Debate Over Tax Cuts Centers on the Rich

The tax-cut debate in Congress resumes today as a contest between the merely rich and the super-rich. Congressional leaders are working on a way to make winners out of both.

The Senate has passed a bill that, in the most costly of its many provisions, would include one more year of relief from the alternative minimum tax, which was added to the tax code in 1969 to prevent the wealthy from sheltering most of their income. Nearly half of the benefits of that provision, according to the nonpartisan Tax Policy Center, would go to taxpayers with incomes between $100,000 and $200,000.

Those are the merely rich.

The House will probably pass a bill, approved by its Ways and Means Committee, that would cut taxes by about the same amount as the Senate bill, but by different methods. It would leave the alternative minimum tax alone and instead extend for two years the historically low 15% tax rate on investment income.

The low tax rates that apply to dividends and capital gains -- the profits on the sale of assets, such as stocks -- are scheduled to expire at the end of 2008. More than half of the benefits of extending them through 2010, according to the Tax Policy Center, would be enjoyed by taxpayers with incomes of more than $1 million.

Those are the super-rich.

The cost of either of these changes fits comfortably within the limits of tax cuts that Congress ordered in the 2006 budget it approved last spring. But combined, the two tax changes would leave hardly any room for any of the dozens of other tax cuts, such as special tax breaks for Hurricane Katrina victims and the extension of a tax credit for product research, approved by the full Senate and the House Ways and Means Committee.

Congress may shoehorn both into law anyway. The budget that lawmakers approved last spring ordered a single tax bill that would cost the government up to $70 billion from 2006 to 2010, but it left room for separate tax cuts totaling $35 billion more.

House Republicans have scheduled a vote for as soon as today on a separate measure to extend relief from the alternative minimum tax, or AMT. Many Democrats, regarding the AMT as about the worst feature of the tax code, are likely to vote for the measure but against the big tax bill that includes the low tax rate for investment income.

If the White House has to choose, it has suggested it would come down on the side of extending the low rates for capital gains and dividends. Allan Hubbard, director of the National Economic Council, told reporters Friday that the low rates encouraged the kind of investment that spurred economic growth.

“It’s very important that those be extended for two more years,” he said. “We’re very supportive of that initiative.”

Business groups mostly agree.

“It has been so effective in stimulating economic growth,” said Dorothy Coleman, vice president for tax policy of the National Assn. of Manufacturers. “It’s very important to do it now because people factor in the lower tax rates in making their investment decisions.”

Many tax policy experts dispute that. Leonard E. Burman, a co-director of the Tax Policy Center, found no evidence from the last 50 years that reducing the capital gains tax rate spurred economic growth, even with a lag of up to five years.

The argument over taxing capital gains has proceeded with few interruptions since the income tax was established in 1913. Congress has changed the rate 17 times, most recently in 2003, when it lowered the maximum rate from 20% to 15% for assets held longer than a year. Until then, the rate had not been lowered since 1933.

Unless Congress extends it, the current law expires after 2008. The maximum capital gains tax rate would then revert to 20%. Dividends, meanwhile, would also lose their maximum 15% rate and be taxed as ordinary income, with a maximum rate of 35%.

Congress’ Joint Committee on Taxation estimates that extending the favorable rates for two more years would cost the Treasury $21 billion -- about the cost of running the Justice Department for that period.

The alternative minimum tax is the tax that everybody loves to hate. A separate income tax system, it requires many taxpayers to compute what they owe twice -- once under usual rules and once under the rules of the AMT. Taxpayers pay the larger amount.

The AMT denies taxpayers the personal exemption, the standard deduction and many itemized deductions, including the one for state taxes -- although it carries the same low rates for capital gains and dividends as the regular tax. After an exemption of $58,000 for couples, the minimum tax is 26% of the first $175,000 of taxable income and 28% of the rest.

Because the eligibility thresholds for the minimum tax do not rise automatically with inflation, the tax has been sneaking up on taxpayers normally considered middle class, with incomes of between $50,000 and $75,000. It has particularly affected those with big families from high-tax states who under the AMT cannot take advantage of the state tax deductions or personal exemptions for dependents. For 2005, according to the Tax Policy Center, 3.5 million individuals and families will have to pay it.

Congress has linked minimum-tax thresholds to inflation on a year-by-year basis for several years, and the Senate bill would continue this tradition for one more year, lifting the exemption for couples to $75,550. This would cost the government $31 billion, according to the Joint Committee on Taxation.

Without the inflation link, the number of taxpayers affected by the alternative minimum tax will soar to 19 million in 2006 and 31 million in 2010, the Tax Policy Center said.