‘Baseline’ Question Is Key to Future Tax Policy

Posted December 2, 2007 at 11:00pm

My goal is an efficient, sensible, modern tax system that encourages savings and investment. For a variety of reasons, it is unlikely that we’ll see any sort of comprehensive tax reform in this Congress, but such a fundamental overhaul seems very likely to occur in the next Congress. The most important thing we can do in the remainder of the 110th Congress is to educate policymakers and the public so that when that discussion begins we all understand what constitutes tax reform and what does not.

The window for considering substantial legislation in 2007 is basically closed, and 2008 will be dominated by the presidential race, leaving little chance for such a major undertaking in Congress. In addition, if the majority in Congress believes it is likely that the next president will be a Democrat, they have little incentive to negotiate with President Bush. In 2009, on the other hand, the scheduled expiration of the 2001 and 2003 tax cuts (a massive tax increase that we can and should avoid) and the ever-growing problem of the alternative minimum tax should create a “perfect storm” for tax reform.

The most important issue we need to address and understand today is seemingly esoteric, but it cuts to the heart of the debate over future tax policy: Will we use a budget “baseline” that assumes a massive tax increase?

Democrats have fallen into a trap created by their rigid and poorly designed “pay-as-you-go” rule. In theory, PAYGO sounds like it will keep the size of government and Americans’ tax bills from growing. But by using the Congressional Budget Office baseline for their tax and spending assumptions, which includes revenue coming into the government from the alternative minimum tax and the expiration of the 2001 and 2003 tax cuts, Democrats have locked in a $3.5 trillion tax increase, the largest in American history.

When Chairman Charlie Rangel (D-N.Y.) introduced the “mother of all tax hikes” bill on Oct. 25, I asked the nonpartisan Joint Taxation Committee to conduct an analysis of the effect of the legislation, compared with the taxes that the American people paid last year. My reasoning was simple: If a taxpayer who earns the same amount of money this year as last year has to write a bigger check to the Internal Revenue Service, that’s a tax hike. If the taxpayer writes a smaller check (or gets a larger refund), that’s a tax cut. That is what I call the “reality baseline” as opposed to the CBO baseline.

The results of the analysis were stunning. The JCT found that in 2011, under the Democrats’ bill, 113 million American taxpayers would pay higher taxes and only 9 million taxpayers would pay less than if 2006 tax law were extended. That is a tax increase for 90 percent of American taxpayers. In 2017, 120.7 million Americans would pay higher taxes and only 9.3 million would pay less.

Take one example: A married couple with an adjusted gross income of $45,000 in 2011 — with two children, so they have four exemptions totaling $14,800, plus $13,000 worth of deductions for their charitable contributions, mortgage interest and state taxes — would have a negative tax liability of $275 under the “reality baseline.” So they would pay no income tax and get a check from the IRS to boot. But under the Democrats’ bill, that same family would owe the government $1,580. Why? The Democrats assume that the 2001 tax cuts expire, meaning that the 10 percent tax bracket — which benefits millions of taxpayers — reverts to 15 percent. And the $1,000-per-child tax credit drops back to $500.

The first step in tax reform should be to decide how much revenue the government needs. Since 1965, federal taxes have averaged approximately 18.2 percent of the United States’ gross domestic product. We have had an unprecedented run of relatively stable prosperity for that time. For 2007, at 18.8 percent of GDP, we already have exceeded that historical average. The Democrats’ plan would increase our taxes to 20.3 percent of our GDP over the next 10 years.

The first clash in the fight over how we measure tax cuts and tax hikes is the debate over offsetting the AMT “patch” for tax year 2007. Most everyone agrees that the AMT, a second tax code designed in 1969 to ensnare a handful of millionaires who were using deductions to avoid paying any income tax, is bad tax policy. In 1999, Republicans passed a bill eliminating it, but President Bill Clinton vetoed the measure, and Democrats in Congress sustained his veto. Since then, Republicans made sure to protect middle-class taxpayers from the AMT by enacting a “patch.” In 2006, the “patch” meant that only 4 million Americans paid the AMT. If the patch is not extended for 2007, an additional 19 million taxpayers will face an average tax increase of $2,000 under the AMT. House Democrats, locked into their flawed PAYGO worldview, are insisting that in order to continue preventing this tax increase, we must raise taxes elsewhere.

That is absurd. The government never intended the AMT to extend to middle-class families. We have never collected that revenue and never expected to. Senate Democrats already have abandoned this ridiculous argument. On Nov. 15, Senate Majority Leader Harry Reid (D-Nev.) agreed to move an AMT patch without other tax increases. House Democrats stand alone in their zeal to pass unnecessary tax increases.

This debate matters because it is the first skirmish in a war over tax policy that will rage through the 2008 elections and beyond. If we allow the Democrats to set the terms of the debate, by agreeing to a worldview that requires a $3.5 trillion tax increase, we have already lost. If we don’t call them out on the assumptions built into their tax increase blueprints, we will find ourselves squabbling over the margins — raising this tax versus that one, or eliminating that deduction instead of the other. Down that path lie higher taxes, lower competitiveness and slower economic growth.

Rep. Jim McCrery (R-La.) is ranking member of the Ways and Means Committee.