Another Tax Gap Hearing, Another Standoff
In case you didn’t already catch the Senate Finance Committee hearing featuring Treasury Secretary Henry Paulson yesterday, here’s a quick summary.
The hearing itself was pretty entertaining and highlighted the on-going stand-off between Paulson and Finance Chairman Baucus. Baucus set a timetable for results saying that he wants a 90% voluntary compliance rate by the year 2017 – placing the responsibility on the Treasury to come up with this plan and deliver it in 90 days – July 18th – to the Committee. Paulson responded that he would be more than happy to come back in 90 days to present their current plan again. Paulson also stressed the difficulty of reaching the 90% rate without delving into the under-reported income area that is responsible for over 80% of the current tax gap – which will cause a lot of pain and require draconian measures.
- Tax havens were a hot topic during the hearing – raised by Senators Conrad, Stabenow and Baucus. Baucus said there is “a lot of angst in Congress” over these issues.
- Senator Wyden asked Paulson about the status of Treasury’s response to the Tax Reform Panel’s report. Paulson stated that there “isn’t a major tax reform proposal being put forward and I don’t see it happening in the near future” and that the Treasury is focusing on more incremental steps toward tax reform.
- Senator Grassley raised hedge funds with Paulson. He asked if Treasury studied hedge fund tax policy in its financial markets study. Paulson said no, but Assistant Secretary Eric Solomon added that Treasury and the IRS are independently looking at hedge fund issues.
More AMT News
Meanwhile, CongressDaily reports that House Democrats are closing in on their plan to permanently address the Alternative Minimum Tax. For our new members, the AMT is an alternative tax system originally designed to ensure that a few rich taxpayers pay at least a minimum level of income taxes, but the combination of poor design and lower tax rates under the regular code have resulted in the unprecedented growth of the AMT among taxpayers whose incomes are decidedly middle class.
As outlined, the plan right now would eliminate the AMT for all taxpayers earning below $250,000 and reduce it for taxpayers with incomes between $250,000 and $500,000. Presumably, the AMT would be left in place for taxpayers earning above $500,000. To offset the revenue impact of AMT relief, the House is apparently looking at raising income tax rates on taxpayers earning more than $1,000,000 a year. Chairman Rangel’s comments also suggest they may still look at adjusting the rate thresholds, as we reported earlier.
While the story to date has focused on the trade-off between reducing taxes for middle-income AMT taxpayers and raising regular income taxes on wealthier taxpayers, we think it’s important to point out that the math simply doesn’t add up. The reported cost of the AMT plan is about $1 trillion over ten years. It will be simply impossible to raise that much revenue by just focusing on millionaire taxpayers. According to our friends at Statistics of Income, of the 132 million taxpayers who filed in 2004, only 240,000 reported incomes exceeding $1 million. To raise $1 trillion, the annual tax increase for each of these taxpayers would exceed $400,000 a year. To achieve that, the top tax rate of 35% would have to be raised to something around 50% for this group.
You don’t have to be a disciple of the Laffer Curve to recognize that marginal tax rates in the vicinity of 50% will result in serious economic dislocation. It will also hurt small businesses. As we’ve mentioned many times before, S corporations pay their taxes at the individual rates, so raising tax rates on millionaires means raising tax rates on successful small and closely held businesses — the very businesses we rely upon to create most of the jobs in this country.
Marginal tax rates of that magnitude are also politically unfeasible in today’s environment. The last time Congress raised the top tax rate (from 31% to 39.6%) in 1993, the majority lost both the House and the Senate in the subsequent elections. Many House members, including Ways and Means Chairman Charlie Rangel, were around in 1993, and they are unlikely to go down that path again.
Nevertheless, the current rhetoric is beginning to sound very much like 1993, when President Clinton promised to raise taxes on millionaires only and wound up signing a bill that raised taxes on just about everybody. The old line about robbing banks because “that’s where the money is” is overused, but it definitely applies here. Taxing millionaires to cut taxes on the middle-class makes for nice press releases, but when Congress seriously looks to raise revenue, it inevitably looks to the middle class, because that’s where the money is.
As long as the House insists on offsetting any changes to the AMT, the story will not be about rich verses middle class. Instead, it will be about how Congress rearranges tax collections on the same group of taxpayers — those in the middle and upper-income tax brackets. Some will see their taxes fall, and some will see their taxes go up. S corporations need to stay on alert.