Tax VOX

In this July 2002 cartoon, the famous painting, "The Scream" by Edvard Munch has been renamed "The 401 (k)" as workers see their pensions diminish as stock markets plunge. A new study finds that auto-enrolling in a 401(k) program could also diminish your savings. (Clay Bennett / The Christian Science Monitor / File)

Why auto-enroll 401(k)'s could reduce your savings

By Howard Gleckman, Guest blogger / 06.30.10

For the past decade, policymakers and pension experts have encouraged employers to increase worker participation in 401(k) plans by automatically enrolling their employees in these retirement programs. And it works. One study concludes that participation among new hires nearly doubles—from less than half to nearly 90 percent—when workers are auto-enrolled.

But important new research by the IMF's Mauricio Soto and Urban Institute’s Barbara Butrica finds there may be a downside: While more employees enroll thanks to the opt-out design, their employers are likely to match less of their contributions. And that might actually reduce the level of overall pension contributions for some workers. No good deed, as they say, goes unpunished.

In many ways, auto-enrollment makes a lot of sense. Because inertia is so powerful, new workers often don’t bother to fill out the paperwork to participate in 401(k)s. But if their employers sign them up, few workers take the trouble to disenroll even though they are allowed to do so. The 2006 Pension Protection Act as well as 2009 Internal Revenue Service regs are intended to further encourage employers to auto-enroll their workers.

The idea was catching on even before those policy changes. The percentage of 401(k) plans with auto enrollment boomed from just 4.2 percent in 1999 to almost one-quarter in 2006. More than 40 percent of firms with 5,000 or more employees automatically enroll their workers. Employers typically match 50 cents for every dollar their workers contribute, up to 6 percent of salary. And, according to a 2006 survey, half of firms said their main reason for offering auto enrollment was to encourage retirement savings.

But Mauricio and Barbara found that employer match rates are about 7 percentage points lower for opt-out plans. They can’t say for sure whether auto enrollment causes lower match rates. But it sure is possible. After all, if more employees participate, their employers will have to spend more to match their contributions. Whatever the cause, it seems that while auto-enrollment may increase the number of workers with 401(k)s, it won't necessarily boost their retirement savings.

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Real estate agent Sheila Power stands at the door as she holds an open house at a home for sale in Silver Spring, Maryland on May 23. The new homes market collapsed in May with the end of the homebuyers tax credit on April 30. (Jonathan Ernst/Reuters)

The homebuyers credit: Is it better to laugh or cry?

By Howard Gleckman, Guest blogger / 06.28.10

For two years, the homebuyer credit has been in the running for Washington’s worst tax policy idea. Now, new evidence about this bit of legislative bilge suggests it may be time to retire the trophy.

The Commerce Department reports the new homes market collapsed in May after booming in March and April (chart). Why? Well, in early spring, in response to an intense marketing campaign by the real estate and mortgage industries, tens of thousands of buyers accelerated home purchases to take advantage of this sweet tax give-away (as much as $8,000 for some buyers) before the credit expired on April 30. Then, just as most sentient economists predicted, the market dried up. Actually, it didn’t just dry up. It became the Death Valley of housing.

Monthly new home sales (which are seasonally adjusted) had been running about 350,000 in early 2010. As buzz about the credit heated up, purchases spiked to about 390,000 in March and to 450,000 in April. Then, the credit disappeared and so did the buyers. Sales in Mayplunged to 300,000, the lowest level in four decades.

As the chart shows, this was--entirely unsurprisingly--exactly the same pattern we saw when the credit was first scheduled to expire at the end of 2009: A big run up in sales in October and November followed by a sharp decline thereafter.

Total amount of permanent job creation from this timing change: pretty close to zero. Cost to taxpayers: $12.6 billion just through last February—even before the latest buying frenzy. What a deal!

As my Tax Policy Center colleague Ted Gayer has been warning, at least 85 percent of those buyers would likely have purchased a home anyway. For them, the credit was a pure gift--courtesy of a government running a $1.4 trillion deficit.

