Commentary

Schumer’s Tax Loopholes

New York Sen. Chuck Schumer and a half-dozen freshman legislators, reports the Los Angeles Times, “want to add tax credits and deductions to benefit narrow groups of largely middle-class constituents. Among potential beneficiaries: people with elderly parents in nursing homes, new parents, college students, volunteer firefighters and organ donors…. Schumer’s bill was modeled on proposals by Third Way, a liberal Washington think tank that President Clinton helped found.”

In a recent column, “Moralizing and politics,” I found it admirable that Third Way economists were shunning the party line by adopting an optimistic approach and demonstrating that the “the middle class is shrinking… because more people are better off.” Unfortunately, sensible statistics do not always produce sensible policies.

The source of the Schumer proposals was a Third Way memo last July addressed to “progressive candidates” and written by Anne Kim, a lawyer and former aide to Rep. Jim Cooper, Tennessee Democrat. It is all about campaign rhetoric — “ways to talk about taxes if you believe that some ought to be increased.” Candidates were advised to develop attractive language to support assorted tax breaks to narrow voting blocs, and also advised how to avoid talking about other taxes raised to make up the loss.

Promising special tax deductions and credits to specific groups of voters means, by definition, adding new “loopholes.” In the similar proposals of Mr. Schumer and Third Way, special tax favoritism is to be granted only to parents of infants rather than parents of school-age children, for example. Third Way would also add tax breaks for couples with $75,000 incomes buying their first home but not for couples with $35,000 buying their second home. Ironically, the Third Way memo also advises progressive candidates to propose “closing loopholes” to “make the tax code simple and fair.” For example, “candidates can decide to choose a savings target — such as $10 billion a year — for closing loopholes.”

In a Third Way press release claiming credit for the Schumer plan, “Kim acknowledged that there would be costs to the plan, but noted that ‘there is plenty of fat in the tax code to pay for this.”’ But her memo said: “The proposals above lay out approximately $250 billion in tax cuts over 10 years.” Mr. Schumer’s similar plan is reported to lose $80 billion of revenue during its first four years, with only a one-year patch for the AMT — but the 10-year revenue loss was unreported.

Vague talk about “closing the tax gap,” or Ms. Kim’s $100 billion “savings target,” will not get around the new congressional paygo rules. Even if it did, that leaves the Third Way plan with a $150 billion gap to fill, without any of the promised relief from the alternative minimum tax (AMT).

Ms. Kim suggested “additional sources of offsets” would be found in “Sen. Kerry’s proposal to repeal tax cuts for high-income households. This proposal would save $61.1 billion over 10 years, which provides ample room for the proposals above [$250 billion] plus AMT reform [about $600 billion] and other initiatives.”

Out of that $61.1 billion, Congress would have “ample room” to add $250 billion in new loopholes, fix the AMT and fund “other initiatives’? That imaginative arithmetic demonstrates what Ms. Kim meant by “ways to talk about taxes” without actually saying “some ought to be increased.”

Legislators still hoping to advocate the tax increases without suffering his political oblivion are advised to describe higher tax rates as mere “offsets” to finance new loopholes for narrow groups. Under those redefined “offsets,” the 33 percent tax rate would be increased to 36 percent and the 35 percent rate to 39.6 percent. One unintended consequence is that thousands of Subchapter S corporations and limited liability companies would promptly revert to filing their profits under the lower corporate tax, so individual tax revenues would end up smaller than otherwise.

The top tax on dividends would be raised by 164 percent under the plan, which would obviously crash the market for dividend-paying stocks. The capital-gains tax would rise to 20 percent, but there would be few stock market gains left to tax.

The political fallout might be as perverse as the impact on tax revenues and stock prices. Personal exemptions and deductions would continue to be phased out at higher incomes, under the tax-increase plan, which (like the AMT) is a sneaky way to raise marginal tax rates on large families in overtaxed “blue” states such as New York, Massachusetts and California.

Even if this soak-the-rich scheme could actually raise $61.1 billion over 10 years, that would not even begin to pay for Mr. Schumer’s grab bag of new loopholes, much less any durable fix for the AMT. Besides, the Congressional Budget Office (CBO) expects federal revenues from the individual income tax alone to total $17.5 trillion from 2008 to 2017. Hoping to extract an extra $6 billion a year from a few rich people cannot possibly be what really motivates so many Democrats’ impulse to raise the highest, most economically destructive tax rates.

My January column “Tax cuts and the rich” used CBO data to show that, “for the bottom 80 percent as a group, the total federal tax fell from 14.1 percent in 2000 to 11.4 percent in 2004 — a 19.1 percent tax cut. The tax cut was deepest among the poorest fifth (29.7 percent), largely because of the Bush administration’s refundable tax credit for children. For the middle fifth, the total tax rate fell from 16.6 percent to 13.9 percent — a 16.3 percent cut. As for the top 1 percent, their overall tax rate was merely trimmed from 33 percent to 31.1 percent — a 5.8 percent cut.”

To raise enough revenue to fund all the Third Way promises would require undoing all those Bush tax cuts — those for the bottom 80 percent, not just the top 3 percent. “[Jim] Kessler of Third Way,” notes the Los Angeles Times, “concedes that the most realistic funding source is the repeal of Bush’s tax cuts.”

Whenever some politician or political strategist begins offering a package of pleasant-sounding tax breaks for this group or that, be wary that the economy may be strangled by the many strings attached.

Alan Reynolds is a senior fellow with the Cato Institute and is a nationally syndicated columnist.