Congressman’s Bill Calls for “Middle-Class” Tax Relief

September 25, 2007

Congressman Nick Lampson released Monday a package he calls “middle-class” tax relief that would include special tax provisions for numerous groups. From the Houston Business General:

Legislation proposed in a series of six bills by U.S. Rep. Nick Lampson (D-Stafford) would extend tax relief set to expire later this year for teachers, armed forces personnel and other middle-class individuals.

The proposals rolled out Monday include:

The America’s Heroes Tax Relief Act would permanently allow military personnel called up for active duty to withdraw from 401(k) or 403(b) annuities without tax penalties.

The America’s Teachers Tax Relief Act would make permanent a deduction for out-of-pocket expenses for classroom supplies set to expire at the end of 2007 for elementary and secondary school teachers.

The State Sales Tax Equity Relief Act would make permanent a current provision that allows taxpayers to deduct state and local general sales tax from their federal income tax.
The Smart Energy Tax Relief Act would make permanent tax credits for production and sale of bio-fuels and alternative fuels and encourages the development of future sources of energy. The bill also extends the tax credit for energy-efficient appliances used by Americans every day.

The package also includes a new proposal, the Middle-Class Investor Tax Relief Act. It would raise the salary cap for capital gains and dividend tax exemption for individuals who make less than $30,000 a year to $100,000 in gross adjusted income per year, and boost the cap for married couples who make less than $60,000 to $200,000 per year.

Allowing those in the military to withdraw without penalty from their pensions may sound good, but why increase their compensation in an indirect way? If Rep. Lampson feels that compensation for military employees needs to be increased, why do it through the tax code in a way that would only benefit members based upon certain criteria (if they withdraw from their pensions)? Why not just increase the salaries of those on active duty directly, and leave the tax code alone so as to not expand complexity? Sen. Jim Webb proposed a tax cut for veterans last year that was also bad tax policy, as we explained here.

As for the teachers’ expenses, legitimate business expenses should be deductible under an income tax system. However, this principle should not stop with K-12 teachers. Professors who make purchases should also be allowed to deduct those expenses, as well as those in other fields. Also, we need to ask whether this spending should simply be done by the school system itself and thereby done through traditional spending means.

With regard to the sales tax deduction, there are two competing issues here. First, equitable taxation would call for the sales taxes paid to be deducted if there is going to be an income tax deduction. This also would not discourage one form of state taxation compared to another. On the other hand, the state and local tax deduction can encourage inefficiently large government at the state and local level, and since it is only claimed by itemizers, tends to disproportionately flow to higher-income individuals. The question comes down to whether or not Haig-Simons Income at the federal level should be deducted by the taxes paid to state and local governments.

As for the Smart Energy Tax Relief Act, it appears to be a highly complex way for government to promote energy conservation. Unfortunately, using the tax code to achieve environmental policy in this way (as opposed to, say, an across-the-board carbon tax, which would be simpler and more direct, albeit not without controversy) the IRS would basically be doing the work of its neighbor on Constitution Avenue, the EPA.

Finally, putting forth special treatment on capital gains and dividends for taxpayers based upon AGI can have both positive and negative aspects. It would undoubtedly create more complexity. Furthermore, having a zero rate for capital gains and dividends based on income level and then suddenly charging the 15 percent rate on all capital gains once a person’s income reaches a certain threshold can create a cliff-type tax rate system where a person would be better off, from an after-tax income perspective, earning $100,000 instead of $100,001. In other words, the marginal tax rate could exceed 100 percent under certain circumstances, which is quite possibly the worst way in which taxes can distort behavior.

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