During his State of the Union address, President Obama proposed that Congress enact his “Buffett Rule,” inspired by billionaire Warren Buffett’s complaint that he has a lower effective tax rate than his secretary.

President Obama said, “Tax reform should follow the Buffett rule: If you make more than $1 million a year, you should not pay less than 30 percent in taxes.”

This might mean that Congress would enact a new minimum tax of 30 percent for those with incomes over $1 million. But a simpler way to implement the Buffett Rule would be to simply end the tax preference for capital gains and stock dividends, which is the reason people like Mitt Romney and Warren Buffett can pay such low tax rates.

CTJ Report Explains Why Romney and Buffett Pay Such Low Tax Rates

A report from Citizens for Tax Justice explains how multi-millionaires like Romney and Buffett who live on investment income can pay a lower effective tax rate than working class people.

As the report explains, there are two reasons for this. First, the personal income tax has lower rates for two key types of investment income, capital gains and stock dividends. Second, investment income is exempt from payroll taxes (which will change to a small degree when the health care reform law takes effect).

The report compares two groups of taxpayers, those with income in the $60,000 to $65,000 range (around what Buffett’s famous secretary makes), and those with income exceeding $10 million.

For the first group, about 90 percent have very little investment income (less than a tenth of their income is from investments) and consequently have an average effective tax rate of 21.3 percent. For the second group (the Buffett and Romney group) about a third get the majority of their income from investments and consequently have an average effective tax rate of 15.2 percent.

This problem could be largely solved by doing what President Reagan did with the Tax Reform Act of 1986, which taxed all income at the same rates.

UPDATE: Candidate Mitt Romney told MSNBC on December 22 that he does not intend to release his tax returns, even if he becomes his party's nominee. Watch CTJ's Rebecca Wilkins explain to ABC News Brian Ross what Romney's tax returns would show about his offshore investments and "carried interest" income. ABC video at this link.

End the Loophole Allowing Romney and other Fund Managers to have "Carried Interest" Taxed as "Capital Gains"

GOP presidential hopeful Mitt Romney's personal wealth, estimated at $190 to $250 million, has been in the news a lot lately, including the sweet retirement deal he negotiated with Bain Capital, the private equity firm he used to head. The stories confirm CTJ director Bob McIntyre's comments to Time Magazine that Romney's multi-million dollar income is likely taxed at the special low 15 percent rate imposed on dividends and long-term capital gains.

This makes Romney a good poster child for the "Buffett Rule," the principle that millionaires should not pay lower effective tax rates than middle-income people. One step towards implementing the Buffet Rule is to close the loophole that allows "carried interest" (the fund managers' share of the deal they get as compensation) to be taxed at the 15 percent rate even though it is not truly capital gain.

Much of Romney's income that is taxed at that super-low rate is actually compensation in the form of a "carried interest" in the private equity deals of Bain Capital. While CEO's, actors, and athletes with multi-million dollar salaries, bonuses, or stock options pay income tax rates of 35 percent (and payroll taxes) on their compensation, managers of private equity firms, hedge funds, and other investment funds pay only 15 percent income tax (and no payroll tax) on their share of the funds' profits that they get in exchange for their management services. Even some managers who benefit from the low rate admit it's not justified.

Since this loophole benefits those who make millions, hundreds of millions and sometimes over a billion dollars in a single year, it is truly a case of the richest one percent being subsidized by the other 99 percent who pay higher taxes or get less in services to pay for this tax break.

Various proposals have been offered to close this loophole and, in the last Congress, one of those measures passed the House (three times!) but didn't make it through the Senate. Republicans and many Democrats in the Senate claimed that the loophole somehow helps encourage investment in poor neighborhoods, helps minorities, small businesses and even cancer patients.

The truth is that it does not encourage any type of investment in any part of the country because it does not benefit the people putting up money for investment. It merely allows those who manage this money to pretend that they have invested their own cash and thus receive the capital gains tax break that is ostensibly in place to encourage investment.

Now that this loophole has the face of a very wealthy presidential candidate on it, perhaps the American public will start to notice and demand that it be eliminated. If you believe the tax code shouldn't favor the richest 1 percent over the 99 percent, here's a place to start: Close the Romney Loophole.

