Democrats Plan Tax on Wealthy, Expanded IRAs

House Democratic leaders, in a desperate bid to defeat President Bush’s proposed capital gains tax cut, agreed Wednesday on an alternative plan to raise taxes on the wealthy while using the funds to expand individual retirement accounts for the middle class and to reduce the federal deficit.

It is the first time in this decade that congressional Democrats have been willing to line up behind a significant tax increase without the backing of the White House.

But, by aiming the tax increase exclusively at the wealthy and packaging it with a plan to reinstate a tax shelter that was enormously popular among middle-income voters before it was curtailed in 1986, Democratic leaders hope to turn their defensive position to political advantage.

The Democratic proposal is expected to be presented on the House floor next week as an alternative to the capital gains tax cut supported by Bush.

“I think it’s important for us to present a better option (than the capital gains tax cut) for the good of the economy,” Rep. Leon E. Panetta (D-Carmel Valley), the House Budget Committee chairman, told reporters Wednesday.

Seeking Bush Voters

Although conceding that Bush’s capital gains proposal still stands a good chance of winning on the House floor, Democratic leaders are aiming their last-ditch fight with the President at precisely the kinds of voters who have been the core of his political strength.

Even if they are defeated, Democrats hope to pick up support from voters by arguing that a capital gains tax cut is largely a Republican plan to benefit the rich while threatening Democratic efforts to aid the poor and middle class.

But the House Democratic plan runs the risk of backfiring by opening the door to Republican charges that the majority in Congress prefers to slap the public with higher taxes as part of any deficit reduction effort.

Bush, who has the support of a number of conservative and moderate Democrats for a capital gains tax cut, has vowed to veto any tax hike.

Under the proposal supported by the White House, the top tax rate on profits from sales of stocks, real estate and other assets would be cut for the next two years to 19.6% from today’s maximum of 33%. Starting in 1992, the capital gains tax rate would rise to 28%, but profits that resulted merely from inflation would not be taxed.

Instead of cutting capital gains taxes, the Democratic alternative would extend the top income tax rate of 33%, which is currently paid only by some taxpayers, so that it hits all upper-income Americans.

Under current law, couples with taxable incomes from roughly $72,000 to $150,000 pay a 33% rate on some of their income, but those with even higher incomes are subject to a maximum rate of 28%.

The Democratic plan, which would raise an estimated $35 billion in additional revenues over the next five years, would subject those earning more than $150,000 to the same 33% tax rate paid by less-affluent taxpayers.

To make it appealing to middle-income voters, the Democratic alternative would expand the widely popular IRA by allowing all taxpayers to receive at least a partial write-off on retirement contributions and would permit early withdrawal of IRA funds for buying a first home or paying college expenses.

Under the proposal, which is largely modeled after a plan presented last week by Senate Finance Committee Chairman Lloyd Bentsen (D-Tex.), taxpayers who are now ineligible for a tax break on IRAs could claim a $1 tax deduction for each $2 saved in an IRA, up to a maximum contribution of $2,000.

Those who are currently allowed to take a full write-off--taxpayers who are not covered by a pension plan or whose incomes fall under certain limits--would not be affected by the change.

In addition, the plan would allow all taxpayers with IRAs to withdraw money from their accounts before reaching age 59 1/2 without paying the current 10% penalty as long as the money was used to buy a first home or to pay college education expenses of a family member.

The exact cost of the IRA proposal had not been determined because details of the proposal were still being worked out. But Panetta said that it would be less than the money gained from the upper-income tax increase, leaving “a significant amount for deficit reduction.”

With the tax and budget showdown looming, Republican leaders, after a meeting Wednesday with Bush at the White House, said it is almost certain that Congress will fail to agree on a deficit-reduction measure by mid-October, the deadline in the Gramm-Rudman budget-balancing law.

That raises the prospect that automatic spending cuts totaling about $16.8 billion, half from defense and half from domestic programs, would be imposed on federal programs next month. But the action would be more symbolic than real, because Congress is expected to restore any cuts once it finally approves a budget for the fiscal year that starts Oct. 1.