Analyzing the Republican Stimulus Alternative

Almost on cue, the Republicans have produced a stimulus alternative like the one I suggested yesterday. This plan does everything I said needed to be done yesterday in order to position themselves as the fiscally conservative, tax cutters if and when Obama's stimulus plan falls short. While there are differences from what I asked for yesterday, the plan is nearly in line with what I called for not 24 hours ago. Here are some of the details... 1) a permanent 5% tax cut in all marginal income tax levels 2) cut the corporate tax rate from 35% to 25% 3) no extra spending and no earmarks 4) make the dividend and capital gains tax of 15% permanent 5) repeal the AMT permanently 6) repeal mandatory withdrawals from IRA's at 70 years of age 7) make all withdrawals from IRA's tax free in 2009.

Largely, I like most of these. I would have called for a mandatory freeze on all non essential government spending. This sends a much stronger message that the Republicans are serious about fiscal restraint. Also, I am not terribly comfortable with making all withdrawals from IRA's tax free. Such a move would put far too much stress on investment firms, many of which are already under stress. IRA management is a lucrative business and most of these firms aren't counting on such withdrawals since they currently come with serious taxes and penalties. If such withdrawals are only allowed for the purchase of a property, it would help stabilize the housing market while also not putting far too much stress on investment firms.

Still, this plan does exactly what I said yesterday such a plan would do. There's of course no way any but a few of these ideas will be law. That actually works in the favor of the Republicans. Come 2010, their hypothetical plan can be matched up against the reality of Obama's stimulus. As I said yesterday, even if his plan works eventually, it is nearly impossible that it will work by 2010. By then though, our deficit will balloon to as much as 2 trillion Dollars. The Republicans can hold out their alternative as a plan that would have maintained fiscal restraint while giving plenty of stimulus. Such rhetoric has a very good chance of working since there is no way to test their statements. Everything they say will be hypothetical. How can anyone say their plan wouldn't have worked? It wasn't tried.

As such, the Republicans have now set themselves up perfectly as the fiscally conservative, tax cutting alternative to the tax and spend liberalism of Obama. While Obama's plan polls well now, that's because it hasn't been tried yet. Once implemented, it will only be favored if it works. It will certainly balloon the deficit, and that gives the Republicans a ready made attack point. If we are still mired in any sort of economic upheavel, the Republicans can attack, attack, attack and hold up their own plan as the alternative that would have worked if tried. It will be hard to argue since it wasn't tried. This plan positions the Republicans perfectly for serious Legislative gains in 2010. Watch for this plan to become a major part of the 2010 campaign.

The Alternative Minimum Tax, Vague Loopholes, and Barack Obama

Last night, Barack Obama often referred to "closing loopholes" as a way to generate revenue for the government and making sure that fat cats and corporations pay their fair share. One thing missing from the rhetoric was a specific loophole and how he would close. I have always found demagoguery on loopholes troubling, without specifics, and that's because of the Alternative Minimum Tax.

Congress enacted the AMT in 1969 following testimony by the Secretary of the Treasury that 155 people with adjusted gross income above $200,000 had paid zero federal income tax on their 1967 tax returns. (See Appendix for the AMT’s legislative history.) In inflation-adjusted terms, those 1967 incomes would be roughly $1.17 million in today’s dollars.

This tax avoidance by a few high-income taxpayers was widely perceived as
unfair. Rather than directly addressing the problem by eliminating the
deductions and credits in the tax code that were leading to the tax avoidance,
Congress laid an additional layer of complexity over the regular income tax in
the form of the AMT.

In other words, 155 fat cats were using a LOOPHOLE to avoid paying taxes and Congress supposedly closed that loophole. What has transpired in the forty years since its creation is nothing short of a monster. In making sure that 155 fat cats did pay their taxes, Congress has since raised taxes on millions. In the last ten years, this pernicious tax has begun to affect millions of middle income earners. Because it was never set to inflation, this tax began to eat at them middle class. In fact, for the last two years, Congress has enacted a single year moratorium just to make sure 20 million more middle income folks aren't hit with this tax.


