Hatching Tax Cuts for the Rich
Why is it that when Republicans in Congress try to address a real problem--whether it be an inadequate minimum wage, the tax code's marriage penalty, or whatever else happens to catch their attention--they so often end up calling for big tax cuts for the rich? The latest example comes from Senator Orrin Hatch, the Republican from Utah, who says he wants to simplify the income tax.
Now, "tax simplification" is a perfectly fine idea, and Hatch has the wisdom to focus on several areas that deserve attention, even though they affect only about six million high-bracket taxpayers. For instance, back when George H.W. Bush was president, he and Congress decided that higher tax rates on the welloff were needed to help reduce the budget deficit. But because lawmakers were afraid to raise tax rates directly, they took a roundabout route. First, they disallowed a portion of itemized deductions, equal to 3 percent of a taxpayer's income above certain levels (currently $128,950 for couples). That effectively adds about a point to the marginal tax rates paid by people in the 31 percent, 36 percent, and 39.6 percent brackets (on both regular income and capital gains). Next, Bush and Congress phased out personal exemptions at even higher income levels, which adds another two and a half points to the 36 percent tax rate. As Hatch correctly points out, these two "sneaky" provisions "obscure the true rate of tax being levied" and "add a great deal of unwarranted complexity."
The straightforward way to get rid of this dishonesty and complication would be to make the higher tax rates explicit. If we scrapped the disallowances and phaseouts and replaced the nominal 31 percent, 36 percent, and 39.6 percent top tax rates with two rates of 32 percent and 40 percent (and similarly boosted capital gains tax rates in these brackets as well), we'd have a simpler tax system with no change in total revenue or distribution. But that's not what Hatch proposes. Instead, his bill "solves both problems by simply repealing these provisions," thereby cutting taxes for top earners by about $201 billion over the next 10 years.
Likewise, the 1997 tax act introduced a bewildering variety of capital gains tax rates for profits from selling different kinds of investments. As Hatch points out, that produced "a 54-line Schedule D accompanied by two worksheets and seven pages of instructions." We could get a similar result in a simpler way, without affecting revenues or progressivity, by replacing the various special capital gains rates with a 35 percent exclusion for all capital gains. But what does Hatch propose? A 50 percent capital gains exclusion! Again, that would be a big tax break for those with the highest incomes, totaling $132 billion over 10 years.
Finally, Hatch points to the growing problem with the individual alternative minimum tax (AMT), which, because it's not indexed for inflation, threatens to affect far more taxpayers than the limited group of high-income tax avoiders it targets. Fixing the AMT problem isn't cheap--the Clinton administration's AMT stabilization plan would cost $33 billion over the next 10 years. But careful AMT reform is necessary. So is that what Hatch offers? Hardly. Although he mentions the AMT's important purpose--"to ensure that taxpayers with [high] economic income who take advantage of the tax code's many incentive deductions and credits still pay some tax"-- he wants to throw the baby out with the bath water by repealing the AMT altogether, at a cost of $123 billion over 10 years.
Hatch obviously recognizes the gross inequities of his plan. Indeed, as a sop to tax fairness, he tacked onto his bill an increased Earned Income Tax Credit (EITC) of some $94 bil-lion for moderate-income working families over the next decade. These changes--which would offer bigger credits to larger families, raise the income levels at which the credits start phasing out, and provide more favorable rules for couples than for single parents--may be excellent ideas, although they have nothing to do with simplifying the tax code. But even with his changes to the EITC, three-quarters of Hatch's $550 billion in total tax cuts over 10 years would go to the top 10 percent of earners, and almost half would go to the top 1 percent. In fact, the average tax cut for the best-off 1 percent would be almost $16,000 a year in today's dollars.
So is tax simplification Hatch's real goal? It sure doesn't look that way. Rather than limiting his plan to an attack on unnecessary complexity, Hatch has chosen to conflate simplification with big tax cuts outrageously tilted toward the well-off.
--Robert S. McIntyre