But that’s not all. Yesterday, the Treasury Department’s inspector general issued its second report on homebuyer credit fraud. And the scams are worthy of a Carl Hiasson novel. Among the lowlights: 1,295 prisoners received $9.1 million in credits for houses they claimed to buy while incarcerated. Two hundred forty-one were serving life sentences at the time. Hiasson—the bard of two-bit Florida hustlers-- will be pleased to learn that almost two-thirds of these frauds occurred in his home state, where ripping off federal taxpayers appears to be about as common as shuffleboard.

And it wasn’t just cons running the hustle. Sixty-seven different people claimed the tax break for one house. More than 2,500 got almost $18 million for homes they bought before the credit was effective. In all, the IG unearthed 14,132 people who received erroneous credits of $17.6 million.

The hardest bit to swallow is not so much that the homebuyer tax credit is a boondoggle. It is that it was a totally predictable waste of money. Economists warned Congress in 2008 that the credit would do little more than shift timing decisions by a few months. But lawmakers ignored the advice again and again. Remarkably, the Senate may be about to give buyers still more time to close on homes they put contracts on before April 30. That way, they can squeeze the last few dollars out of a failed credit.

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House Speaker Nancy Pelosi of Calif., accompanied by House Majority Leader Steny Hoyer of Md., left, during a news conference on Capitol Hill on March 17 for the signing of the jobs bill. The $80 billion jobs bill stalled in the Senate last week. (Harry Hamburg/AP/File)

A no-jobs jobs bill?

By Howard Gleckman, Guest blogger / 06.22.10

Congress' effort to pass a jobs bill stalled in the Senate on Wednesday. In part, the upper chamber tied itself into Senate-like knots thanks to the usual partisan wrangling. But the proposal has also rekindled a debate over the need for more economic stimulus versus fear of rising deficits. This argument is important and healthy, but wildly overblown in the context of such a small and poorly-targeted bill.

In one corner are those liberals who argue that failure to pass this measure will send the economy spiraling into a catastrophic double-dip recession. This, they say, is what happened in the mid-1930s, when Congress tightened fiscal policy and a nascent post-Depression expansion collapsed. Don’t worry about deficits, the progressives say. There is no inflation. Treasury bond rates are at historic lows. Create jobs and stabilize the recovery, and the budget will take care of itself.

By contrast, fiscal hawks say this bill, on top of President Obama’s earlier $862 billion stimulus, is the last straw. We cannot continue to spend money we do not have without turning ourselves into Greece. And while Treasury rates may be low now, the day may come when investors lose their enthusiasm for our bonds. The economy, they say, has grown smartly for three consecutive quarters and there is no need to make an already $1.4 trillion deficit any worse.

So we invent the following bumper-sticker debate: Oppose this stimulus and you are a jobs-killing, tea party-loving, myopic deficit hawk. Support it and you are an irresponsible big spender. Both claims are fairly silly. Here’s why:

First, the bill's short-term $80 billion price tag is loose change, at least by Washington standards. It is one-tenth the size of Obama’s 2009 stimulus. And in a $14 trillion economy, its impact on the overall economy is hardly measurable. Similarly, adding another $80 billion in one-time initiatives (assuming they are one-time) to a $1.4 trillion deficit is hardly going to waken a complacent bond market.

But the argument over the total cost completely misses the real question: Will the subsidies and incentives in this bill create jobs? It is not the size that matters, but how the dollars are spent. And here, there is a strong case to be made that a lot of this bill is money wasted.

Start with the roughly $32 billion in expiring tax provisions (aka the extenders) that the bill would continue for another year (or in a few cases two). Some of my favorites: $46 million in tax subsidies for movie producers and $38 million for NASCAR racetrack owners. As I have written in the past, most of these highly targeted subsidies will do little or nothing to create new jobs. They will, however, provide a financial windfall to their recipients. The other day, Bob Bixby of the Concord Coalition had a suggestion: Kill the Extenders. That's not a bad idea.