I am always weary of the demagoguing politician preaching against so called loopholes when they have no specifics. That's because I have seen with the AMT that the solution to closing a loophole is often much worse than the problem caused by the loophole itself. What's worse, letting 155 fat cats get away without paying taxes at all or hitting millions of middle income folks with an unexpected tax?

The word loophole is easy to rail against and that's because it carries with it such a negative connotation. Barack Obama acts as though corporations use accounting tricks to hide money. If that were really the case, he would have specifics. Often times, what Barack Obama refers to as a "loophole" is the disclosure of a legitimate expense that corporations should have every right to write off.


Politicians have been railing against loopholes for decades, and yet, I don't know of any that has ever actually successfully done anything to close what are illegitimate loopholes used squarely to avoid paying taxes. I know this because this continues to be a favorite tool of populist politicians. Barack Obama is just the latest to promise to "close loopholes", and the next time one calls for it, just remember the AMT, it closed one loophole and opened up an all new tax nightmare.

Rudy's New Tax Plan

Here is the press release from the Club for Growth about Rudy's new tax plan.

Club for Growth President Pat Toomey praised Mayor Rudy Giuliani’s new comprehensive tax reform and reduction plan, unveiled today in Florida, calling it “a bold and innovative proposal that will reward hard work, encourage investment, and promote economic growth for Americans across the economic spectrum.”

The Giuliani tax cut plan would extend the 2001 and 2003 tax cuts immediately; eliminate the Death Tax completely; lower the capital gains and dividends tax rate to 10% and index capital gains to inflation; lower the corporate tax rate from 35% to 25%; and permanently index the Alternative Minimum Tax to inflation with a plan for eventual elimination.

The Giuliani tax cut plan also contains a particularly bold pro-growth tax simplification strategy that would give taxpayers the option of opting into a simple tax plan in which their taxes could be done on one page. Instead of the current tax behemoth, the voluntary tax plan would constitute across the board cuts in marginal tax rates by proposing three simple rates of 10%, 15%, and 30%.

“Giuliani’s tax cut plan will encourage capital formation, and capital is the key driver of productivity, higher wages, and a better standard of living for all Americans,” Mr. Toomey continued. “He does that by not only lowering the capital gains and dividends rates, but also by indexing capital gains to inflation. Also, the Mayor’s plan dramatically lowers marginal tax rates at the personal and corporate level, which will encourage a significant burst of economic activity and growth.”

“The current U.S. tax code is a monstrosity of inefficiency and deterrence, with some of the highest corporate tax rates in the developed world and a tax code that totals more than 66,000 pages. Mayor Giuliani’s tax cut proposal today would dramatically move the American tax code and economy in the right direction. This is exactly the kind of plan economic conservatives should embrace.”

There are several things to add. First, when I saw Rudy, he said something interesting and illuminating about taxes. He saw taxes in two ways: productive and unproductive. He thought unproductive taxes were those that were high compared to other entities. When he was mayor, he compared his tax rates to other large cities in the U.S. As President, he will compare our tax rates to those of other civilized nations. He specifically mentioned corporate taxes which he intends to cut as an unproductive tax. He believes that when taxes are higher than most other places, it drives business and people away. On the other hand, those taxes that are right in the middle are productive.

It is also clear that the battle lines will be drawn come the general election between the Republicans who will defend the Bush tax cuts and point to them as the catalyst to a four year pro growth agenda and the Democrats who will blame the tax cuts for what they see as a faltering economy. (Here is my defense of the tax cuts.)

Simplification of the tax code is something that a lot of pols have promised and so far it hasn't been delivered. Rudy also touched upon the alternative minimum tax. I am also in favor of its elimination, however, I have already pointed out that merely eliminating it is not that simple. I don't know the specifics of Rudy's plan to eliminate AMT however it must account for the significant loss in revenue.

Finally, this endorsement of Rudy by CFG is not their first, here is how they described his economic management as mayor of New York.

