The Entrepreneurial View #457
The Rangel Tax Plan: Solving Some Problems, While Creating Bigger Woes
by Raymond J. Keating
Last week, New York Congressman Charles Rangel, chairman of the House Ways and Means Committee, presented a piece of legislation called the "Tax Reduction and Reform Act of 2007." If only the contents lived up to the title.
Now, there certainly are some positive measures in the Rangel plan. Most notably, it not only would extend relief from the individual alternative minimum tax (AMT) to 2007, but would repeal the AMT starting in 2008. That would be most welcome.
After all, Congress imposed the AMT in the late 1960s to make sure that fewer than 200 wealthy taxpayers, who did not pay any income taxes, would pay something. But since it was not indexed for inflation, the AMT now hits millions of taxpayers, and if left alone, will shortly sock tens of millions more. It also makes a messy, complex tax code even more messy and complex. The AMT is a classic example of trying to tax the rich, and hurting everyone.
Another big plus from Chairman Rangel would be the reduction of the top corporate income tax rate from 35% to 30.5%. The U.S. corporate tax rate, unfortunately, ranks as one of the highest among developed nations. For good measure, several of our competitors are reducing or have recently cut their corporate tax rates, while the U.S., once the global leader in pro-growth tax relief, has been doing nothing. So, a lower corporate tax rate makes sense.
Finally, Rangel would make permanent the current enhanced levels of expensing for small business capital expenditures. Right now, small businesses can expense $125,000 (indexed annually for inflation) in capital investments, subject to a phase-out threshold of $500,000 (also indexed for inflation). But at the end of 2010, the expensing level reverts to $25,000, with a phase-out starting at $250,000 (with neither indexed for inflation). Expensing enhances incentives for entrepreneurs to make the investments that drive economic growth and create jobs. Making the higher level of expensing permanent is sound economics.
So, what's the problem then with the Rangel plan?
Well, the woes have to do with how the Ways and Means chairman tries to "pay for" these tax changes through tax increases. And there are a bunch of them. For example, the plan would eliminate the LIFO method of accounting, and raise taxes on, for example, carried interest, hedge funds, investment partnerships, S-Corps and dividends.
Worst of all for entrepreneurs, small businesses and the economy in general is the Rangel proposal to increase the top personal income tax rate, which is now 35%. For individuals earning $150,000 and couples earning over $200,000, an added 4% income tax would be imposed. For individuals earning $250,000 and joint earners making $500,000, the added tax would increase to 4.6%.
As if this were not bad enough, keep in mind that the 2001/2003 reductions in personal income taxes expire at the end of 2010. Combine the Rangel proposal with that looming tax increase, and the top personal income tax rate would jump from 35% to 44.2%.
So, while Rep. Rangel apparently recognizes that the income tax rate is too high for C corporations, he proposes jacking up tax rates on the many other businesses that pay the personal income tax. Indeed, while Rangel proposes a class warfare measure that would jack up taxes on the so-called rich, higher tax rates would discourage investing and entrepreneurship, hit the bottom line of many businesses, and thereby do damage to the entire economy.
Please understand that about 90% of businesses (i.e., sole proprietorships, partnerships, S-Corps, etc.) pay the personal income tax. In addition, a 2004 Tax Foundation analysis made several important findings: 1) that 74% of the top 1 percent of income earners had business activity; 2) that "business owners - specifically those with a positive tax liability - will pay 54.3 percent of all individual income taxes in 2004," including 37.4 percent of all income tax revenues coming from business owners making more than $200,000; and 3) that 69 percent of all income tax collections coming from businesses are paid by those earning more than $200,000.
To sum up, the Rangel plan features a huge tax hike on entrepreneurs and small businesses.
Of course, someone will ask: Well, how would you "pay for" eliminating the AMT, reducing the corporate tax rate and making high expensing levels permanent - not to mention making permanent the lower personal income, capital gains and dividend tax rates from the 2003 tax package that are due expire in 2011?
It's a two-part answer. First, tax relief never causes the government to "lose" as much revenue as static government estimates suggest. Pro-growth tax relief obviously means faster economic growth, which results in greater revenue feedback into government coffers.
Second, any needed offsets should come on the spending side of the fiscal equation. After all, the current budget deficit, for example, is not the result of any revenue shortfall - federal revenues in fact have been growing robustly since the 2003 tax cut - but from government spending streaking ahead. All that's needed is some fiscal discipline.
For example, if annual growth in federal outlays had been limited over the past six years to inflation, then outlays in fiscal year 2007 would have been about $2.2 trillion, instead of $2.7 trillion.
Just a little spending restraint goes a long way in making room for substantive tax relief.
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Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.
This article may be reprinted with appropriate citation and credit.