The bill also would spend about $6 billion to delay a big cut in Medicare physician payments for another six months. Congress had been putting off the day of reckoning on this issue for 13 years. Yes, 13 years. Cutting doctors’ pay by 21 percent (which would happen in the absence of this bill) is absurd. But kicking this can down the road yet again has nothing at all to do with boosting the economy.

A handful of proposals may create--or at least save--some jobs. For instance, a measure to help states pay teachers (which may or many not end up in the final bill) would prevent some layoffs, although how many is a matter of great dispute. But most provisions could die, or be paid for, without doing any damage to the economy. It is fair to debate whether the economy needs another fiscal jolt. But for better or worse you won’t find much real stimulus in this bill.

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A father and his son hold onto a pole as they ride the Washington Metro in Washington, DC in this September 2007 file photo. The Metro relies on a system of congestion pricing, charging people more during rush hour peaks. (Andy Nelson/ The Christian Science Monitor/File)

What lawmakers can learn from the DC Metro system's fare schedule

By Howard Gleckman, Guest blogger / 06.15.10

I use the Washington subway—the Metro—to commute from my home in the D.C. suburbs to my downtown office. The system has just approved a $109 million fare increase. But, in a tour de force of obfuscation, it has designed the hike so that few riders will have any idea what a given trip will cost.

This is, in part, a result of Metro’s effort to tie fares to demand. Thus, folks who ride at rush hour or use the busiest stations will pay more than those who do not. Economists love this idea.

But Metro has taken to slicing its pricing system like the local deli guy carves corned beef. There are regular fares (Metro calls them “reduced”), rush hour fares (Metro calls them “regular”), peak of the peak fares, surcharges for traveling through certain stations, and fare differentials for those who pay with cash and those who use those plastic SmarTrip cards. Best I can tell, this means I could pay as little as $2.15 or as much as $4.20 for my ride to work.

Someone who makes my commute each day could face an annual fare increase of more than $1,000. But because most of us pay with those plastic cards, which we refill regularly with a credit card, Metro is betting we won’t fully recognize this painfully steep hike.

Unlike demand pricing, economists don’t like this at all. In general, it is better that we know what we pay for something. This consumer awareness of price (salience in econo-speak) helps us buy smarter. But if we don’t know the real cost of something, we are likely to overpay. See, for example, health care.

A couple of years ago, MIT economist Amy Finkelstein looked at those highway E-Z passes, where drivers have their tolls deducted from a pre-paid card as they roll through toll booths. Amy’s conclusion: the levies are 20 percent to 40 percent higher than they'd be if people were still throwing quarters into baskets. Sweet, if you are the highway authority. Not so so much if you are a driver who worries more about cost than time.

It has been obvious to us regular riders that Metro is desperately short of money. While it was built with federal tax dollars (thank you all for that, btw) Metro relies heavily on fares to meet its operating budget. Remarkably, Metro has no other dedicated funding source so it must go, tin cup in hand, to local jurisdictions for help paying its bills. The entirely unsurprising result: Metro is falling apart.

In town meetings, riders overwhelmingly preferred fare hikes to service cuts. And making people pay more when trains are most crowded probably makes sense. It may encourage some commuters to adjust hours, thus reducing pressure on Metro to buy more equipment and hire more staff to meet peak demand. But while opaque fares may generate more revenue, the transit system may lose the benefit of congestion pricing if riders don't know how much they are paying.

Tax policymakers would do well to keep this all in mind, especially as they think about levies such as a Value Added Tax. In the meantime, I suppose somebody will write a smart phone app to help me figure out my Metro fare.

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In this April 15 file photo, a woman wears tea bags hanging from her hat as she attends a tea party rally in New Jersey. (Mel Evans/AP Photo/ File)

The tea party: smaller government, but more red ink

By Howard Gleckman, Guest blogger / 06.14.10

Treasury Secretary Tim Geithner, among others, thinks the tea party movement might help drive deficit reduction. I disagree. I don’t believe most tea party leaders or candidates are remotely interested in slowing the flow of federal red ink.