"Mayor Giuliani's economic record is not perfect, but he deserves credit for the remarkable nature of his accomplishments," Club for Growth President Pat Toomey said. "In a city long accustomed to high taxes and ballooning budgets, Rudy Giuliani successfully cut taxes; kept spending below the growth of inflation and population; instituted sweeping welfare reform; privatized and deregulated many aspects of the city's bulky bureaucracy; and fought aggressively for school choice."

The white paper emphasizes the liberal context in which Giuliani was forced to govern. Although the Mayor took a number of anti-growth positions-such as his opposition to NAFTA, his support for McCain Feingold, and his opposition to several tax cuts-he used free-market, limited-government values to turn around a faltering economy in a political environment dominated by a left-wing City Council; public sector labor unions; social welfare activists; and an unfriendly media.

"Rudy Giuliani will still need to flesh out his positions on a number of federal issues, and we hope he will reconsider his few anti-growth positions," Mr. Toomey said. "But it is impossible to ignore Giuliani's overall commitment to a pro-growth philosophy and his executive talent for implementing that philosophy in a hostile political environment."

This plan should be music to the ears of all fiscal conservatives, a huge base for Reps. Rudy needs to get back in the game. Only time will tell if this plan gets him there.

The AMT: A Study in Opportunism, Cynicism, and Incompetence

Last week the Congress agreed to a one year moratorium on the alternative minimum tax...

Congress on Wednesday gave final approval to a plan that will spare millions of middle-class taxpayers higher tax bills for 2007. The White House welcomed the development and said President Bush would sign the bill.

The tax reprieve postpones for one year only an expansion of the alternative minimum tax, a parallel tax system enacted in 1969 to prevent very wealthy investors from using deductions and tax shelters to avoid paying income tax altogether. The alternative tax has ensnared a growing number of middle-class Americans in recent years because the 1969 law was not indexed to inflation.

Without the fix by Congress, some 25 million filers would have had to pay the tax on their 2007 income, up from four million who paid it on 2006 income, according to the White House.

Like with many things, the politicians didn't necessarily solve anything for the long term but rather punted responsibility for a year. While they may have created a one year moratorium, they haven't dealt with the fundamental difference in the two party's approach in confronting the AMT. Until that is dealt with, there is no long term solution to the AMT.

The AMT should be studied not only in accounting classes everywhere but also in political science classes because it is a case study in opportunism, cynicism and incompetence gone wild. This tax started merely as a means of closing a loophole so that 155 fat cats paid their fair share of taxes.

The AMT was introduced by the Tax Reform Act of 1969,[1] and became operative in 1970. It was intended to target 155 high-income households that had been eligible for so many tax benefits that they owed little or no income tax under the tax code of the time.[2]

The AMT is imposed under 26 U.S.C. § 55 and disallows many deductions and exemptions allowable in computing "regular" tax liability. (Regular tax liability is defined in 26 U.S.C. § 55(c)(1), with reference to 26 U.S.C. § 26(b), and does not include AMT and various other categories of taxes imposed under Chapter 1 of Subtitle A of the Internal Revenue Code.) The AMT sets a minimum tax rate of either 26% or 28% (depending on the amount of the taxpayer's "alternative minimum taxable income," as adjusted) on some taxpayers so that they cannot use certain types of deductions to lower their tax. By contrast, the rate for a corporation is 20%. Affected taxpayers are those who have what are known as "tax preference items". These include long-term capital gains, accelerated depreciation, certain medical expenses, percentage depletion, certain tax-exempt income, certain credits, personal exemptions, and the standard deduction.

The problem was that in their thirst to stick it to the wealthy Congress didn't dot every I and cross every T so to speak. What the AMT failed to do was account for inflation and soon these loopholes started to affect a lot more people than the really wealthy.

The AMT's lack of an indexation is widely conceded as a flaw across the political spectrum. In 2005, the Urban-Brookings Tax Policy Center and the Treasury Department estimated that around 15% of households with incomes between $75,000 and $100,000 must pay the AMT, up from only 2-3% in 2000, with the percentage increasing at high incomes.[citation needed] That percentage is set to increase quickly over the coming years if no change is made such as indexing for inflation. Currently, households with incomes below $75,000 are subject to the AMT only very rarely (and thus most tax advisors do not recommend computing AMT for such households). That is set to change in only a few years, however, if the AMT remains unindexed.

