Dec. 5 (Bloomberg) -- The U.S. Congress's next tax-cut battle pits the really wealthy against the merely very affluent.

House and Senate lawmakers are divided over how to structure a tax cut of as much as $70 billion. The House will vote this week to extend for two years the 15 percent tax rate on dividends and most capital gains, which primarily benefits millionaires. The Senate last month adopted a measure that protects 14 million people, most earning between $200,000 and $500,000, from paying higher taxes as a result of the alternative minimum tax.

"It's the moderately rich versus the super-rich," says Leonard Burman, co-director of the Tax Policy Center, a nonpartisan research organization in Washington.

The Republicans controlling Congress, who are seeking to craft the sixth tax cut since 2001, say they are left with few good choices because the need to reduce the $319 billion federal budget deficit makes it impossible to enact both measures.

Even among Republicans, some say extending tax benefits for the richest appears callous as Congress trims programs such as Medicaid, food stamps and student aid, which benefit the poorest. "There is concern, and rightfully so, about the perception," Representative Robin Hayes of North Carolina said Nov. 18.

Americans with household incomes more than $1 million accrued 22 percent of dividends and 59 percent of capital gains last year, according to the Internal Revenue Service. The Tax Policy Center, operated by the Urban Institute and the Brookings Institution, two Washington research groups, figure 51 percent of the benefits of the House plan would go to the richest 1 percent of Americans.

A Stop-Gap Provision

The House measure extending the 15 percent rate doesn't include renewal of a stop-gap provision, already approved by the Senate, limiting the impact of the alternative minimum tax. The tax, originally enacted in 1969 to ensure that richest Americans paid some income tax, isn't indexed for inflation. So over time, more people become subject to it as their incomes rise.

Failing to renew the stop-gap provision would raise taxes next year for 87 percent of Americans who earn $200,000 to $500,000. Only about 30 percent of people making more than $1 million would be affected, according to the Tax Policy Center; that's because most already pay at rates more than those of the alternative minimum tax.

The conflict between the alternative minimum tax and dividend and capital-gains provisions may endanger the tax legislation, says Ed McClellan, a former senior aide on the Senate Finance Committee who is now a tax attorney with Alston & Bird in Washington.

Vastly Different Bills

"There is a trade-off there," McClellan says. "You've got two vastly different bills that have to be reconciled."

Republican senators such as Jon Kyl of Arizona and Trent Lott of Mississippi say they won't vote for a tax measure unless it extends the dividend and capital-gains rates through 2010, while other senators have expressed reservations about a bill that doesn't have the alternative minimum tax limit in it.

Senate Majority Leader Bill Frist said Dec. 2 that while he was sure a spending-cuts package would pass within two weeks, he was less certain about the tax-cutting measure. "I cannot predict on the tax side," he told reporters.

The measure faces other challenges, including a Senate provision imposing a $4.3 billion tax increase this year on oil companies by changing an accounting rule for inventories. President George W. Bush, who has never used his veto power, has threatened to block any measure, including the increase.

Economic Effects

Lawmakers also must consider the impact of tax cuts on the economy. Trade groups representing securities brokers, such as the Washington-based Securities Industry Association, credit the 2003 dividends and capital-gains cut with helping spur economic growth. They say a signal from Congress that it won't extend the low rates past 2008 would erode confidence in the markets.

Although the wealthy have the most at stake, supporters of the alternative minimum tax fix and the investment tax breaks are each battling to cast their position as most beneficial for the middle class, says Mark Bloomfield, president of the American Council for Capital Formation, a Washington-based group that is lobbying for the dividend tax break.

"The easiest thing to do is try to characterize your tax cut as more middle-class than the other, because the middle class is the politically powerful group in America," he says.

For several years, Congress has limited the alternative minimum tax's reach by temporarily indexing it for inflation, usually for a year at a time.

Democrats such as New York Representative Charles Rangel, the party's senior member on the House Ways and Means Committee, say letting that lapse would hurt large numbers of people who earn $75,000 to $200,000, which may be considered middle-class in urban areas. Rangel says letting the alternative minimum tax fix lapse would cost these families as much as $3,640 in higher taxes.

`The Very Wealthy'

The House measure " purports to choose capital gain and dividend tax relief over AMT relief," Rangel wrote in a letter to his colleagues last week. "Actually, it chooses the interests of the very wealthy over middle-income taxpayers."

According to the Tax Policy Center, the percentage of taxpayers earning $75,000 to $100,000 subject to the alternative minimum tax would increase to 29.8 percent in 2006 from 1.1 percent; the percentage earning $100,000 to $200,000 would rise to 63.7 percent from 6.9 percent.

Ways and Means Committee Chairman Bill Thomas, a California Republican, says the dividend and capital-gains tax breaks help people whose income is too low to trigger the alternative minimum tax.

About 20 percent of the 11.7 million taxpayers who reported capital-gains income to the IRS in 2005 earned less than $50,000, Thomas says. Of the 22.1 million taxpayers reporting dividends, about 5.4 million earned less than $50,000, according to the congressional Joint Committee on Taxation. About 131 million Americans file tax returns overall, and the median income is about $29,000, according to IRS data.

Filibuster

Burman of the Tax Policy Center says Thomas is gambling that the alternative minimum tax fix has enough bipartisan support to pass in a separate measure that won't require special protection against a Senate filibuster, a parliamentary blocking maneuver that requires 60 votes to overcome. The dividend and capital-gains tax break is favored only by Republicans, who have 55 seats in the 100-member Senate.

McClellan, the former Senate aide, says it will be tough for Republicans to find 50 votes for a measure in the Senate, where lawmakers such as Ohio Republican George Voinovich and Nebraska Democrat Ben Nelson who supported Bush's tax cuts in the past say they don't support new reductions. Vice President Dick Cheney may be called upon in his role as president of the Senate to break a tie, as he did on a $330 billion tax-cutting measure in 2003, McClellan says.

"It'll be very close," McClellan says. "I suspect the vice president will not be that far away when that vote comes up."

To contact the reporters on this story:
Catherine Dodge in Washington at  cdodge@bloomberg.net;
Ryan J. Donmoyer in Washington at  rdonmoyer@bloomberg.net.

Last Updated: December 5, 2005 00:04 EST

Commentary:
Republicans are insane. We're probably going to have another year of record deficits and they're fighting over cutting taxes for the super rich while at the same time cutting programs for the super poor. It's more of their family values crap. If it were possible to impeach the entire GOP I'd list this as an impeachable offense. If/when Bush signs tax cuts, I'll list this as an impeachable offense. At some point he has to grow up and do the right thing.

If you're a republican and you like tax cuts, enjoy every moment. There will never be another tax cut after these idiots leave office because we're broke.