They are plainly interested in tax cuts—a core belief that appears repeatedly on Websites, position papers, and speeches throughout the movement. And while tea partiers say they favor smaller government, many in fact propose to shrink it in only trivial ways—by cutting earmarks or waste and abuse. Candidates elected on platforms supporting very large tax cuts and small spending reductions are likely to oppose aggressive efforts to reduce deficits, not back them. While some analysts see the tea partiers as the 21st century progeny of Ross Perot’s fiscal conservatism, nothing could be further from the truth.

Of course, it isn’t easy to sort out their views. The tea party is many organizations and individuals attracted to a loose ideology of conservative populism. They loathe taxes and President Obama with equal fervor, but otherwise agree on little. Yet, according to an April CBS News poll of self-described tea party supporters, nearly half say their main goal is to reduce the role of the federal government. Only 6 percent say it is to cut the deficit. And as tea party candidates begin to win Republican primaries the outlines of the movement’s agenda is coming clearer.

Two national organizations provide logistical and financial support to this faction: The Club for Growth and Freedom Works, the creation of former House GOP leader Dick Armey and others. Their goals are similar: low taxes, Social Security private accounts, free trade, and reduced government spending. The Club for Growth, whose Political Action Committee gets much of its funding from the financial world, would eliminate taxes on capital (an interesting view for a populist movement) and replace the current income tax with a flat tax. Deficit reduction, however, is of little interest to either organization.

It is the same with many tea party candidates. Pennsylvania GOP Senate nominee Pat Toomey opposes what he calls a “dangerous spending spree” in Washington and favors lower taxes on both income and capital. Reducing the deficit, however, gets barely a mention on his Website. Toomey, who once served as president of the Club for Growth, does remind voters, however, that he “never voted for a tax increase.”

Sharron Angle, a tea partier likely to win today’s GOP nomination to challenge Senate Democratic leader Harry Reid for his Nevada Senate seat, holds similar views. Angle says she’d abolish the Internal Revenue Code but doesn’t quite say how she’d finance government. While she’d repeal Obama’s health reform, including its insurance subsidies for people under 65, she’d protect current retirees from cuts in Medicare and praises the government-run insurance program for veterans and their families.

Her ambivalence on health care mirrors that of many rank-and-file tea party supporters. One-third are 65 and older and many would exempt Medicare from their vision of smaller government. This view makes deficit reduction a challenge at best, especially when paired with big tax cuts.

Rand Paul, the tea partier who won the GOP Senate nomination in Kentucky, is a rare candidate who seems to give equal weight to balancing the budget and cutting taxes.

But for the most part, these candidates and their tea party backers have been quite clear. Deficit reduction, as opposed to tax cuts, is far down their Hit Parade. To borrow a phrase, I knew Ross Perot and these people are no Ross Perot.

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European Commission President Jose Manuel Barroso addresses a news conference at the EU Commission headquarters in Brussels on June 2. Barroso said he favored a tax on financial transactions or bank profits. A bank tax is being considered in the US as well as Europe, but how, or whether, it could work is being debated. (Francois Lenoir/Reuters)

Does a bank tax make sense?

By Howard Gleckman, Guest blogger / 06.04.10

The temptation to raise taxes on financial institutions is almost too great to resist. These institutions were largely responsible for the recent economic crisis. While the financial collapse cost millions of Americans their livelihoods, many top bank executives happily took their bonuses (in some cases paid with taxpayer money). And the arrogance and sense of entitlement that oozes from some is beyond offensive.

But besides making the rest of us feel better and perhaps providing a fiscal windfall for deficit-strapped politicians, would a tax on financial institutions benefit society? And if so, what form should it take? These are question being asked not only in the U.S. but by much of Europe as well. The answers, sadly, are not so clear cut.

