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Five Tax Increases To Expect

Author: Amity Shlaes, Former Hayek Senior Fellow for Political Economy
March 29, 2007
Bloomberg.com

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Lawmakers in both houses of Congress are at work writing budget resolutions. All of them, especially the Democrats, talk about new benefits they intend to extend: an expansion of federal outlays for child–health care in the states, community–health centers, reauthorization of the farm bill — you get the idea. Lawmakers also are planning middle–class breaks, including billions to limit the sting of the alternative minimum tax.

Yet under Congress's own pay–as–you–go rule, someone has to pay for these increases. For every new entitlement dollar it spends, or tax breaks that it offers, Congress must also come up with sufficient entitlement cuts or tax increases to compensate. The AMT change alone would reduce revenue by $40 billion during the next two years.

And when it comes to offsetting that amount, lawmakers aren't being exactly clear. Aside from some muttering about how he might ``rearrange'' the tax–rate schedule by House Ways and Means Committee Chairman Charles Rangel, we're not hearing a lot about tax increases.

Maybe that's because in the end the increases the Democratic leadership is most likely to support will be paid by the very highest earners on Wall Street. Indeed the effect is so disproportionate that even Democrats, who normally have no shame about such things, are putting off to the last possible minute any announcement of them.

Raising Rates

Consider five possible changes:

The first is the most obvious: raising the top marginal rate on income tax back to

President Bill Clinton's old 39.6 percent levy.

For 2006, the top bracket of 35 percent starts once income exceeds about $335,000 in taxable income, a level routinely breached by even modestly successful staffers at Wall Street firms. Lawmakers would push that back up.

Second, lawmakers would also like to fiddle with the next rungs on the tax ladder. Don't be surprised if in the name of tax reform Democrats start talking about recalibrating so that the current 28 percent and 33 percent brackets become 36 percent.

A third likely change is especially important for Wall Street, which has enjoyed a tax on dividends of 15 percent for the past several years. Lawmakers are likely to revert to the old system for dividends, under which the payments are treated as ordinary income and taxed up to the top 35 percent rate. Or make that 39.6 percent — if the first of the changes above is made.

Capital Gains, Estate Tax

Capital gains likewise are under the gun, with the possibility that the tax rate may move back to the 20 percent of the 1990s from the current 15 percent.

Then there is the estate tax, which is already a mess. It phases out under current law in 2010, only to roar back in following years. In order to prevent its revival, lawmakers must enact a new law. Democrats are likely to take advantage of disillusionment at the complexity and write a new law that makes the estate tax, once again, an American fixture.

The reason these tax uglies are likely to be on the table is that they are reversions to the rates in place before George W. Bush came to power.

Democrats therefore can tell themselves and their constituents that they aren't really raising taxes. They are merely going back to the happy status quo of the 1990s. Undoing the Bush Legacy is easier and more enjoyable than writing a new tax increase.

Waging War

Democrats will consider these changes for another reason. They really do see political value in making war against higher earners. The 1–in–3 chance of recession that former Federal Reserve Chairman Alan Greenspan predicts may materialize. Then the country will be ready to hear stories about how the wealthy deserve the blame.

And before you know it, New York will be home to one of the great intrastate wealth transfers in history. Middle–income taxpayers will get a break because of the AMT patch. But very high earners will subsidize that.

Not all of this is logical, especially when it comes to New York. By raising taxes, Charles Schumer, New York senator, and Rangel, New York Congressman, would be hurting many of their own constituents.

When Wall Street gets hit, so does the rest of the New York economy. But insuring that Bush doesn't join former U.S. President Ronald Reagan in the Republican pantheon may seem more important, especially in the 18 months before a presidential election.

As for Republicans, they are doing their share of the damage by failing to offer the needed spending cuts.

Keep It Quiet

The only reason you don't know about this already is that lawmakers don't want you to. They are hiding behind the multistep process of budgeting. If lawmakers promise too much in coming weeks in their budget resolution, then later in the year tax committees will have to write legislation that comes up with extra money.

What could prevent such tax increases? A veto by President Bush, for starters. More revenue than forecast may flow into federal coffers as well. Watch the Treasury's daily statements — they may list enough dollars to make fewer tax increases necessary.

Revenue flows, strong or weak, shouldn't cover the perverse intention here. In an era when markets have proven the best engine to pull the country forward, these lawmakers are again making it their goal to squeeze the higher earner.

Around September, in other words, you may well hear Schumer begin to talk about the sacrifice that must be made. And there's no doubt about who will be making that sacrifice.

Dear reader, it is you.

This article appears in full on CFR.org by permission of its original publisher. It was originally available here.

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