- The Washington Times - Friday, November 18, 2005

President Bush’s Tax Reform Commission came up with some good ideas, and some not so good. But deep within its details is a particularly bad idea: a $1.2 trillion tax increase.

The problem stems from the Alternative Minimum Tax (ATM). The ATM was adopted more than 30 years ago because a few hundred rich individuals with very high incomes qualified for so many deductions they paid very little in income taxes.

Though these individuals complied with the law, liberals found the matter scandalous. So the ATM was adopted to ensure these millionaires paid their supposed fair share of taxes. The ATM did so by denying certain deductions as income rose, particularly when deductions are a high percentage of income.

The biggest problem is that the income thresholds for the ATM penalties were never indexed for inflation or wage growth. So instead of applying to just a few millionaires, it begins applying to millions of upper-middle-class families. Over time, as nominal wages rise with no inflation adjustment, the ATM penalties will apply to more and more of the middle class.

The problem is getting so bad the ATM is now projected to raise taxes by $1.2 trillion over the next 10 years, and much more beyond that. A fascinating political twist is that the ATM hurts most the liberal states of the Northeast and the West Coast, because incomes there tend to be substantially higher on average. So even liberal Democrats from those states have squawked that the ATM must go.

The tax reform commission rightly recommended abolishing the ATM. But it also recommended $1.2 trillion in tax increases over the next 10 years alone to make up for the lost revenue.

The ATM, however, was never intended to raise big buckets of taxes from the middle class. Policymakers have generally assumed the ATM would be indexed or abolished before it started affecting large proportions of upper-middle-income earners, or the middle class generally.

That is why Senate Finance Committee Chairman Charles Grassley, Iowa Republican, recently called on tax and budget committees in Congress to exclude expected ATM revenues from their baselines.

Republicans and conservatives must not accept $1.2 trillion in middle-class tax increases as the price for abolishing the ATM. When Congress enacted the ATM more than 30 years ago, it did not vote for a whopping middle-class tax increase. But the commission’s revenue offsets would make it precisely that.

This suggests a solution that could save the now politically stillborn commission reforms: Remove ATM repeal from the tax reform package altogether. Force liberals from California, New York, Massachusetts, Connecticut, etc. to support outright repeal of the ATM in a separate vote, with no revenue offsets.

With the $1.2 trillion “revenue loss” from the ATM abolition out of the tax reform package, tax rates in the package could be cut substantially. Moreover, tax rates could be cut much more if the revenue effects of the reform were estimated on a dynamic rather than static basis.

Static estimates assume tax reforms change nothing. No one’s behavior changes on savings, investment, entrepreneurship, work. Therefore, such static estimates tend be wildly inaccurate, because the incentive effects from proper tax reform would produce dramatic changes in all these things, and in overall economic growth.

Dynamic estimates would take these expected changes into account, and therefore would be far more accurate. Counting these changes would produce more revenue from the reform, which could be used to reduce tax rates more.

Ideally, income tax rates under reform would be reduced to 10 percent, 15 percent and 25 percent, with that last rate applying to the corporate income tax too.

The precise final revenue estimates would have to be more carefully calculated. But maybe the above two changes alone, removing ATM abolition from the package and using dynamic scoring, would bring the reform package close to these rates.

That would make the tax reform proposals very politically appealing and stunningly pro-growth. President Bush, call your office.

Of course, we can still consider more fundamental reforms, such as replacing the income tax completely with a sales tax, or adopting a purer, but optional, flat income tax. But if all we could get now is the tax commission’s proposals with the above low rates, that in itself would be a huge step forward.

Peter Ferrara is director of entitlement and budget policy reforms at the Institute for Policy Innovation and a senior fellow with the Free Enterprise Fund.

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