Photo of Mitt Romney via Gage Skidmore Creative Commons Attribution License 2.0

Some commentators have suggested that, because people with incomes exceeding $1 million, on average, pay higher effective tax rates than middle-income people, the problem targeted by President Obama’s “Buffett Rule” does not exist. As demonstrated in a new report from CTJ, the problem is not the effective tax rates of millionaires across the board but a particular class of millionaires whose income is mostly from investments. Investment income is taxed less than other types of income, allowing millionaire investors to pay a smaller percentage of their income in federal taxes than do many working-class people.

The report demonstrates that this problem is not isolated to rare cases. In fact, almost one third of taxpayers with income exceeding $10 million fall into this category (of taxpayers who rely on investment income for over half of their total income). Over 90 percent of taxpayers making between $60,000 and $65,000 (which includes Mr. Buffett’s famous secretary) rely on investment income for less than a tenth of their income — and pay a higher federal tax rate as a result.

The report also explains what Congress can do to implement the Buffett Rule and solve this problem. The first step, perhaps surprisingly, is to prevent repeal of health care reform, which includes a change in the Medicare tax that will take a limited first step in addressing this unfairness. Additional reforms are needed, which may include eliminating tax preferences for investment income or a surcharge on income exceeding $1 million as recently proposed by Senate Democrats.

Photo of Warren Buffett and Barack Obama via The White House Creative Commons Attribution License 2.0

If the following actions were taken, some of the inequity that is driving the Occupy Wall Street and other affiliated protests would be eliminated. Suggestions include making corporations pay their fair share in taxes, ending the tax break for corporations that shift jobs and profits overseas, implementing the "Buffett Rule," and imposing a tax on the "too-big-to-fail" banks...

Read the fact sheet.

Photo of Occupy Wall Street via Eye Wash Creative Commons Attribution License 2.0

When House Speaker John Boehner said on Thursday that “tax increases destroy jobs” and are not a “viable option” for the Joint Select Committee tasked with reducing the budget deficit, he was probably unaware that a major business lobbyist and a high-profile conservative economist had admitted a day earlier that the last significant tax increases did not hurt the economy.

Bill Rys of the National Federation of Independent Businesses (NFIB) tried to explain to the  Senate Finance Committee on Wednesday his view that tax increases today would hurt the economy even though the economy thrived after the 1993 tax hikes enacted under President Clinton.

“In the 1990s,” he said, “we had a dot.com boom, we had Y2K, a lot of money being spent there, so we had much stronger economic winds pushing, pushing, which we don’t have right now.”

The obvious circularity of the argument seemed to go unnoticed by members of the committee. Rys said, in essence, that the tax increases of the 1990s did not prevent economic growth because we had economic growth in the 1990s.

Stephen Entin of the conservative Institute for Research on the Economics of Taxation, made a similar comment to explain why the Clinton tax increases did not cause the economic stagnation that he predicts would result from tax increases today.

“The Clinton marginal tax rate increases were fairly modest and we were coming out of a downturn. The growth was going to look good anyway.”

Most of the tax increases proposed today, which Entin believes will lead to a reduction in GDP, actually would just allow some rates to revert to the Clinton-era rates, so it’s surprising that he calls the Clinton tax increases “fairly modest.”

Even more surprising is his comment that the Clinton tax increases were not damaging because “we were coming out of a downturn.” No one asked the obvious follow-up question: If tax increases did not prevent a recovery in the 1990s, why would they prevent a recovery today?

Entin went on to say that what also allowed the economy to grow in the 1990s was the capital gains cut signed into law by President Clinton in 1997, which reduced the top capital gains rate to 20 percent.

“Please remember that he did sign a capital gains tax reduction and a lot of the growth in that decade was due to that reduction in the cost of capital. It dwarfed the effect of raising the marginal rates.”

The capital gains cut did not go into effect until 1998 so it’s interesting that Entin thinks that accounted for “a lot of the growth in that decade,” meaning the 1990s.

