Sunday, February 12, 2006

Cracking the Tax Code

The New York Times
Cracking the Tax Code


ANYONE who thinks that the federal income tax code is baffling now ought to brace for what lies ahead: big changes and uncertainty.

To many, any change may sound like welcome news. What kind of income tax system could be more incomprehensible and more riddled with special preferences than the current one?

But the main reason for change may be more unsettling. Never before has so much of the income tax code consisted of temporary measures. And never before has it been so inherently unsustainable.

Virtually all of President Bush's tax cuts and credits — the lower rates, the child tax credit, the special breaks for married couples and the lower tax rates on investment income — are set to expire by 2011.

That might not be a huge problem in itself. Mr. Bush and his Republican allies have vowed to make the tax cuts permanent, at a cost of $1.3 trillion over 10 years.

But the huge volume of expiring tax cuts is set to collide with an equally expensive challenge that neither Mr. Bush nor the Congress has started to address.

That problem is the alternative minimum tax, or A.M.T. — a tax that was originally aimed at only the very richest people but is now set to impose big tax increases on tens of millions of middle-income families over the next few years.

Mr. Bush and Congressional leaders in both parties have vowed to prevent that tax increase. But the cost would be more than $1 trillion over the next 10 years — almost identical to the cost of preserving the president's tax cuts.

That leaves taxpayers looking at several possibilities. If Mr. Bush's tax cuts are extended, but the A.M.T. is unchanged, tens of millions of people will face big new surcharges.

If the alternative tax is frozen or simply repealed, Congress is likely to make up for the lost money by cutting back or eliminating scores of other tax breaks.

If Congress lets Mr. Bush's tax cuts expire, regular tax rates are likely to shoot up sharply but the A.M.T. may become fairly easy to repeal.

At the moment, neither Mr. Bush nor Congress is proposing any of those options.

Instead, both Congressional and White House budget plans assume that the alternative minimum tax will generate hundreds of billions in extra revenue.

In a sign of growing paralysis, House and Senate Republicans have also been increasingly unable to agree on any long-term tax plan. Far from making Mr. Bush's tax cuts permanent, they are now struggling just to extend today's tax breaks for another year or two.

"The process itself is really broken," said C. Eugene Steuerle, a senior fellow at the Urban Institute and author of numerous books on tax policy. "It presents people with a very misleading picture of what's going on. You have increases in spending without tax revenues to pay for them, and you have tax increases that won't occur."

Mr. Bush and top administration officials contend that they want to eliminate the alternative minimum tax as part of a top-to-bottom overhaul of the income tax.

But Mr. Bush has all but abandoned any effort at tax reform in 2006, even though he listed it as a top priority just one year ago.

Mr. Bush omitted any mention of the issue in his State of the Union address on Jan. 31, and the White House has been silent about the detailed proposals made last fall by his handpicked advisory council on tax reform.

Treasury Secretary John W. Snow, defending Mr. Bush's other tax proposals at a Senate hearing on Tuesday, flatly refused to hint at when the administration would propose a broader overhaul.

"I think it's best for me to refrain from offering thoughts on that until we pull together our total package" and are in a position to present it to the president, Mr. Snow said.

To be sure, Congress has a long history of passing supposedly temporary tax breaks that are routinely extended year after year. But where temporary provisions were once a sideline issue, they are now the dominant feature of the tax code.

That is a result of a deliberate decision by the White House and Republican leaders in Congress to have the tax cuts of 2001 and 2003 expire by 2011.

Part of the reason was procedural: temporary tax cuts can be part of a budget "reconciliation" bill, which can pass the Senate with only 51 votes rather than the 60 votes needed to stop a filibuster.

But Republican lawmakers also saw political advantages. Temporary tax cuts look cheaper than permanent cuts. And many Republicans delighted in voting for the same tax cuts year after year.

"What started to happen in 2001 was qualitatively different," said Joel B. Slemrod, a professor of tax policy at the University of Michigan. "Part of it was to fit the letter of the law into the budget rules, and part of it was calculated to keep issues on the agenda that were to the Republicans' favor."

Whatever the reasons, virtually all the tax cuts of 2001 and 2003 and scores of other tax breaks are set to expire by 2011. The list is long and expensive. Among the biggest items are these:

The rate reductions for people at every income level; these cuts would cost more than $100 billion a year to extend.

The tax cuts on stock dividends and capital gains, which expire at the end of 2008; an extension of these cuts would cost more than $20 billion a year

The $1,000 child tax credit, which would cost $35 billion a year to extend.

Repeal of the estate tax on inheritances, which would cost more than $50 billion a year to extend.

Mr. Bush and Republican leaders have pushed to make permanent all the 2001 and 2003 tax cuts. But that goal will compete directly with a long list of other promises, the biggest of which is to freeze or simply repeal the alternative minimum tax.

If the law is left unchanged, about 15 million additional families will face the alternative tax in 2006, and their collective tax increase will be more than $30 billion for this year alone, according to government estimates.

Those amounts climb even higher in each subsequent year and would total $1.1 trillion over the next 10 years, according to the Congressional Joint Committee on Taxation.

Simply keeping the alternative minimum tax at its 2005 level would cost taxpayers nearly $100 billion in 2010 and more than $200 billion in 2015, according to estimates by the Tax Policy Center, a joint venture of the Urban Institute and the Brookings Institution.

To glimpse the difficulty of the tax choices ahead, look no further than the struggle this month among House and Senate Republicans to extend just a small collection of expiring tax breaks.

President Bush had placed special urgency on permanently extending his tax cut on stock dividends.

But Republican leaders have not come close to that goal. The Republican-led Senate passed a $60 billion package that omitted any extension of the tax cut on stock dividends, which does not expire until 2008, in order to keep the A.M.T. from rising in 2006.

Restraining the alternative minimum tax for just one year will cost about $34 billion, while extending the dividend tax cut alone for one year would cost about $10 billion.

House Republicans were bolder and more willing to increase the deficit. The House passed a $90 billion package of separate laws that included a two-year extension of the dividend tax cut and a one-year fix for the A.M.T.

House and Senate leaders are still locked in a struggle over their rival approaches. But even if they agree on $90 billion worth of tax-cut extensions, they will face bigger quandaries next year.

Politically, that means that fewer and fewer tax breaks will be considered too sacred to sacrifice. It also means that tax breaks benefiting those with less political power could be at greater risk.

Scores of other expiring tax breaks for middle-class and lower-income people could face challenges as well. Among them are a tax deduction for parents who pay college tuition, a tax deduction for schoolteachers who buy classroom supplies, and tax credits for hiring workers in areas of high unemployment.

As the competition to save endangered tax breaks grows more intense, survival is likely to go to the fittest.