Three of the nation’s top tax experts—Doug Shackelford, Dan Shaviro, and Joel Slemrod—have put their heads to together to try to sort it all out. They didn’t find the ideal tax, but they have developed a useful way to think about bank taxes. Their paper is a useful follow-up to a recent speech by Minneapolis Fed President Narayana Kocherlokota.

Their first question: What is the purpose of a bank tax? Is it to raise money (to reduce deficits, support a bailout fund, or pay for new spending or other tax cuts?) Is it to punish the institutions and their managers for past sins? Is it to prevent future financial madness? Or is it some combination of all three? Not surprisingly, different taxes achieve different results that often conflict with one another.

A second question: Who actually pays the tax? For example, a bank tax might hurt those who hold shares in the institution at the time the tax is announced (since it will drive down its stock price). But those investors may not have owned shares when the bank wandered into the derivatives market, so what does it accomplish to punish them?

Alternatively such a tax might be paid by depositors in the form of higher fees or lower interest rates. That’s not likely to convince banks to change their behavior. In some tax regimes, however, depositors might earn a bit more interest in return for providing banks an untaxed source of capital.

They also remind us that a “bank” tax should be designed as broadly as possible, and not on specific transactions (derivatives, for instance) or on specific institutions (banks, for instance). Targeting only encourages the institutions to redefine both themselves and their transactions to dodge the tax. Similarly, any tax should be tied as closely as possible to levies imposed by other countries to limit the ability of banks to locate in low-tax jurisdictions.

Finally, keep in mind that these taxes must somehow mesh with a new and complex set of financial regulations that Congress will soon pass.

With these and similar unpleasant truths in mind, the authors look at a financial transactions tax, a tax on bonuses, and two bank taxes—an excess profits tax and a financial activities tax. Here are their conclusions:

Financial Transactions Tax: A low tax rate on a very broad base—zillions of trades— has the potential to raise lots of money. But there is little evidence that increasing the cost of transactions improves markets.

Bonus Tax: A one-time tax on past bonuses would be a pretty blunt instrument, punishing both sinners and saints. A tax on future bonuses begs for avoidance.

Taxes on financial institutions: The devil here is in the details. President Obama proposed one and other countries are exploring their own versions. Taxing uninsured liabilities of big institutions could discourage risky investments. But the authors are skeptical about an Obama-like plan to use the revenue to finance a bank bailout fund and then cap the tax once the pot is full. However, they figure taxing profits and compensation that exceed some "normal" amount, as the IMF would through a Financial Activities Tax, might be even less useful. I’ll talk about these ideas in more detail in a future post.

Whether you agree with Dan, Doug, and Joel’s assessments of these specific taxes, take a look at their paper. It is a useful guidebook as you travel through some exceedingly unfamiliar and potentially dangerous territory.

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A sign announces an open house for a home for sale on May 23. The home mortgage interest deduction is meant to encourage home ownership, but will cost the federal government $131billion in 2012. Economists question whether the deduction is effective and worth maintaining as the US faces a growing deficit. (Jonathan Ernst/Reuters)

Should we eliminate the home mortgage interest deduction?

By Howard Gleckman, Guest blogger / 06.02.10

Do we want to use the tax code to subsidize home ownership? And, if we do, is the mortgage interest deduction the best way to do it? A new paper by my Tax Policy Center colleagues Eric Toder and Katherine Lim, along with Urban Institute researchers Margery Turner and Liza Getsinger, asks these provocative questions, and comes up with some surprising answers.

To even ask seems almost un-American—almost like suggesting we replace barbeque at the Memorial Day picnic with, oh, tofu. But a close look suggests there is much less to the hallowed deduction than meets the eye. Thus, we’d miss it much less than we think.

In 2012, the deduction will reduce federal revenues by $131 billion. In contrast, the entire budget for the Department of Housing and Urban Development is just $48 billion. The conventional wisdom says these tax breaks are important because A) they increase home ownership and B) homeowners are more engaged in their communities than renters.

