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196 IRET Congressional Advisory 1 (2005)

handle is hein.taxfoundation/iretcgadv0193 and id is 1 raw text is: INSTITUTE FOR RESEARCH ON THE ECONOMICS OF TAXATION IRET is a non-profit 501 (c)(3) economic policy research and educational organization devoted to informing the public about policies that will promote growth and efficient operation of the market economy. December 5, 2005 Advisory No. 196 TAX RECONCILIATION: CAPITAL GAINS, DIVIDENDS, AND THE AMT The Senate and House have yet to complete conference work on the tax portion of Budget Reconciliation. Each has passed bills with the usual old perennial extenders of temporary provisions, such as the R&E credit, which have been authorized annually for some time. Two other extenders, one involving the AMT and one involving dividends and long term capital gains, are under dispute between the House and the Senate. The House has passed a two year extension of the 15% tax rate cap on dividends and capital gains, which is due to expire at the end of 2008. Extending the cap through 2010 would put its expiration date in line with that of the 2001 marginal tax rate reductions and other provisions of the 2001 tax bill. If the cap is allowed to expire, the tax rates on dividends will revert to those on ordinary income (up to 35%), and the top tax rate on capital gains would jump back to 20 percent. The Senate has passed a one year extension of the expiring fix of the Alternative Minimum Tax (AMT). That fix, adopted for three years in 2001 and extended annually since 2004, provides a temporary increase in the unindexed AMT exempt amounts to $58,000 for joint filers and $40,250 for single filers (in 2005). Without the extension, the exempt amounts would drop back in 2006 to their permanent levels of $45,000 (joint) and $33,750 (single). The number of angry taxpayers subject to the AMT would jump from 3 million to about 21.5 million. Under the arbitrary Budget Reconciliation limits given to the tax Committees, there isn't room to do both without first passing reconciliation spending cuts or dropping some tax sweeteners that were added to the bill. This is a self-inflicted Congressional dilemma. The 15% rate cap on dividends and long term capital gains is more necessary for a strong economy. The AMT fix extension is more necessary to keep angry taxpayers from storming Members' offices, though it too has some economic benefits. What to do? Do both. It would be better to find more entitlement cuts or trim the tax goodies than to delay either extender. Dividend and Capital Gains Rate Cap The 15% rate cap on dividends and capital gains lowers the service price of capital, the rate of return that investments in new factories, equipment, and buildings must earn to justify their existence. The dividend and long term gains cap was one of the three provisions in the 2003 tax cut that made it more attractive to create and employ plant and equipment, and that really got the economic recovery moving. (See Chart 1.) The other two items were the moving forward of the remaining marginal tax rate reductions being phased in under the 2001 tax cut, and the temporary 50% expensing provision that has since expired at the end of 2004. The dividend and gains rate cap accounted for over half of the improvement in the treatment of investment. The marginal rate relief was over a third of the effect. The expensing provision contributed less than ten percent. (See Table 1.) A * * gg~ e ~ee

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