Why am I not surprised?

Those people over at CTJ have made a proposal to reduce to impact of the Alternative Minimum Tax (AMT). You will remember that the CTJ is the group called Citizens for Tax Justice (I know when you read their stuff that you often think of it as Comedians for Tax Justice but most of that they say is not that funny.)

Their solution would have two key elements: 1) Extend the 2006 AMT exemptions through 2010, indexed for inflation. 2) Remove the special low 15% tax rate on capital gains and dividends from the AMT. That would mean treating capital gains and dividends the same as other income for AMT purposes. Who could have thought it that simple? Anyone who knows something about this group would not be surprised.

The AMT, as discussed previously in this blog, is that invention to snare errant taxpayers who don't pay their "fair" share. In reality it works like many other parts of the tax code that were added with the same intent - it cuts across an increasingly large number of taxpayers (as the attached WSJ graph shows). The "fix" in the last tax bill reduced the hit, but not by much, especially for the people that the designers say they never intended to get.

Unlike the AMT, which is a creation trying to solve something that by most accounts doesn't really exist(the myth that milions of wealthy taxpayers do not pay taxes), the capital gains preference was created to recognize that a) our society benefits from incentives to invest in capital and b) an income tax system which counts income on an annual basis does not accurately count the contributions of capital or the income. Perhaps a more accurate system on capital would index the cost (basis) for the investment. That would at least take out the windfall that the government gets from capital investments which are held for a long period of time based on inflation. But indexing is complicated. Nicholas Kaldor, who wrote one of the required texts for all tax wonks - the 1955 book called An Expenditure Tax, in his broad theory of how taxes should function declared that we should tax these incremental changes. But as the first Reagan Tax Commission found in the early 1980s the difference between good theory and good practice is wide indeed.

CTJ, in one of their papers, yammers that shudderpeople who hold appreciated assets can keep them from the tax man forever. Yet, CTJ has no consideration for the long term effects on capital formation that higher rates has (it is negative or else many countries in the world would not have lowered their rates on the taxation of capital.) What is clear from any reasonable analysis, is that if the differential rate (I hesitate to call it preferential because it does not fully reflect the long term costs of inflation) is eliminated, taxpayers will continue to hold appreciated assets until the rate is reduced at some point in the future.

Capital investments require some assumption of risk and while the current system offers some recognition of that with the preferential rate, the system still does not adequately recognize the risks of losses. CTJ has whipped this dog for a long time. Their "analysis" is consistent. For example, in a paper called the Hidden Entitlements, CTJ argues that "in terms of cost and maldistribution--and contentiousness--tax breaks for capital gains are at the top of the list." They then go on to argue that the "evidence" of the effects on capital formation is not real because, for example, although the 1978 reduction in capital gains rates did as its sponsors suggested (increased by dramatic rates the realization of capital gains) the country went into a recession after the Steiger amendment was adopted. They look at one year results - but any first year economics student understands that investments take time to develop. A preferential rate for capital gains is a long term thing, but I guess CTJ believes in instant gratification.

What's more the capital gains preference only goes, substantially, to people shudder again in the highest tax brackets. The AARP is as silly about this in a "research" paper on the issue AARP argues that while a substantial portion of the benefits of captial gains exclusions would go to people they supposedly lobby for, the AARP opposes a reduction in the rate because it is skewed to high income taxpayers. At the current time, the top 1% of taxpayers pay as a percentage in taxes about twice what they earn as a percentage of their income share - but AARP and CTJ think that is not "justice." CTJ cites a Department of the Treasury comment before the 1995 Republican Contract for America which stated "Increasing the preferential treatment of capital gains would create economic efficiency losses and make the tax system more complex by encouraging taxpayers to convert ordinary income into capital gains." as an indication that even conservatives (remember 1995 is the Clinton presidency) oppose the preferential rate for capital gains.

CTJ's sponsors simply don't want to recognize the benefits of a capital gains preference. That is not surprising. But it is disappointing. Long term benefits of capital investments improve capital formation, but then supposedly that does not matter to their sponsors.