It turns out that neither of these assumptions is necessarily true. For instance, for a half century--until the recent real estate boom and bust--home ownership rates in the U.S. have barely budged even though the value of the deduction has fluctuated widely. Similarly, there is no clear connection between home ownership and the availability of mortgage deductions in other countries.

The exact relationship between home ownership and other social benefits is just as uncertain. We know home owners are more connected to their communities than renters. But is that because they own a house, or is it merely that the same types of people who are engaged in their communities are also prone to home ownership? We don’t really know.

We do know, however, that the deduction is not a very efficient way to encourage home ownership. Most benefits go to high-income households that would probably buy a house with or without the deduction. Since non-itemizers get no benefit from the deduction, it is not surprising that most of the subsidy goes to upper-bracket taxpayers.

So is there a better way? The paper looks at a half-dozen alternatives, from eliminating the mortgage subsidy entirely to capping its value or turning it into a credit. Not surprisingly, each design has its own set of winners and losers.

To take one example: If the goal is to encourage homeownership among people who otherwise would not buy, what if we replaced the deduction with a credit? Remember that credits are usually a better deal for middle-income households. Simple example: A 20 percent credit on $1,000 of interest is worth $200 no matter what your tax bracket or whether you itemize. But a $1,000 deduction is worth $350 to someone in the 35 percent bracket but only $100 to an itemizer in the 10 percent bracket, and nothing to someone who takes the standard deduction ).

The paper looks at four different credits, each of which provides the same total subsidy amount as the current deduction. For instance, replacing the deduction with a non-refundable credit equal to 20 percent of interest payments would raise average after-tax incomes for households in the lowest 80 percent of the income distribution, with middle-income households getting the biggest average benefit. However, on average those in the top 20 percent would do less well with the credit than with today’s deduction. A non-refundable 100% credit capped at about $2,000 would benefit middle-income households even more but raise taxes more for people in the top 20 percent.

Sadly, the study also explains why the deduction is likely to stay right where it is. The big winners under the current system are upper-middle-class suburbanites who disproportionately own homes, itemize deductions, and spend a relatively large share of their income on mortgage interest. And nobody wants to get them mad, either by cutting their housing subsidies or feeding them tofu.

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Sen. Charlie Huggins, left, and Senate Finance Co-Chair Bert Stedman listen to testimony during the Senate Finance committee hearing on the proposed reduction to the cruise ship head tax in Juneau, Alaska on April 14. A new bill meant to curb special interest tax breaks does anything but. (Chris Miller/AP/File)

New bill extends special interest tax breaks

By Howard Gleckman, Guest blogger / 05.26.10

I wasn’t going to write about Congress’ latest effort to continue scores of soon-to-expire special interest tax breaks. But there is something about the joint Ways & Means/ Senate Finance Committee bill’s Orwellian title: “The American Jobs and Closing Tax Loopholes Act" (AJACTLA) that makes it impossible to ignore.

It isn’t just the fingernails-on-the-blackboard grammar that drives me crazy. It’s the idea that a bill that would do so little to create jobs or close loopholes—and would in reality continue so many special interest tax breaks—would be so hideously mislabeled. The bill would extend, count ‘em, 70 expiring subsidies at a cost of $28.5 billion over the next two years. There is little or no evidence that any of these goodies have ever created jobs, and thus it is unreasonable to believe they will produce any in the future—or that their long-postponed deaths would cost jobs.

To be sure, the bill includes many other proposals, including yet another delay in a scheduled Medicare payment cut for doctors and another $24 billion in extra federal Medicaid assistance to states. But to keep it simple, let's focus on the expiring tax breaks.

It is, for instance, hard to see how continuing to allow generous tax depreciation for NASCAR racetracks will create many jobs. It is easier, however, to imagine how this will continue a windfall for the track owners. It is similarly hard to see how the national economy benefits from special tax-exempt bonds for investments in New York City’s “liberty zone.” Good for developers and contractors doing work in lower Manhattan, as well as investment bankers and bond lawyers. Not so good for developers trying to build projects just outside the specially-designated zone.

