Stupid Tax Tricks

By Daniel Kadlec

At first there was clarity and discipline behind the shaping of the nation's largest tax cut in 20 years. Lobbyists were kept at bay. Businesses were told to wait their turn because other cuts would be coming. This one, the Republicans promised, would focus on individual taxpayers and make good sense. It would simplify the filing process while promoting long-term economic growth through tax savings of some $1,600 a year for the average household.

Then it all went bad. Late last month, during three days of chaotic, last-minute, closed-door negotiations between House and Senate leaders, Washington demonstrated its immense talent for mucking things up. A tax package was rushed through Congress just in time for lawmakers to make the Memorial Day barbecues back home, and what should have been a taxpayer feast looks instead like a botched grilling. Most households will see less than $600 of savings this year, and as for simpler tax returns, well, that's just a laugh. A more confusing tax bill is hard to imagine.

The mess that the President is expected to sign this week is loaded with targeted tax breaks and maddening phase-ins and phase-outs--tax reductions that come and go like a spring afternoon. It contains some last-minute special-interest morsels, including one that may be a precursor to school vouchers. Most of the relief comes at the tail end of the 10-year plan--and the year after that, the whole thing disappears, restoring in 2011 the very same tax laws that were in force last April 15.

Is Bush to blame? Perhaps. But not alone. He may have turned on the Washington meat grinder, but both parties fed it foul flesh. And both sides were so hungry for a bill that neither paid close attention to what the bill was. "Nobody was down there on the Senate floor combing through the details," says a Democratic Senator's chief of staff. Most Senators and House members were clueless about the bill's fine print right up to the vote, even most members of the Senate Finance Committee and House Ways and Means Committee, the bodies charged with steering this kind of legislation.

On the House side, only the ranking Ways and Means members--Republican Representative Bill Thomas and Democrat Charles Rangel--were involved in late-hour haggling. Among the Senators, the conferees included Republicans Charles Grassley, Trent Lott and Don Nickles and Democrats Max Baucus, Tom Daschle, Jay Rockefeller and John Breaux. But for most of the final 48-hour marathon to complete the bill on the Thursday and Friday before Memorial Day, only Grassley, Thomas, Breaux and Baucus were actually in the room.

Rangel, who at one point during negotiations was asked to leave the room because the Republicans wanted to negotiate among themselves out of earshot of a Democrat, calls the bill "a fraud on the American people." He and others charge that the bill underestimates the true cost of the tax cuts by half a trillion dollars and that it is aimed squarely at the richest Americans.

Republicans, of course, take offense at the characterization. "That demagoguery and class-warfare rhetoric is pure nonsense," says Republican whip Nickles. "Low-income taxpayers get immediate relief retroactively. Some people are just throwing arrows and playing class warfare because they do it out of habit, not out of knowledge of the bill."

Yet the sponsors of the bill--those who know it best--are hard-pressed to explain it. Topping the list of odd features is the "sunset" provision that repeals the entire bill at the end of 2010. Budget rules require Congress to include a sunset clause in all major tax legislation, but this sunset arrives a year early--after 10 years instead of the 11 years covered by the current budget resolution. That year was shaved off to keep the total cost of the bill under $1.35 trillion. By repealing the legislation in the 10th year, Congress saved billions of dollars. Without the repeal and a few other tricks, the cost of the full 11-year plan would balloon to more than $1.8 trillion by the end of 2011, far exceeding anything the Democrats would vote for. And the cost in the second decade would reach as much as $4 trillion. Even some conservatives on Capitol Hill are dismayed by the apparent dishonesty of the early sunset. After both parties agreed to a smaller tax cut, the conference committee pulled a fast one.

These bigger numbers remain relevant because no future Congress wants to commit political suicide by allowing this tax cut to expire. Simply stated, all of Washington knows many of these provisions are in effect permanent. The Big Lie is that it costs only $1.35 trillion. Since the real cost is much greater, future Administrations--and Congresses--will have to deal with a political nightmare: the real possibility of deficit spending a decade from now as baby boomers begin to retire en masse and sap the Social Security and Medicare systems.