It’s also noteworthy that allowing the Bush tax cuts to expire would allow the top capital gains tax rate to simply revert to 20 percent, the rate that Clinton enacted and which Entin seems to think was conducive to growth.

A close look at the numbers demonstrates that there is no policy basis for allowing capital gains income to be taxed at lower rates than ordinary income. Advocates of tax cuts for investment income have for years argued that the revenue collected from taxes on capital gains will actually rise in response to a capital gains tax cut, but the data does not bear this out. For example, capital gains tax revenue was lower in the years following Bush’s 2003 capital gains tax cut than during the Clinton years. This revenue fluctuates with the economy and does not seem correlated with tax rates.

Of course, we could give Rys and Entin the benefit of the doubt and assume they really mean that economic growth would have been even higher during the 1990s if President Clinton had not raised tax rates. But even that argument is entirely unsupported by the data. A 2008 report from the Center for American Progress and the Economic Policy Institute compares the economic recoveries following the major tax changes enacted during the administrations of Presidents Ronald Reagan, Bill Clinton, and George W. Bush. The report illustrates that the recovery under Clinton was far stronger, despite the tax increases that he enacted, than the recoveries during the other two administrations. 

Rys and Entin have both long advocated for making permanent all of the Bush tax cuts and enacting additional tax reductions. In 2010 CTJ wrote a response to arguments made by Rys and NFIB concerning the impacts of taxes on small businesses. In 2009 CTJ wrote a response to a report from Entin claiming that elimination of the estate tax would actually increase revenue.

Warren Buffett, the billionaire investor and CEO of Berkshire Hathaway, called for higher taxes for millionaires in a widely-noted op-ed this week. As expected, the Wall Street Journal reacted with a variety of misleading counter-arguments. We conclude that:

1. Buffett is correct that the tax breaks that benefit the wealthy investor class, like the capital gains and dividends preferences, are unfair.
   
   
2. The Wall Street Journal’s arguments that these types of investment income are double-taxed are incorrect.
   
   
3. Contrary to what the Journal claims, President Obama’s tax plan is in keeping with Buffett’s call for higher taxes on millionaires.

Billionaire Investor Is Right to Call for Higher Taxes for the Rich and End of Breaks for Investment Income

Buffett points out that middle-class Americans are being asked to “sacrifice” as Congress and the new twelve-member “super committee” search for ways to reduce the budget deficit, but millionaires have not been asked to sacrifice anything. He argues that the super committee should ask millionaires to pay at higher rates than they pay today and should also end or reduce special tax preferences for investment income, which makes up most of the income of millionaires.

Citizens for Tax Justice has long made the case that these tax preferences — the special low income tax rates for capital gains and stock dividends, should be repealed entirely.

CTJ offers the example of an heiress who owns so much stock and other assets that she does not have to work. She receives stock dividends, and when she sells assets (through her broker, of course) for more than their original purchase price, she enjoys the profit, which is called a capital gain. On these two types of income, she only pays a tax rate of 15 percent.

Now consider a receptionist who works at the brokerage firm that handles some of the heiress’s dealings. Let’s say this receptionist earns $50,000 a year. Unlike the heiress, his income comes in the form of wages, because, alas, he has to work for a living. His wages are taxed at progressive rates, and a portion of his income is actually taxed at 25 percent. (In other words, he faces a marginal rate of 25 percent, meaning each additional dollar he earns is taxed at that amount).

On top of that, he also pays the federal payroll tax of around 15 percent. (Technically he pays only half of the payroll tax and his employer pays the other half, but economists generally agree that it’s all ultimately borne by the employee.) So he pays taxes on his income at a higher rate than the heiress who lives off her wealth.

What make this situation even worse are the various loopholes that allow wealthy individuals to receive these tax breaks for income that is not really even capital gains or dividends. As Buffett explains, fund managers use the “carried interest” loophole to have their compensation treated as capital gains and taxed at the low 15 percent rate, while the “60/40 rule” benefits traders who “own stock index futures for 10 minutes and have 60 percent of their gain taxed at 15 percent, as if they’d been long-term investors.”