A word about the cost of all this: The Joint Committee on Taxation estimates that extending the expiring provisions would reduce federal revenues by $32.5 billion over 10 years. But keep in mind these tax subsidies would all expire—on paper at least—over just a year or two. A more accurate 10-year estimate of the revenue loss (assuming the tax breaks eventually are continued throughout the decade) would likely approach $200 billion.

Lawmakers get some credit for at least nodding to the idea of having to pay for extending these tax breaks. This is a change, especially for the Finance Committee that until now has rejected even this modest bit of fiscal responsibility out of hand. Most of the revenue-raising proposals fall into three categories: Investment fund managers would have to pay tax at ordinary income rates, rather than capital gains rates, for income they receive as carried interest; self-employed people would no longer be able to avoid Social Security and Medicare taxes by routing income through S corporations; and U.S. corporations would lose some tax breaks on income they earn overseas.

But while nearly all of the cost of extending the 70 expiring provisions occurs in 2010 and 2011, 90 percent of the revenue to pay for these goodies would not be collected until 2012 and beyond. It isn’t hard to imagine that much of this money will never materialize, either because the law will be changed or because very smart lawyers will figure ways around it. The overall bill, including the new spending, would add about $140 billion to the deficit.

It is hard to be too cynical about tax extenders that have reached a state of near-immortality. But the least Congress could do is to call this annual rite what it is: Continuing tax loopholes, not closing them.

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Demonstrators gather at the Greek Parliament in front of riot police in Athens on May 20. In order to avoid a Greek-like crisis the US must reduce spending and increase revenues. One way congress can do this is with the a simplified Alternative Minimum Tax. (Petros Giannakouris/AP)

One step Congress can take to avoid bringing Greece's fiscal problems home

By Ben Harris, Guest blogger / 05.24.10

To avoid Greece-like fiscal woes, Congress needs to raise more revenue and cut spending. A value-added tax or a tax on carbon make economic sense, but implementing either could take years. Broadening the income tax base seems politically unrealistic, and Congress already upped tax rates to pay for the health care bill. One option for more revenue is a simplified Alternative Minimum Tax (AMT).

The current AMT isn’t a minimum tax at all; it’s simply a parallel tax. Relative to the regular income tax, the AMT is a mostly flat rate applied to a different tax base with a large standard deduction. The result is that about 4 million upper-middle income taxpayers, often with children and living in high-tax states, pay more under this parallel tax system.

Congress could improve the current system by creating a true "minimum tax": Adjusted-gross income (AGI) above a certain threshold—perhaps the $200,000 for single filers and $250,000 for married filers that President Obama favors—would be subject to a minimum tax rate. High-income taxpayers would lose the benefits of various deductions and credits if their average tax bill on AGI above the threshold fell below the minimum rate.

This plan would raise a substantial amount of revenue relative to current tax policy. Setting the minimum tax rate at 15 percent on AGI above the President’s high-income threshold (annually adjusted for inflation) would raise $165 billion over 10 years—roughly the amount the estate tax raises under current law. A 20 percent minimum tax rate would nearly triple the revenue gain to $480 billion, while a 25 percent rate would bring in five times as much—$832 billion. That’s real money. Congress could raise even more by expanding the AMT base to include certain types of exempt income, such as all interest on municipal bonds.

A simplified AMT would also ensure that all wealthy households pay a reasonable tax bill. Although the wealthy pay a lot in income taxes as a group, many pay relatively little. TPC recently estimated that among the richest 20 percent of tax units, about half paid less than 11 percent in income taxes. At least one-quarter paid less than 4 percent. A simplified minimum tax would hit those who pay little income tax, but protect those with an already-high tax burden.

As with all new taxes, there are drawbacks. Having two tax systems—even if one is extraordinarily simple—is a complex and burdensome way to tax income. Limiting itemized deductions for AMT taxpayers could have some unintended consequences, such as depressing housing prices in expensive markets or curtailing charitable giving. And if the minimum tax rate is set higher than the preferential rate on capital gains and dividends—currently 15 percent—some investors would see their after-tax returns diminish.

