January 03, 2008

Conservative Spin Machine Fights to Define 2007

While 2007 is over and we really want to just move on, it's hard to avoid getting tangled in the battle to interpret what Congress has done on the tax front and why.

Clearly, Congress extended the so-called "patch" that keeps most of us from paying the Alternative Minimum Tax (AMT) and did not replace the $50 billion that the AMT was supposed to collect. As we've reported, it's extremely disappointing that Congress waived the pay-as-you-go (PAYGO) rule that it reinstated when the Democrats took over. But conservatives are still trying to spin this issue into something entirely different from what it actually is.

Let's look at the Wall Street Journal's coverage. I know, I know, we can't respond to every ridiculous thing the WSJ says because that in itself would be a full-time job for a staff of one-hundred. But they exemplify the sort myth-making that is still going on about the AMT and about the two parties' positions on it.

"...because it isn't indexed for inflation, and because Democrats raised AMT rates in 1993 to 26% and 28% from a single rate of 24%, the AMT has turned into a blob that sucks in ever more taxpayers earning between $75,000 and $200,000 a year.

Now back in the majority, Democrats have found themselves hoist on their own 2006 campaign pledge for "pay as you go budgeting," which meant offsetting any AMT tax "cut" with $50 billion in other tax increases or spending cuts. Mr. Bush and Republicans sensibly argued that, because it was never intended to hit so many people, the AMT shouldn't be used as an excuse to raise taxes on other Americans. And with an election year coming, Senate Democrats didn't want to raise taxes on their rich hedge-fund donors. So House Democrats had little choice but to abandon "paygo" as well and pass AMT relief without any offsetting tax increases.

This is good news for the economy, which is struggling enough without a new tax on private equity or other risk takers... "

In these few paragraphs I immediately spot at least five statements that are... Well, I'll just say it: There are at least five blatant, bald-faced lies in these paragraphs.

1. The Democrats are responsible for the expanding reach of the AMT. As this blog has already
explained, first, the Clinton AMT changes of 1993 actually reduced the growth of AMT liability, and, second, failure to index the AMT for inflation is a bipartisan failure, equally attributable to the folks who run Congress now (Democrats) and the folks who ran it for the previous 12 years (Republicans).

Just take a step back and think for one second about how ridiculous it is for the party that has controlled Congress from 1995 through 2006, and controlled both Congress and the White House for six years, and passed several tax bills that did not permanently fix the AMT, to blame the Democrats for not permanently fixing the AMT.

But it's particularly absurd to claim that Democrats are responsible for this problem because the
Bush tax cuts greatly increased the number of people who are subject to the AMT. Since the AMT is an alternative tax that kicks in if it's greater than your regular income tax, there will clearly be more AMT payers if you lower the regular income tax rate without making a corresponding change to the AMT, which is what the Bush tax cuts did.

2. AMT relief does not represent a new tax cut, since no one expected the AMT's reach to expand. The editorial puts the word "cut" in quotation marks as if to suggest that AMT relief is really not a tax cut at all, buying into the Republican talking points that this measure somehow prevented a tax increase that was never supposed to happen and therefore does not constitute a new tax cut.

First of all, President Bush and his aides knew full well that when they cut regular income taxes, they were making a conscious choice not to change the AMT, which would increase the number of AMT-payers because the AMT would take back a large chunk of the tax breaks. In fact, Bush’s chief economic advisor during his first campaign was adamant that Bush’s plan contemplated a huge increase in the AMT.

Since the cost estimates for the tax breaks accounted for this fact, this made Bush's first tax cut proposal look less costly than it otherwise would be. But of course it was always a sham. Bush and his allies always knew that the corresponding reductions in the AMT would come later. These AMT reductions would therefore be additional tax breaks. Now the Republicans say AMT relief does not represent a new tax break but simply the prevention of a tax increase that was never expected, and therefore AMT relief doesn't have to be paid for. (So we should just ignore that $50 billion increase in the federal budget deficit.)

Let's talk about just how "unexpected" this situation is. The Center on Budget and Policy Priorities brilliantly
explains that several people in the Bush administration and allied with it were quoted early on as stating that the number of AMT payers would clearly increase due to the Bush tax cuts.

One person who is probably feeling absolutely humiliated by the Center on Budget paper is Senator Chuck Grassley of Iowa, the ranking Republican on the Senate Finance Committee.

Senator Charles Grassley, January 4, 2007:

“It’s ridiculous to rely on revenue that was never supposed to be collected in the first place… It’s unfair to raise taxes to repeal something with serious unintended consequences like the AMT.”

Senator Charles Grassley, March 8, 2001:

“Roughly one in seven taxpayers will come under the shadow of the Alternative Minimum Tax by the end of the decade… That figure will significantly be higher if President Bush’s tax plan is adopted, and that is according to the Joint Tax Committee of the Congress.”