CTJ has found that if Congress simply repealed the preference for capital gains entirely, three fourths of the tax increase would be borne by the richest one percent of taxpayers. (See page 19 of this report for estimates.) The tax preference for dividends expires at the end of 2012 if Congress does not extend it.

The Myth of Double-Taxed Investment Income

The Wall Street Journal starts with the following complaint about Buffett’s argument that his capital gains and dividend income is insufficiently taxed:

“What he doesn't say is that much of his income was already taxed once as corporate income, which is assessed at a 35% rate (less deductions). The 15% levy on capital gains and dividends to individuals is thus a double tax that takes the overall tax rate on that corporate income closer to 45%.”

Anti-tax ideologues often claim that corporate profits are taxed twice, once under the corporate income tax and then again under the personal income tax when the shareholders receive them in the form of capital gains and dividends. There are several fatal flaws in this argument:

First, many corporate profits are not taxed, as GE, Verizon, Boeing, and many other corporations have demonstrated.

Second, two thirds of those dividends are actually paid to tax-exempt entities like pension funds or university endowments.

Third, a capital gain from selling a corporate stock is not necessarily a form of corporate profit. If stock value rises based on some expectation of a future increase in profits (which a drug company might enjoy after the FDA approves a new product, for example) that does not have anything to do with profits that the company has already received or paid taxes on.

In any case, the capital gains earned outside of tax-exempt plans are not taxed until shareholders sell their corporate stock at a profit, meaning those gains can be deferred indefinitely. Even when shareholders do report capital gains they often offset them with capital losses.

If one applies the logic of the “double-tax” argument more broadly, one would have to conclude that the wage and salary income of ordinary Americans is subject to several forms of taxes that wealthy investors don’t worry much about. For most Americans, income consists entirely of wages and all of it is subject to Social Security taxes and much or most of it is subject to the federal income tax. Then when people spend their income, a great deal of their purchases are subject to sales taxes.

Somehow the Wall Street Journal and its devotees only express concern over taxing income multiple times when wealthy investors are involved.

Ending Tax Cuts for Income Over $250,000 Actually Targets Millionaires

The Wall Street Journal also complains that, “Like Mr. Obama, Mr. Buffett speaks about raising taxes only on the rich. But somehow he ignores that the President's tax increase starts at $200,000 for individuals and $250,000 for couples.”

But President Obama’s plan does target millionaires. A recent report from Citizens for Tax Justice explains that if enacted in 2011, 84 percent of the revenue savings from Obama’s income tax plan would come from people who make more than $1 million annually.

What is often not understood is that Obama’s plan would leave in place the Bush income tax reductions for the first $250,000 of adjusted gross income (AGI) for all married couples (and the first $200,000 for all unmarried taxpayers).

A married couple with adjusted gross income of $250,001 would pay higher taxes on at most one dollar, and face a tax hike of only 3 cents at most. But even that tiny tax hike would be extremely rare, since almost all couples at that income level itemize deductions. Typically, couples would have to make more than $295,000 before they lost any of their Bush income tax cuts.

Married taxpayers with incomes between $250,000 and $300,000 would lose just one percent of their Bush income tax cuts, on average, under President Obama’s plan.

The Wall Street Journal calls taxpayers with AGI in excess of $250,000/$200,000 “middle-class.” CTJ estimates that in 2013, when the Bush tax cuts are scheduled to expire, only 2.6 percent of taxpayers will have adjusted gross income in excess of the $250,000/$200,000 threshold.

This shows that President Obama is asking too few, rather than too many, Americans to pay higher taxes than they do today. 

Photos via The White House Creative Commons Attribution License 2.0

The Internal Revenue Service (IRS) recently released new data showing that the number of individuals paying zero US income taxes on an adjusted gross income (AGI) of $200,000 or more almost doubled between 2007 and 2008.

In 2008, the number of returns declaring an AGI of over $200,000 represented about 3.1 percent of the total returns filed to the IRS. Out of these returns, as many as 18,783 had no U.S. income tax liability whatsoever in 2008; that’s nearly double the 10,465 who owed nothing in 2007.

Although this may represent only 0.43 percent of taxpayers reporting an AGI of over $200,000, it is the biggest percentage of non-payers in this category since the IRS began reporting the data in 1977.

