Outside editorial: Paying for the patch, fixes get expensive

Posted: Friday, November 23, 2007

The following editorial appeared in the Chicago Tribune:

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The alternative minimum tax was created nearly 40 years ago to make sure a few very rich taxpayers couldn't use loopholes to reduce their tax bills to zero. It's a parallel tax system that eliminates many deductions. Taxpayers must calculate their returns two ways. If the AMT comes out higher than a standard tax calculation, they have to pay the higher tax.

The AMT was not indexed for inflation, though, so its impact has steadily crept down the income scale. This year, about 23 million households, some with incomes as low as $50,000, will be subject to its provisions.

Congress has passed fix-it legislation since 2003 to limit the reach of the AMT. And lawmakers say they don't want middle-class taxpayers to feel the sting of the AMT this year. But the fixes are getting expensive.

The proposed patch for the 2007 tax year will cost about $50 billion in tax revenues. Democrats are determined to accomplish this temporary fix while living up to their pledge to be fiscally responsible. They have promised to offset any reductions in federal revenue by raising taxes elsewhere or cutting spending.

So have Democrats found $50 billion in spending to cut? Of course not.

It has been business as usual. To wit: a $286 billion farm bill stuffed with subsidies, a pork-laden $23 billion water projects bill, an earmark-stuffed $606 billion domestic spending bill. President Bush vetoed the water bill and the domestic spending bill. The House has voted to override the veto of the water bill.

House Democrats propose to pay for the 2007 AMT patch solely through tax increases. They've chosen what they believe is a popular target - managers of hedge funds and private equity firms. They propose to change the tax code so that certain profits earned by managers of these private partnerships would no longer be treated as capital gains, in which they're taxed at 15 percent. They would be treated as ordinary income and subject to income taxes as high as 35 percent.

Democrats paint this as closing a loophole that benefits only the wealthy. But this "loophole" governing tax treatment of what is called carried interest has been part of the tax code related to private partnerships for decades. Springing such a change in long-standing tax treatment would have a substantial impact on all partnerships, large and small, and would not be limited to the multi-millionaires in the top tier of private equity firms and hedge funds.

It would also cover real estate and venture capital partnerships. The economic ripples of this change could be profound. Private equity has played an increasingly large role in reinvigorating the economy by buying, restructuring and then reselling companies. This tax change would discourage risky but potentially lucrative investments and put the U.S. at a disadvantage with other markets, such as London, where carried interest is treated as a capital gain.

House Ways and Means Chairman Charles Rangel insists that "this is not a tax increase. This is the closing of a tax loophole." But whatever you call it, it would have broad economic ramifications. The Democrats should come up with a different solution, one that includes spending cuts, and do it soon. Tax time is coming soon.

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