House Battles Over Middle-Class Tax Fix

If lawmakers can't resolve a messy tax fight on Capitol Hill by the end of the year, it could end up costing millions of middle-income taxpayers as much as $2,000 when April 15th rolls around.

House Democrats have passed a bill that blocks the alternative minimum tax from spreading to middle income people. The tax was originally created back in 1969 to make sure very wealthy people don't duck their obligations to Uncle Sam with crafty deductions and tax breaks. But, because the tax never took inflation into account, every year it is set to affect more and more people.

Congress has been responding with a series of annual fixes, and that's what House Democrats did again today.

The White House and Republicans are less than thrilled by the $80 billion bill because it includes tax increases that will mainly ding investment fund managers. The White House says that would "undermine the competitiveness of U.S. businesses" on the international scene.

The 216-193 vote to "patch" the alternative minimum tax for a year sends the issue to the Senate, where its prospects are at best uncertain. Not one House Republican voted for it.

House Ways and Means Committee Chairman Charles Rangel, D-N.Y., last month outlined a plan to repeal the AMT, at a cost of $831 billion over 10 years, but acknowledged that action on his proposal is a long way off.

Friday's bill would extend AMT relief for one year, at a cost of about $51 billion. It includes another $30 billion in largely popular tax relief measures, including expanding the child tax credit, providing a property tax deduction to some 30 million families and extending a tax exemption for the combat pay of military personnel.

It extends several dozen targeted tax breaks due to expire at the end of the year, including a deduction for college tuition, a deduction for teachers' out-of-pocket expenses and deductions for residents of states that do not have income taxes. Others benefit winemakers, employers of Katrina victims, contributors to charities and state lawmakers.

The controversies come over some $80 billion in new tax revenues required under House Democratic rules that tax cuts or spending increases be offset so that the federal deficit does not grow.

The bill, said House Speaker Nancy Pelosi, will enable Congress "to plant a flag for fiscal responsibility."

But anti-tax Republicans said the AMT was a mistake and thus offsets were unneeded. "What absolute lunacy," said Rep. David Dreier, R-Calif., "paying for a tax that was never intended."

The bill would bring in $25 billion over 10 years by taxing so-called "carried interest" as ordinary income. Critics say that it is unfair that private equity managers pay the 15 percent capital gains rate on profits from fees or services instead of the ordinary income tax rate of 35 percent for high earners.

Democrats argued that 23 million people in danger of getting hit by the AMT would be protected by tax changes affecting some 50,000 people earning carried interest.

But changing this tax rule, as well as others affecting corporate transactions, "would undermine the competitiveness of U.S. businesses in the global economy and could have adverse effects on the U.S. economy," the White House said in a statement warning of a presidential veto if the House bill clears Congress.

Some pro-business Democrats joined Republicans in expressing concern that the carried interest provision could hurt venture capital and real estate investors as well as hedge fund managers making hundreds of millions of dollars.

Senate Finance Committee Chairman Max Baucus, D-Mont., plans to put together what he says will be a fiscally responsible Senate version of the AMT after the House vote, but has not committed to any specific tax raisers. Under Senate filibuster rules, Republicans have the votes to kill any bill with tax increases.

"Congress can and must stop this middle class tax hike before Thanksgiving - without raising taxes," Senate Republican leader Mitch McConnell of Kentucky said Friday.

But Pelosi said that "we have an understanding with the Senate that this legislation, in order to go forward, must be paid for."

"Raising revenues takes political courage," said House Majority Leader Steny Hoyer, D-Md. "There is no courage whatsoever in plunging our country into debt, spending and not paying."

The Internal Revenue Service has warned that delays in passing an AMT fix bill, because of House-Senate differences or a presidential veto, could have immediate repercussions for next year's tax-filing season. The IRS says it is now preparing forms for next year and ambiguity about the fate of the AMT could delay processing of returns for as many as 50 million taxpayers and delay issuing of about $75 billion in refunds.

The White House also said language in the bill to terminate an IRS program farming out delinquency cases to private debt collectors would subject it to a veto.

The bill is H.R. 3996.