The IRS report also revealed that the much publicized top marginal rate of 35 percent exists primarily on paper: according to the data, only 0.007 percent of ALL taxpayers pay an effective tax rate of 35 percent or higher. Put differently, nine times as many high income taxpayers pay zero in taxes than pay an effective, actual 35 percent tax rate.

Much of the explanation for the low effective rates for higher income individuals can be explained by the over $1 trillion in special tax deductions and treatment often referred to as tax expenditures. Examples of expenditures that rich taxpayers exploit would be: special treatment of capital gains, tax-exempt interest and the mortgage interest deduction.

Reducing or eliminating tax expenditures for businesses and investors would not only help reduce the deficit, it would also make the system more fair by reducing the number of higher income taxpayers who are able to avoid paying a substantial part or all of the taxes they owe.

The IRS data proves once again what Citizens for Tax Justice has said all along, our tax system is not as progressive as you think.

Some 44 House Democrats have reportedly written a letter to Speaker Nancy Pelosi calling for an extension of the Bush tax cuts on investment income for the richest two percent of Americans. These Democrats would preserve the historically low income tax rate of 15 percent for capital gains and stock dividends for the wealthiest taxpayers. This stance places them to the right of Ronald Reagan and illustrates a surprising lack of familiarity with history and economics.

Read the report. 

With Congress out of Washington for the August recess, more and more reporters and opinion makers are turning their attention to the enormous decisions on tax policy that await lawmakers when they return.

Anti-Tax Lawmakers Ignoring Public Opinion

The public supports President Obama's approach to the Bush tax cuts. A new CNN poll finds that only 31 percent of respondents think that Congress should extend the Bush tax cuts for the very rich as well as everyone else. This is in keeping with previous polls with similar results.

The main justification given by anti-tax lawmakers and activists for ignoring public opinion on this matter is that higher taxes on the rich, they claim, will hurt business investment and therefore hurt job creation. But a growing chorus of analysts agree that allowing the Bush tax cuts to expire for the rich will not harm the economy.

Anti-Tax Lawmakers Ignoring Rational, Informed Economic Analysis

For example, Allan Sloan, senior editor for Fortune and a columnist for the Washington Post, writes that "From the start of the income tax through 2003, dividends were taxed as regular income, and capital gains were treated far less favorably than now. Somehow both the republic and the financial markets survived. They'll survive higher rates, too."

Sloan provides a refreshingly calm approach to a subject that sends many people into hysterics: the impact of taxes on investment.

For example, he points out that the 2003 tax cut bill signed by President Bush "set dividend taxes for the high-bracket crowd at preferential rates for the first time and brought the rate on long-term capital gains to its lowest point since 1941, according to the tax publishing firm CCH. But that didn't exactly result in a bull market. According to Wilshire Associates, whose numbers I'm using throughout this column, the U.S. stock market rose only 14.6 percent from the May 5, 2003, tax cut through Obama's election on Nov. 4, 2008... That price gain, about 2.5 percent a year compounded, was less than half the historical rate."

In Sloan's view, the ups and downs of the stock market have little if anything to do with tax rates. He goes on to say, "Since Obama's election, the market has been very good. In fact, the market's 10.4 percent rise during Obama's first 100 days in office bested tax-cutting Ronald Reagan (a 4 percent gain for his first 100 days) and George W. Bush (a 2.3 percent loss for the equivalent period)."

Higher taxes on the very rich will not reduce their investment in stocks and bonds and also will not reduce their investments in their own businesses that they actively operate (as we have explained elsewhere).

When it comes to job creation, the non-partisan Congressional Budget Office agrees that the other measures that have been discussed in Congress (like aid to state and local governments and extended unemployment benefits) are many times more effective than income 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 close the "carried interest" loophole allowing multi-millionaires running investment funds to pay taxes at lower rates than their secretaries.

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

Public interest advocates, faith-based groups, labor unions and others continued their push this week to prod Congress to enact a jobs bill that extends unemployment insurance benefits, COBRA health benefits for unemployed individuals, Medicaid funding for states and other vital measures that would boost the economy. The House approved its bill (the latest version of H.R. 4213) only after severely weakening it by dropping COBRA and Medicaid funding, and the Senate left for the Memorial Day recess without acting on it.

