Democrats Seek to Lead the Way in Tax Overhaul
NY Times
Published: April 9, 2007

WASHINGTON, April 8 — House Democratic leaders, in an effort to upstage Republicans on the issue of tax cuts, are preparing legislation that would permanently shield all but the very richest taxpayers from the alternative minimum tax, which is likely to affect tens of millions of families as early as next year if it is left unchanged.

The effort, which lawmakers emphasize is still in its early stages, would exempt millions of people from the tax but would have to come up with a way to offset an enormous loss of revenue in the next decade. Measured in dollars, it would be far bigger than Democratic initiatives to provide money for children's health care, education or any other spending program.

The alternative minimum tax was created in 1969 to prevent millionaires from using loopholes to avoid all federal income taxes. Under it, affected taxpayers have to do a second tax calculation without claiming popular deductions like those for state and local taxes that they have come to rely on. It is akin to a flat tax of 26 to 28 percent.

But the tax is expanding at a rapid pace, partly because it is not adjusted for inflation. It can hit people with incomes as low as $50,000 and if left unchecked is expected to affect 23 million households during the 2007 tax year — up from 3.4 million last year.

Republicans, including President Bush, agree that the alternative minimum tax is out of control and ought to be frozen if not eliminated entirely. But so far Congress and Mr. Bush have only prevented its expansion with a series of one-year fixes. The House Democrats, by contrast, hope to force the issue of a permanent overhaul of the tax, despite the potentially huge cost.

Between now and the end of May, House Democratic leaders hope to draft a permanent overhaul of the tax that would effectively exclude anyone who earns less than about $200,000 a year — about 97 percent of taxpayers.

But that plan would leave a $1 trillion hole in the federal budget over the next decade, which Democrats would have to replace with revenues from other places or with spending cuts, under new "pay as you go" budget rules. Just postponing the expansion of the tax for one more year would reduce revenues by about $50 billion, according to Congressional budget projections.

To pay for permanent tax relief, Congress would have difficulty avoiding two basic choices: impose a substantial tax hit on the remaining 3 percent of taxpayers at the very top, or scale back tax breaks, like the deduction for state and local taxes, that benefit people in many tax brackets.

House Democrats see multiple political benefits from seeking a permanent fix. Some are eager to position themselves as tax cutters. Others want to show their ability to tackle a big and difficult initiative. Last but not least, the alternative minimum tax has a disproportionate impact on states with higher average incomes and high state and local taxes — like New York and California — which tend to vote Democratic.

"It's a tax cut to the 23 million American families who have no concept that they're going to get hit with this tax increase," said Representative Rahm Emanuel of Illinois, chairman of the House Democratic Caucus. "If President Bush wants to defend the others, that's a debate we are ready to have."

The Democrats themselves are divided on how to alter the alternative minimum tax. The Democrats' chief tax-writer in the Senate, Max Baucus of Montana, has shown little enthusiasm for replacing it with tax increases in other areas. Mr. Baucus also needs support from at least some Republicans to have the 60 votes needed to stop a filibuster, and Republicans are likely to oppose anything that dilutes Mr. Bush's tax cuts.

While perhaps counterintuitive, the House Democrats' embrace of tax-cutting rhetoric stems in part from a pragmatic consideration: the alternative minimum tax has a disproportionate impact on Democratic-leaning states. That is because those states tend to have higher incomes, higher property values and higher state and local taxes — all factors that expose people under the alternative tax formula.

A new analysis by Citizens for Tax Justice, a liberal research group, predicts that almost one-quarter of all taxpayers in Connecticut, New Jersey and Massachusetts will have to pay the alternative tax in 2007 unless Congress freezes it again. About one-fifth of all taxpayers in New York and California would be exposed.

To remind lawmakers of the urgency of addressing the alternative minimum tax, the House Ways and Means Committee recently prepared estimates on the number of people in each committee member's district who were likely to pay the tax. Seven of the top 10 districts were held by Democrats.

"When you look at the statistics and see who this is going to impact, the numbers are pretty staggering," said Representative John B. Larson, Democrat of Connecticut.

Jill Kozeney, a spokeswoman for Senator Charles E. Grassley, a Republican of Iowa who is the ranking Republican on the Finance Committee, said that eliminating the alternative minimum tax was one of the senator's top priorities. Earlier this year, she noted, Mr. Grassley introduced a bill that would repeal the tax entirely, without trying to recoup the lost revenue from tax increases elsewhere. Mr. Baucus joined in sponsoring that bill.

"A.M.T. relief has been a top priority for Senator Grassley," Ms. Kozeney said. "He demonstrated that time and again as chairman and remains committed to that as the ranking member of the committee."

For the Democrats, the political perils of overhauling the alternative minimum tax are significant. Most taxpayers who benefit from relief would barely notice a difference, because Congress has shielded most people from the tax so far with temporary fixes. On the other hand, any tax increase to pay for the relief would probably hit people at the very top with a tangible jolt.

"You're talking about replacing a hidden tax which most people don't even know about with an explicit tax," said Leonard Burman, a senior fellow at the Urban Institute. "On policy grounds, it's a good idea. On political grounds, it's a lot easier to have the tax hidden."

Senior House Democrats caution that they have not decided any of the details of their plan. Mr. Emanuel would exclude families with incomes below $200,000 or even $250,000 a year from the tax, but keep the tax for people with incomes above $250,000 and add new taxes for people with incomes above $500,000.

"We want to fix this once and for all," said Representative Richard E. Neal of Massachusetts, who is chairman of the House Ways and Means subcommittee on select revenue measures. Representative Charles B. Rangel of New York, chairman of the House Ways and Means Committee, said there were countless options for raising revenue and that he was drawn toward simplifying the tax code and eliminating specialized breaks.

"What we're trying to do is talk about simplification and elimination of the A.M.T.," Mr. Rangel said. "We have to find out the extent, the amount of money that we could get out of the tax code. You can't start off by saying this class of people will pay lower taxes and that class will pay higher taxes."

While nobody likes to admit it, neither Mr. Bush nor Democratic lawmakers want to give up the torrent of revenue from the alternative minimum tax. Mr. Bush's budget proposal as well as Democratic budget resolutions passed by the House and Senate all assume that the tax will either continue or be replaced by other taxes that yield the same revenue.

Bewildering to calculate and capricious in its impact on individuals, the alternative minimum tax requires taxpayers to perform a second calculation of their tax bill, on top of their regular tax calculation, that erases personal exemptions, the child tax credit and widely used deductions like those for state and local taxes.

The reach of the alternative tax is expanding rapidly, for two main reasons. The first is that the tax is not indexed for inflation, which means that more people fall into its maw as nominal incomes rise. But an equally important reason stems from Mr. Bush's tax cuts of 2001 and 2003. The cuts lowered taxes under the regular tax, but were not applied to the alternative calculation. As a result, the alternative tax bill is higher than the regular tax bill for millions of additional people.

After his re-election in 2004, Mr. Bush vowed to overhaul the income tax and abolish the alternative minimum tax as part of the process. But even though he received recommendations from a handpicked advisory panel, Mr. Bush ignored the proposals and never came out with a plan of his own.

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