Of course, this isn't a problem that just came about in the last year. In fact, it has been looming for years. In 1999, it already affected one million people and the problem was exacerbated by the tax cuts of 2001.

...up from 1 million in 1999. This would make the AMT almost as common as the mortgage interest deduction is today. The AMT will be the de facto tax system for households with income between $100,000 and $500,000, 93 percent of whom will face the tax. It will encroach dramatically on the middle class, affecting 37 percent of households with income between $50,000 and $75,000 and 73 percent of households with income between $75,000 and $100,000 (compared to less than 3 percent for each group in 2002).

The expansion occurs because the AMT is not indexed for inflation and because of the 2001 tax cut. Because it is not adjusted for inflation, AMT liability tends to increase every year, even if real income does not change.

The problems with eliminating a tax almost everyone, including politicians, hates, is layered. First, despite never being meant as a tax for the masses, the Congress has become reliant on the AMT a serious source of revenue.

Repealing the AMT in 2005 would reduce revenues by $660 billion through 2014 if the 2001 tax cut expires as scheduled in 2010, and about $1,090 billion if the tax cut is extended. By 2008, it would cost more to repeal the AMT than to zero out the regular income tax. More than 75 percent of the benefits of repeal would go to households with income above $100,000 in 2010.

Thus, merely eliminating isn't as simple as it may seem. Neither side has stepped up with any reasonable solution. According to the activist web site, Reform AMT, there are roughly twenty different bills currently in one stage or another to deal with the alternative minimum tax. The Democrats version of fiscal responsibility is eliminating this insidious tax and replacing it with other taxes that are also meant only to target the rich. This is highlighted with a plan lead by Charlie Rangel. In his plan, Rangel goes after the wealthy demon du jour, private equity firms, as his main target.

Well, we haven't really concluded exactly how we're going to do it. There's some discussion as to, if there are people that are operating equitable funds and they do a good job, why should one group get taxed at a rate of 15 percent as capital gains when they've made no investment and another firm get paid at ordinary income?

Another thing that we're looking at is that we have the ability to have people who get large sums of money for pension funds to have this taken to tax havens overseas, and there's no tax consequence of it for them. Billions of dollars are lost with all of these tax schemes.

It is both surreal and absurd to watch a politician eliminate one tax that was originally meant to target only the wealthy with a series of others that they now again claim will only target the wealthy. Remember, the AMT was originally meant to close another loophole so that other fat cats couldn't take advantage of other supposed tax havens. The exact same language that Rangel is using now was used back then to sell the AMT on the public. Here is the language LBJ used when selling the AMT in its original format.

to embrace a conception of tax reform consisting in closing revenue leaks and erosion of the tax base concomitant to the many preferences that had crept into the tax code

Despite the obvious failings of the AMT, Rangel is now using much the same language to the target many of the same type of new taxes in order to eliminate the AMT.

The Republicans, on the other hand, see fiscal responsibility as the elimination of the AMT, and its hundreds of billions of dollars worth of revenues, and increasing spending at the same time. The Republican's plan is highlighted by a propsoal by Paul Ryan.

But the proposal also underscored why it will be so challenging for lawmakers to reach common ground on a permanent solution to this particular tax and budget dilemma.

The Ryan plan pointedly provides nothing to replace the estimated $840 billion in tax revenue that would be lost over 10 years with the abolition of the AMT, as it's known.

Meanwhile, neither side dares to decrease spending which would actually be the fiscally responsible thing to do when such a huge source of revenue is eliminated. The latest omnibus spending bill has 9170 earmarks.