Most of the spending provisions in the bill are considered emergency spending, and do not have to be paid for under Congress's budget procedures. The bill also includes provisions extending several temporary tax breaks (mostly for business), and these provisions are often called the "tax extenders." The costs of the tax extenders are offset with provisions that close unfair tax loopholes.

These loophole-closing provisions are among several factors that have slowed down progress on the bill. Unfortunately, some Senators seem reluctant to close even the most abusive tax loopholes.

Citizens for Tax Justice released a group of reports over the past few weeks about the tax loophole-closing provisions in the bill.

The American Jobs and Closing Tax Loopholes Act of 2010 (a.k.a. the “Extenders” Bill) Would Boost the Economy and Improve Tax Fairness
This report explains the three general types of loophole-closers in H.R. 4213, including provisions to end abuses of foreign tax credits, provisions to clamp down on the "carried interest" loophole, and provisions to end the "John Edwards" loophole for business people with "S corporations."

Senators Defend “Carried Interest” Loophole for Investment Fund Managers in the Name of the Poor, Minorities, Small Businesses and Cancer Patients!
This report debunks the outrageous arguments that investment fund managers have made in defense of the "carried interest" loophole.

Key Provisions in H.R. 4213 Would Prevent Abuse of Foreign Tax Credits
This report explains the provisions of H.R. 4213 that would make the U.S. international tax system fairer and more rational and cut down on corporations shifting profits offshore.

Some investment fund managers admit that there is no justification for the carried interest loophole, which allows a part of their compensation (their "carried interest") to be taxed at the low capital gains rate.

On May 18, talk show host Charlie Rose asked Jonathan Nelson, CEO of the private equity firm Providence Equity Partners, if he could "live with it" if Congress taxed his carried interest at ordinary rates instead of the low capital gains rate. Nelson responded, "We could live with it if they changed it overnight. Absolutely."

On May 29, Fred Wilson, a venture capitalist of a firm called Union Square Capital, wrote that his carried interest should be taxed as ordinary income because it's compensation for work rather than gain on an investment. "It is not fair or equitable to other recipients of fee income to give a special tax break to certain kinds of fees and not to others," he explains, before explaining other policy reasons for ending the loophole.

Bill Stanfill, founder of a Colorado-based venture capital firm called TrailHead Ventures, testified before the Ways and Means Committee in favor of closing the loophole back in 2007. He recently asked Senators in a letter (and in several meetings and phone calls), "Why should the 'bonus' (carried interest) earned by v.c.'s be taxed more favorably than the bonus of any other working person — whether teacher, salesperson, athlete or corporate manager?  Life can be unfair, but it does not follow that the government should institutionalize unfairness. Instead, it should level the playing field as much as possible."

Interestingly, even two Republican Senators have indicated that they have no use for the carried interest loophole. FDL News reports that Republican Senators Olympia Snowe and Susan Collins of Maine have indicated that they have no objection to closing the loophole.

Investment managers are now lobbying furiously to get what they are calling the "enterprise value" tax dropped from the carried interest loophole closer. This provision in the bill would treat gain from the sale of a carried interest (the partnership interest owned by the investment manager) as ordinary income instead of capital gains.
 
The U.S. Chamber of Commerce threw its considerable weight behind the effort to strip this provision from the bill in a letter last week to members of the House. The Chamber's letter is very misleading — it sounds as though the provision will impact all sales of partnership interests, but, in fact, it affects only the manager's interest. A Wall Street Journal editorial is even more misleading, implying that the income of the investment manager will be taxed twice. This is a complete falsehood. Any partnership income that the manager gets increases his tax basis in his partnership interest which will reduce the gain realized on its ultimate sale.
 
This provision must stay in the bill. Otherwise, investment managers can easily avoid the ordinary rates by selling their "carried" partnership interest and paying capital gains taxes on that income. If they reinvest the sales proceeds back into the investment partnership, they have converted their carried interest into a qualified capital interest and will get capital gains treatment on all subsequent partnership income.