Senator Charles Grassley, February 28, 2001:

“In addition, President Bush’s plan [will] bring millions more Americans into the AMT process; the Joint Tax Committee estimates that the Bush tax plan will nearly double the number of American taxpayers affected by the AMT.”

3. "Senate Democrats didn't want to raise taxes on their rich hedge-fund donors." Democrats in the House and Senate wanted to pay for AMT relief, since it clearly constitutes a new tax cut that will increase the federal budget deficit if it is not paid for. It seemed logical to Democratic leaders, and to us, that one way to offset the costs could involve closing a tax loophole for fund managers that should never have existed in the first place. The loophole for "carried interest," a certain type of compensation paid to fund managers who can make hundreds of millions of dollars a year, allows them to pay taxes at a lower rate than middle-income people.

It's true that there was resistance from some quarters within the Democratic caucus in the Senate on the proposal to end this outrageous tax giveaway. But in the end the Democrats were united in their effort to eliminate it. Every Democrat present on December 6 voted to end the loophole (which the WSJ describes as an effort to "raise taxes" on hedge funds). Regardless of how you describe the measure, the truth is that all the Democrats in the Senate voted for it, except for the presidential candidates who were off campaigning, most of whom have specifically, publicly, said that they support closing the loophole.

The bill could not pass because 60 votes are needed to approve legislation in the Senate. The Republicans voted unanimously to kill the bill.

4. We need to continue a tax subsidy for wealthy fund managers because the economy is struggling. No reasonable human being could believe that, to keep the economy running, middle-income people need to subsidize billionaires. But that's what the loophole in question does.

If Congress grants a tax break to a buyout fund manager that saves him $20 million, that's effectively the same thing as giving him a direct subsidy for $20. It costs the federal government the same amount, which really means it costs the rest of the taxpayers -- mostly middle-income people working hard to get by -- the same amount. A tax break targeted to one person means that others who don't get that tax break will have to shoulder a greater proportion of the tax load, and pay higher taxes or face cuts in public services, as a result.

Which gets us to a question conservatives have never adequately addressed: Why should middle-income people subsidize, through the tax code, the compensation paid to these folks who earn millions, hundreds of millions, and even sometimes in excess of a billion dollars?

5. Ending the tax subsidy for wealthy fund managers by closing the loophole is a "new tax" on "risk takers." The conservative spin machine is very keen to describe any effort to close even the most blatant tax loophole as a "new tax." This is particularly crazy in the case of the effort to close the carried interest loophole.

Let's just look at the law as it stands today, with the loophole still in place. If an unmarried receptionist working for a private equity firm earns $42,000 a year, the top federal marginal tax rate that applies to his income is 25 percent. This is on top of the 15.3 percent he pays in payroll taxes on all of his income. The fund managers he works for, however, pay only the 15 percent “capital gains” rate on the “carried interest” they receive as compensation for managing other people’s money.

This makes absolutely no sense from a tax policy perspective (see our first and second fact sheets explaining why this compensation cannot be honestly called capital gains) or from the perspective of fairness. The effort to close this loophole was motivated by the desire to have these wealthy fund managers pay taxes under the same rate structure that everyone else is subject to, which hardly constitutes a "new" tax.

Further, the idea that closing the loophole will constitute a new tax on "risk takers" is nonsense. When people from the financial industry came to the Hill to defend their loophole, there was a lot of talk about how the special capital gains rate of 15 percent was needed, even for these folks who don't really have capital gains, to encourage risk.

Why the tax code should be used to encourage people to place their money in risky investments was never clear, but that's largely besides the point since the fund managers we're talking about aren't even investing their own money but are actually managing other people's money.

Anyway, risk has nothing to do with what taxes you pay. There are many types of income that are risky, meaning you don't really know whether they will materialize at all, like performance bonuses, stock options, and royalties, and yet these are all taxed at ordinary income rates rather than the 15 percent rate for capital gains.

So why rehash this all now? Isn't the debate over?

Unfortunately, no, it's not over. Congress enacted an AMT patch just for 2007. The whole thing needs to happen again for 2008. Few of us are in any mood to endure this sorry ordeal again, but it really does not have to be hard, if only the Republicans would display a modicum of rationality.

There are very straightforward ways to pay for the next AMT patch even without closing the loophole for carried interest. In fact, the Democrats did attempt to pass another bill to pay for AMT relief without the carried interest provision, after Republicans in the Senate blocked the first bill. The
second bill had excellent provisions to offset the costs of AMT relief, including language that would close a loophole for offshore compensation by wealthy fund managers and language delaying a business tax break that hasn't even taken effect yet.

Incredibly, the Republicans in the Senate blocked this second bill also. We think the bill demonstrates that the tax code is riddled with loopholes that have no justification, and that closing these loopholes is an obvious way to offset the costs of other initiatives (such as AMT relief). The question is: How long can the Republicans in Congress deny the obvious?


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