Yet, the 2008 omnibus spending bill contains 9,170 earmarks in the 2008 omnibus spending bill. This total, in addition to the 2,161 earmarks in the 2008 defense spending bill (none of which were requested by the Pentagon), bring this year's earmark total to 11,331 earmarks for 2008, a mere 16 percent reduction compared to OMB's baseline of 13,492 earmarks in 2005. (Note: all earmark estimates exclude earmarks requested by the White House.) See Sen. Coburn's site for more details...

with such notable spending items as: Rodent control in Alaska ($113,000)Olive fruit fly research in France ($213,000)Hunting and Fishing Museum in Pennsylvania ($200,000)Louis Armstrong Museum in New York ($150,000)A bike trail in Minnesota ($700,000)A river walk in Massachusetts ($1,000,000)A post office museum in downtown Las Vegas ($200,000); andThe Lincoln Park Zoo in Illinois ($37,000).

The problem here is also more complicated than one would think. The sort of spending cuts necessary to be fiscally responsible in dealing with the elimination of such a huge source of income are impossible in this climate, in my opinion. That's because I believe that spending has become a tool of horse trading among legislators, and most of the spending has been promised as payback for support on some measure or another. I can't see Congress tightening its belt properly to deal with the reduction in revenue from the AMT because that would mean eliminating spending promised for votes.

Thus, here we are. The Congress has kicked the can on the AMT for one more year. A tax that was originally meant only for 155 people has now become so vital that it can't merely be eliminated. One side wants to eliminate and replace it with several other new taxes eerily similar to the AMT itself, and the other side wants to eliminate and spend some more. Thus, a tax that was created in an opportunistic, cynical and incompetent manner is being dealt with just the same.

The AMT and the Lessons of Taxation and Class Warfare

In 1969, in order to make sure that about 100 fat cats paid their fair share Congress created the Alternative Minimum Tax...

In August 1969 as he was preparing the next year's budget Barr warned that the country faced a taxpayers' revolt. He explained, according to the Washington Post, that in 1967 there were a total of 155 individuals with incomes over $200,000 who did not pay any federal income taxes; twenty of them were millionaires. These individuals successfully used all tax loopholes available to legally evade paying taxes. The revelation attracted wide media attention and led to public shock. As he presented the next annual budget, published in the final weeks of his administration, President Johnson indicated that the problem needed to be addressed...

Unfortunately what started as a tax against fat cats has now begun to affect a large majority of Americans.

For more than three decades, the individual income tax has consisted of two parallel tax systems: the regular tax and an alternative tax that was originally intended to impose taxes on high-income individuals who have no liability under the regular income tax. The stated purpose of the alternative minimum tax (AMT) is to keep taxpayers with high incomes from paying little or no income tax by taking advantage of various preferences in the tax code. The AMT does so by requiring people to recalculate their taxes under alternative rules that include certain forms of income exempt from regular tax and that do not allow specific exemptions, deductions, and other preferences. For most of its existence, the AMT has affected few taxpayers, less than 1 percent in any year before 2000, but its impact is expected to grow rapidly in coming years and affect about one-fifth of all taxpayers in 2010.

In her 2003 report to the Congress, the Internal Revenue Service's National Taxpayer Advocate, Nina Olson, labeled the AMT "the most serious problem faced
by taxpayers."(1)The evolution of the AMT from going after 155 fat cats to one that will hit ten million people if it isn't dealt with is a great example how taxes often morph into something totally from its initial purpose and should be a lesson to all politicians about the dangers of using taxes as a means of fighting class warfare.

Unfortunately, many politicians continue to use taxes as a means of fighting class warfare in hopes of finding themselves on the same side of the table with the majority of Americans against the wealthy. For instance, here is how Hillary Clinton feels about the estate or death tax.“

I am more focused on preventing the repeal of the estate tax and returning to what I think are fairer, more effective tax rates for the wealthiest. There may be an argument to be made, which I would be open to but I think you need to look at the entire tax picture. There isn’t any credible argument that the taxes under the Bush administration have gone down disproportionately on high-income investors and earners.”

So what is the so called death tax and why should everyone be concerned when a politician uses it as a means of class warfare?

The estate tax is technically a tax on the transfer of property to others, generally to children of a decedent. It was envisioned to prevent families from passing on huge fortunes and developing a type of royalty in America.