For individual Americans, the tax cuts play havoc with estate planning. Starting next year, when the estate-tax exemption rises to $1 million per person (instead of the current $675,000), rates will decline and taxpayers will be able to leave more to their heirs on a tax-free basis. But the estate tax doesn't disappear entirely until 2010--and a year later, unless Congress acts, the tax is restored to what it is today. This is absurdity of the highest order, making dying in 2010 so attractive for the rich--and dying in 2011 so unappealing--that wags say some millionaires will pull their own plugs early to shelter their wealth.

The shell game gets ridiculous in its treatment of corporate taxes. One provision delays the collection of $33 billion of estimated corporate taxes from Sept. 15 to Oct. 1 this year. Why? By pushing the collection into the next fiscal year, the bill makes this year's immediate relief look larger. "Republicans had to make sure it looked less dangerous by packing it with every kind of gimmick and sleight of hand I have ever seen," fumes Rangel.

The tax bill isn't all bad. Beginning in 2002, it introduces a generous college-tuition deduction that increases up to $4,000 a year. But that lasts only through 2005. The bill expands the education ira to an annual contribution limit of $2,000, up from just $500, and for the first time permits that money to be put toward private elementary, middle and high school costs. Some see that as a stealth move toward a voucher system because it helps more families afford private school and thus undermines public education.

In another give-and-take break, the bill addresses the marriage penalty but then makes the fix disappear. Lawmakers have long lamented that some married couples pay more tax than they would if they filed as singles. The problem is that the standard deduction for married people is less than twice the standard deduction for singles. And for married couples, income thresholds for higher tax brackets are less than twice the level for singles. The tax bill raises the standard deduction between 2005 and 2009. But the new schedule dissolves at the end of 2010.

Finally, there is the most bizarre levy of all, the alternative minimum tax, or AMT. It's supposed to hit just the rich by forcing taxpayers with substantial deductions to compute their taxes twice--once the normal way and then at a lower rate but without many of the deductions. They pay whichever calculation costs them more.

Because the AMT, which now affects some taxpayers making less than $100,000 a year, is not indexed to the inflation rate, it is creeping up on many middle-income taxpayers. This year 1.4 million paid the tax. That number is expected to reach 5.6 million in 2004 and more than 35 million in 2011. And there's the rub. The law provides $2,000 to $4,000 in AMT relief this year but drops the relief in 2005. So when the crunch really hits, the AMT will steal whatever tax relief many Americans think they're getting.

The hope on both sides is that when future lawmakers evaluate the nation's finances, they will find that surpluses have grown and be able to make all these tax reductions permanent. That hope looks a bit futile in the face of the new, more pessimistic surplus projections that are expected later this month.

Bush and the Republican leadership think the numbers will work out--and some economists agree. These optimists believe the stimulative effect of lower taxes "will strengthen the economy and increase the projected budget surplus by generating larger tax revenues," in the words of Mark Weinberger, Assistant Secretary of the Treasury for tax policy and the government's top tax expert. Plenty of people dismiss that as classic supply-side dogma. But Weinberger notes that tax revenue increased after Ronald Reagan's tax cuts took full effect in the mid-1980s. The Reagan deficits, he argues, resulted from his military buildup and other spending, not the tax cuts.

It's too late to turn back now. The machinery is in place to begin mailing a rebate check of $300 to $600 to nearly every taxpayer by the end of September. Each filer should get a letter in July stating the amount of the rebate. All told, the rebates will inject $40 billion into the economy. Many economists believe that may be enough to hold off a recession. "A lot of the analysis simply does not take into account the fact that the tax cut will promote economic growth and changes in consumer behavior," Weinberger asserts. "It's difficult to quantify. But the changes will be positive." Let's hope so. To pay for all these tax cuts and make them permanent, the country is going to need plenty of growth.

--Reported by Douglas Waller and Adam Zagorin/Washington

With reporting by Douglas Waller and Adam Zagorin/Washington