On the plus side, a simplified minimum tax would lower marginal tax rates for scores of households, simplify the extraordinarily complex current AMT, and reinstate the primary reason for a minimum tax in the first place: to ensure that the wealthy pay a reasonable amount of tax. The total number of AMT taxpayers would plummet from over 4 million to less than 500,000. The simple minimum tax would be an economists' dream: a broad tax base with a low rate. Best of all, a simplified minimum tax would help us pay our bills. It’s worth considering.

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In this June 2000 House Speaker Dennis Hastert, flanked by GOP colleagues and small-business owners, called for the repeal of the estate tax. the Senate may soon consider restoring the tax. (Dennis Cook/AP/File)

An estate tax deal: pay now, die later

By Bob Williams, Guest blogger / 05.20.10

News reports suggest that the Senate may soon consider restoring the estate tax with an option allowing people to prepay their tax before they die. Details are apparently still in flux as senators negotiate. We—and maybe they--don’t know yet what they’ll propose for the basic estate tax but it’s unlikely to be harsher than the 2009 version.

Right now, we have no estate tax. When the Senate failed last year to extend the 2009 rules—a $3.5 million exemption and 45 percent tax rate—the tax disappeared as scheduled by the 2001 tax act. But when the full 2001 law sunsets at the end of this year, the estate tax will reappear in all of its pre-2001 glory—a $1 million exemption and a 55 percent top rate. Those who favor the smallest possible estate tax don’t have the votes to repeal it entirely and hope instead to shrink it. They also know that deficit hawks will oppose changes that increase the deficit, so they have to find palatable tax increases to offset the reductions they want. And, according to Tax Notes, they’re limiting their search for offsetting revenue to the estate tax itself.
That may explain why Senator Jon Kyl (R-AZ) is reportedly mulling a prepaid estate tax that would generate tax revenue within the 10-year budget window but lose tens of billions of dollars beyond that.
We don’t exactly how the proposal would work, but here’s one version: People could create “prepayment trusts” into which they could transfer any assets they choose (subject to the assets not having an overall capital loss). Over five years, the trust’s owner would pay a 35-percent capital gains tax on the accumulated gains of the transferred assets and the assets’ bases would become their values at the time of transfer. When the owner dies, the trust would go to the heirs without incurring any estate tax. Because the trust pays tax up front but nothing when the owner dies, revenue gains show up in the 10-year budget window while much of the revenue loss doesn’t occur until the distant future where it doesn’t count under PAYGO rules. The option provides two big tax breaks: there’s no tax on the owner’s basis of assets transferred to the trust and any subsequent profits are taxed at the preferential capital gains tax rates. What’s not to like?
A couple of things. As my colleague Joe Rosenberg points out, the prepayment option would benefit people with liquid assets who could pay the capital gains tax on assets put into the trust. But small businesses and family farms—the groups for whom opponents of the estate tax express greatest concern—would be hard pressed to pay the tax on their illiquid assets. And, as long as the top tax on long-term capital gains is less than 35 percent, the wealthy could realize gains on their assets, pay the gains tax, and transfer the assets tax-free to a prepayment trust. TPC colleague Eric Toder notes that the way around that problem is to raise the tax on gains to 35 percent. Doing so would deal with lots of tax problems—but that’s a topic for another day.
Keep in mind, too, that Kyl only has to pay for part of the lost revenue. Congress has already agreed to ignore any cost of extending the 2009 rules for two years—a tab topping $30 billion.
A pre-paid estate tax would not only save the wealthy lots of money; it would also continue the full employment of estate tax lawyers. Plus many wealthy families would have to hire financial analysts to help pick the assets to put into the trusts. It surely won’t simplify the tax. And, at a time when the U.S. faces huge future deficits, it would produce a windfall for a few thousand of the nation’s wealthiest families.

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