Just as a foolish idea is about to fade away from the tax law, the new Administration seeks to bring it back in an even more perverse form. I'm talking about tax increases masquerading as phaseouts. Many years ago, some clever but manipulative members of Congress decided that they could fool the American public into thinking that they did not raise taxes if they found a way to raise tax revenue without raising rates. Their thinking was that by leaving tax rates alone they could argue that they had not raised taxes. What they did was to reduce itemized deductions and the deduction for personal and dependency exemptions by a percentage or amount reflecting the extent to which the taxpayer's adjusted gross income exceeded a defined threshhold. The result was an increase in taxes without an increase in rates. To call this deceptive is to be too kind.

It took years to persuade the Congress to rid the Internal Revenue Code of these provisions, which have taken on the names Pease and PEP. The former is a unwarranted memorial to the member of Congress who shared this confidence game technique with the rest of the legislature. PEP is an acronym for personal exemption phaseout. It's technically inaccurate, but generates something that can be pronounced even though it hardly adds any energy to anything. What it does, along with its analogous Pease of junk, is to sap the energy of taxpayers trying to prepare returns, students and citizens trying to learn the tax law, and teachers trying to explain something that imposes a ten-fold time requirement on what was once a fairly simple tax topic.

As can be seen from page 123 of the President's Budget Proposal, the Administration wants to "reinstate the personal exemption phaseout and limitation on itemized deductions." Why? If the goal is to raise revenue, and I cannot think that the goal is anything but to raise revenue, why fall back to a failed mechanism? Why not have the courage to raise tax rates? Aside from the absurd complexity of Pease and PEP, it imposes a higher marginal rate on taxpayers with incomes just above the threshhold than it does on the megamillionaires who ought to be bearing the brunt of the revenue increases. I wrote about the problem in Getting Hamr'd: Highest Applicable Marginal Rates That Nail Unsuspecting Taxpayers, 53 Tax Notes 1423 (1991). I suppose if Congress is going to bring Pease and PEP back to life, I may need to put my pen to work and produce an updated version of that article. And then find a way to persuade members of Congress, the President, and his staff to read it and get a free education.

Worse, the Budget Proposal contains an even more complicated rate phaseout mechanism, designed to "limit the tax rate at which itemized deductions reduce tax liability," as summarized on page 128 of the proposal. As explained on page 29 of the proposal, the revenue raised from this mechanism would go into a reserve fund to be used for health care purposes. I can guarantee that the tax computation form on which this mechanism is worked out will be even more complicated than the one on which the special low tax rate on capital gains and dividends is computed. It is an extremely inefficient way in which to raise revenue. For example, why not convert itemized deductions into a credit equal to 28% of the amount otherwise qualifying for a deduction? That accomplishes the same goal, and actually benefits some taxpayers in the lower tax brackets.

What's missing from the proposal is any sort of forward-looking change in the way tax policy is developed and implemented. Pulling a failed idea from the trash heap is unwise. Why are taxpayers earning $500,000 a year treated in the same manner as those earning more than $5,000,000 a year? Why not a progressive rate structure that increases the rate by 1 or 2 percentage points for every $1 million or $2 million increase in taxable income? Why not total elimination of the special low rates on capital gains and dividends? Why not termination of depreciation for property that does not go down in value? Would not streamlining the tax law do more for lubricating the national economic engine than fooling around with mudflaps and exhaust pipes?

How did this happen? The answer is fairly easy. There still has not been anyone nominated and confirmed to serve as Assistant Secretary of the Treasury for Tax Policy. It is unlikely that the Secretary of the Treasury paid any attention to these matters, and even if he did, it's unlikely he has any clue as to what's going on, considering he cannot do his own tax return properly. One would think he'd be an advocate for simplification, not for more megacomplexity. My guess is that these ideas were tossed in by some young, eager staff at the White House and/or the Office of Management and Budget, perhaps influenced by some old-timers who remember the "good old days" when they were able to infect the tax law with gimmicks more reminiscent of toxic derivatives manufacturing rather than wholesome economic productivity. I'm confident none of these folks has any sort of worthwhile experience with tax compliance, tax return preparation, business planning, or even tax policy, other than having some conceptual and theoretical notions that do not translate very well from the world of philosophy to the world of real life.

It's likely that the response to my advocacy for increased rates scaled throughout the upper income ranges, rejection of complex gimmicks such as Pease and PEP, and repeal of the special low rates for capital gains and dividends is that these things are not "politically" feasible. So what? The nation, the President, the Administration, and the Congress should be doing what is right and necessary for the economic survival of the nation, and not what sells politically. Politics has become nothing more than a series of manuevers in which office holders engage in order to grab and hold power. For a moment, it appeared as though the current President wanted to rise above politics, spurn partisanship, and read the riot act where and when it needs to be read. What is emerging has too much "let's not ruffle the feathers of the powerful" and too little "let's listen to the American citizen who voted for change and step forward with those folks behind us."

Let's face it. The days of using Pease and PEP to hide tax increases are long gone. Everyone knows the score. Aside from the impropriety of raising taxes using clandestine gimmicks, there's no need to do so. There's no genuine impediment to doing what needs to be done in the way it needs to be done. The bleating from the privileged few that taking away their capital gains break or their special dividend rate will destroy the economy should fall on deaf ears. The special interest groups have cried wolf too many times.

Change is defined as "a transformation," as "novelty," as "the passing from one … form .. to another," as "the supplanting of one thing by another." To change is defined as "to transform." It is time for transformation with novel approaches, as the tax law passes from its current and past form into one that is suitable for the challenges of the twenty-first century. Running on a tax treadmill is not change. Turning back to the failed policies of Pease and PEP is no better than turning back to the failed policies of tax cuts, as I described on Friday. President Obama, you're an advocate of change. You and your crew can do better than to breathe new life into a stale, unwise, and inefficient idea. And you know that. Change means scaled progressive rates, no more special rates for capital gains and dividends, itemized deductions replaced by credits or eliminated, no more depreciation on property not going down in value. Don't back down in the face of the bullies. Don't be reluctant to propose and fight for the tax law changes that need to be made. Some wealthy folks and some powerful politicians may be unhappy, but the overwhelming majority of Americans who take the time to study and understand the realities of the current crisis will appreciate your decision and applaud your determination.
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