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January 3, 2013
Opinion: Double Disappointment With the Deal
by Martin A. Sullivan

Full Text Published by Tax Analysts®

by Martin A. Sullivan


Martin A. Sullivan discusses the downsides of the fiscal cliff compromise.

Congress is unpredictable. But a good rule of thumb is that when legislators have a deadline, they will do the minimum at the last minute. That's what happened Tuesday night.

Except it was even worse. Once again, simplicity was sacrificed on the altar of political expediency. Working behind closed doors, leaders managed to muck up even more the code they perennially vow to simplify.

Despite a blanket of overdramatic television coverage, viewers hardly knew that other issues were on the table beyond the level at which the Clinton-era 39.6 percent rate would be reinstated. But lo and behold, when negotiators came out of their Capitol meeting rooms, they had a deal that included two real stinkers that few reporters had bothered to preview.

The first is an increase in the 15 percent rate on capital gains and dividends to 20 percent for individuals with adjusted gross income over $400,000 and couples with AGI over $450,000. This is on top of the additional 3.8 percent tax on all net investment income that took effect on January 1. You may recall that the 3.8 percent tax, enacted as part of the 2010 healthcare reform law, applies only to individuals with AGI over $200,000 and couples with AGI over $250,000.

So last week a married couple paid a 15 percent rate on capital gains and dividends. Now they face a graduated rate structure of 15, 18.8, and 23.8 percent, depending on whether their AGI is below $250,000, between $250,000 and $450,000, or over $450,000. As William Gale of the Brookings Institution has pointed out in the past, a progressive tax system does not mean every aspect of the code has to be progressive. This fine-tuning of capital gains rates is complexity that serves little purpose.

The second is the return of the phaseout of itemized deductions (Pease) and of personal exemptions (PEP) for incomes for individuals with AGI over $250,000 and couples with AGI over $300,000. Pease and PEP are just complicated backhanded rate hikes for cowardly politicians who are afraid to raise the rate outright. Here is what the 2008 IRS taxpayer advocate report said about phaseouts:


    Phase-outs are burdensome for taxpayers, reduce the effectiveness of tax incentives, and make it more difficult for taxpayers to estimate their tax liabilities and pay the correct amount of withholding or estimated taxes, possibly reducing tax compliance. Phase-outs also create marginal "rate bubbles" -- income ranges within which an additional dollar of income earned by a relatively low-income taxpayer is taxed at a higher rate than an additional dollar of income earned by a relatively high-income taxpayer. Because Congress could achieve a similar distribution of the tax burden based on income level by adjusting marginal rates, phase-outs introduce unnecessary complexity to the Code.

The public is always asking why the tax law is constantly getting more complicated. It's exactly because of deals like these. Members whom they elect spend 364 days of the year howling for a simpler code. But on the one day that matters -- the day they vote -- they are totally preoccupied by politics.



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