day, but it is the accepted wisdom among many lawmakers who don't have much time to think about economics. But even if we accept this premise, it does nothing to explain why this tax preference should be enjoyed by people who are not investing their own money but merely managing other people's money. That's what the carried interest loophole currently allows.

Five Senators (Scott Brown, Jeanne Shaheen, Bob Casey, Patty Murray, Mark Warner) signed a letter to Finance Committee Chairman Max Baucus asking to amend the provision to allow venture capital fund managers to continue to enjoy the loophole.

The basic idea is that venture capital firms create innovation and jobs, unlike some of the other types of investment managers (like hedge fund and buyout fund managers) and this type of investment needs to be encouraged. The letter does not explain why this calls for tax breaks allowing the people who manage the money (not the people putting up their own money) to pay taxes at lower rates than middle-income people.

It has also been rumored that the venture capital industry has put a great deal of effort into persuading the Senators from California, Barbara Boxer and Dianne Feinstein to resist the provision.

Senators Maria Cantwell, John Kerry and Robert Menendez have also voiced concerns. Kerry and Menendez have called for some sort of "compromise" so that investment fund managers do not have to entirely pay at ordinary rates on their carried interest. This could involve taxing a smaller portion of carried interest as ordinary income (taxing less than 75 percent of it as ordinary income).

Another idea being floated would allow for investment managers to continue to enjoy a loophole to the extent that the investments they manage are held for a certain number of years. The idea seems to be to reward "patient" capital rather than those trying to make a quick buck. But of course, this really has nothing to do with rewarding patient capital since it would benefit the people managing the money, not the people actually investing it. Even more alarmingly, it could actually delay certain investments if fund managers are encouraged to hold onto assets for a longer period of time than would otherwise make sense just to enjoy the tax break. Certain deals would be delayed, meaning this provision could actually slow down economic development and job creation.

Staffers for several other Democratic Senators also expressed concerns about the carried interest provision, which seems to mean that ALL Senators need to hear from their constituents on this issue.

No one has explained why making the people who manage investments pay taxes at the same rate as everyone else will discourage investment. The argument that is occasionally trotted out by the industry is that the people managing the money and investments will have to charge more for their services in response to a tax increase. This is simply not true. If they could charge more, they would already being doing that right now. And it's worth remembering that investment fund managers did not decide to charge less when their tax rates were reduced (in 1997 and 2003 when the capital gains rates were cut) so it's illogical to believe that they will charge more in response to a tax increase.

The only explanation for the Senate's resistance that readily comes to mind involves the campaign contributions that investment fund managers make. Senate Democrats are, frankly, in danger of creating an extremely unflattering impression of themselves as beholden to their wealthiest contributors.

Many who have been following this bill are extremely concerned that the Senate may not pass the bill this week, or may pass the bill after amending it to reduce the impact of the carried interest provision. An amended bill could be disastrous in that it might make it impossible for the two chambers to come to agreement and send a bill to the President before the Memorial Day recess.

A new report from Citizens for Tax Justice explains that the new jobs and "extenders" bill released by the chairmen of the House and Senate tax-writing committees on Thursday contains several long-overdue provisions to close tax loopholes. The bill (H.R. 4213) takes aims at corporations that shift profits offshore, investment fund managers who use the "carried interest" loophole to pay lower tax rates than their secretaries, and business people who use the "John Edwards" loophole to avoid their Social Security and Medicare taxes.

Many people are more familiar with the important spending provisions in the bill geared to speed up the economic recovery, including an extension of unemployment insurance and COBRA health care benefits for the unemployed, Medicaid funding for states, TANF jobs and emergency funding for states and other measures that will help boost the economy.

The tax loophole-closing provisions are used to offset the costs of extending several small tax breaks. The spending portion is mostly considered emergency spending that does not have to be paid for under Congress's budget procedures because it is temporary and necessary to prevent the economy from drifting back towards recession. (The Center on Budget and Policy Priorities explains why the spending portions of the bill are economically necessary and fiscally sound.)

Call your lawmakers now and urge them to vote in favor of H.R. 4213. Visit the website for Jobs for America Now, which makes it extremely easy for you to make a toll-free call to your lawmakers to support this bill.