Once again, we have a tax created to make sure that we punish the fat cats. This time they are actually taxed in death. Unfortunately, while the tax death does punish the fat cats it also punishes another class: the savers. Here is a chart of the bottom line levels of an estate's value before it is taxed. For instance, in 2002, any estate worth one million dollars and more would have been taxed. Keep in mind that an estate is everything you own including your home. It is also any retirement that you may have saved up. Let's suppose you saved $100 per month for 40 years and earned an average of 12% on that money. That savings would grow to just over one million dollars after forty years. Someone saving 100 dollars a month is no fat cat and yet they would likely be affected by the estate tax.

Let's look at another tax used by many politicians as a tool in class warfare: the capital gains tax.

A capital gains tax (abbreviated: CGT) is a tax charged on capital gains, the profit realized on the sale of an asset that was purchased at a lower price. The most common capital gains are realized from the sale of stocks, bonds, precious metals and property. Not all countries implement a capital gains tax and most have different rates of taxation for individuals and corporations

.Here is what Barack Obama would like to do to the capital gains tax.

As part of his "Tax Fairness for the Middle Class" plan, Barack Obama is in favor of nearly doubling the capital-gains tax rate from 15 percent to 28 percent. Leaving the fairness issue aside for a moment—as well as the impact of higher taxes on economic growth—the Obama plan could also be called a "Ways in Which Government Can Collect More Taxes to Pay for New Spending" plan, since Democratic candidates are all scrambling to figure out ways to plausibly pay for new healthcare, education, and infrastructure spending if elected.

Keep in mind that the capital gains tax taxes an gain in any long term investment including stocks and real estate. So, what percentage of American households currently own stocks?

Dramatically more Americans own financial assets now than in the recent past. As recently as 1980, only 4.6 million U.S. households owned mutual funds; by 2003 the number was 53.3 million.More than half of American families currently own stocks, bonds or real estate. Nearly half of all U.S. households own stocks or stock mutual funds.

So, when Barack Obama promises to raise the capital gains tax to make the tax system more fair he is actually promising to raise taxes on more than half of American households and growing.Another way in which politicians use taxes as class warfare is through the nebulous word: loophole.
Whether its John Edwards, Barack Obama, orHillary Clinton, the word loophole is used as another tool in fighting class warfare.

Every day, millions of working Americans go to their jobs, play by the rules and hope to make a decent living for themselves and their families. These workers strengthen our middle class and keep oureconomy going. In turn, the vast majority of American employers holdup their end of the bargain by treating their employees fairly.But sadly, many working men and women are not being treated fairly because some businesses are using a little-known tax loophole to avoid paying their fair share. It's workers and American taxpayers who paythe price.

...New York Sen. Hillary Clinton, the front-running Democratic presidential candidate, on Friday urged closing a tax loophole that she said unfairly benefits a few top Wall Street financiers.Clinton called the loophole a "glaring inequity" and joined other lawmakers in a push to raise the tax rate on "carried interest" gains made by senior partners in the booming private equity and hedge fund businesses.

...Sen. John Edwards, D-N.C., told crowds Thursday in Des Moines, Iowa, that he would pay for new programs to benefit the middle class by closing loopholes and tax breaks now benefiting the wealthiest Americans.Remember, the Alternative Minimum Tax itself was created to supposedly close a tax loophole that was also supposed to affect only the wealthiest Americans.

A tax increase speaks for itself. (res ipsa loquitur) The problem is that many a politician have used tax increases as some sort of tool to appeal to emotions. We have a country of nearly half a billion people and at any given time there are millions who are less successful than they would like to be. Those millions can almost always be quantified by someone and put into percentages. The unsuccessful almost always have a resentment toward those at the top. Politicians see opportunities in appealing to such emotions. By increasing taxes that they see as primarily applying to the successful, they seek to score points with the masses who are largely less successful. Unfortunately, the reality of tax policy is almost never in line with the perception that is created by politicians.

Whether it is the AMT, the capital gains tax, the estate tax, or the nebulous tax loopholes, these, like most taxes, almost always end working the same: by affecting the majority of people.