Tax code escalates as Democrats' power tool

From reforming the nation's health care system to helping victims of Wall Street fraud mastermind Bernard Madoff, the White House and Congress have turned to the tax code to push their policy priorities. With Congress gearing up to tackle President Obama's proposed $1.5 trillion budget for fiscal 2010, the tax battles are certain to intensify.

Using the tax code to push a presidential agenda is nothing new. But with a budget that proposes expensive and far-reaching reforms in health care, energy and education, Mr. Obama has taken the tactic to a new level.

"Speaking very broadly, it's pretty common," said J.D. Foster, a tax policy analyst at the conservative Heritage Foundation. "The tax code, from bow to stern, is full of policies that are proposed by the president and congressmen that are intended to manipulate the economy or social structures and social behavior."

What is unusual about Mr. Obama's agenda, he said, is that "he is trying to redesign our nation in such broad strokes, covering so many areas at once."

Robert Greenstein, executive director of the liberal Center on Budget and Policy Priorities, praised the thrust of the Obama budget.

"All the tax increases either affect only people earning more than $250,000 or close tax loopholes that should not have been there in the first place," he said, adding that the Obama budget would peel back the $120,000 average tax cut on those making more than $1 million, while the "vast majority" of small-business owners would benefit from the president's health care reform.

The administration looked to the tax code when trying to help victims of Madoff's Ponzi scheme. The 20-year fraud, uncovered in December, took in charities, hedge funds, universities and celebrities. The personal savings of many small investors were wiped out.

The Internal Revenue Service announced last week that the tax agency had issued two rulings intended to soften the losses for the thousands of individual and institutional investors taken in by financial scams, such as the $64 billion scheme operated by Madoff.

The new guidelines clarify rules letting victims of Ponzi schemes claim "investment theft losses" on their tax returns, allowing for greater deductions than could be claimed under other types of capital losses.

Congressional Democrats turned to the tax code again for a quick fix in the furor surrounding bonuses paid to executives of insurance giant American International Group Inc. The bonuses were paid after the company had accepted more than $170 billion in taxpayer aid to avoid bankruptcy.

The House of Representatives, after just a couple of hours of debate, passed a bill Thursday to tax 90 percent of the bonuses granted to top earners at AIG and any other company that received more than $5 billion in taxpayer bailout funds. The Senate may take up its own confiscatory tax bill targeting AIG as early as this week.

"By any measure, you are disgraced professional losers," Rep. Earl Pomeroy, North Dakota Democrat, said during the brief House debate. "And by the way, give us our money back."

Mr. Obama has not said whether he would sign the measure if it reaches his desk.

"What he has said is that he's going to look at any legislation. And I'm sure he will do that," Christina Romer, chairman of the White House Council of Economic Advisers, said on "Fox News Sunday."

Jared Bernstein, economic adviser to Vice President Joseph R. Biden Jr., called the bill "a dangerous way to go."

"I think the president would be concerned that this bill may have some problems in going too far - the House bill may go too far in terms of some - some legal issues, constitutional validity, using the tax code to surgically punish a small group," he said Sunday on ABC's "This Week."

But the resort to highly targeted taxes - even against such an unpopular target as AIG - has left others uneasy. "People have to understand that using the tax code for punishment is a horrible, disastrous precedent," said Rep. John Campbell, California Republican.

"It's 'everybody grab the pitchforks,' " said Sen. Judd Gregg, New Hampshire Republican and one of several lawmakers who warned that the AIG tax increase was unconstitutional.

As the administration searches for money to fund its biggest campaign promises, Mr. Obama has backed away from some proposed tax increases in the face of popular opposition.

The administration hastily dropped a proposal to require some disabled veterans to pay for medical treatments through their private insurance companies, heeding a chorus of outrage from veterans groups and Capitol Hill lawmakers who said the idea was immoral, unconscionable and un-American.

The White House scrapped the plan after meeting with a contingent of veterans and military advocacy groups last week.

Conservative critics say one of the most far-reaching tax changes in Mr. Obama's budget involves greatly expanding the practice of giving tax refunds to low-income people who owe no taxes - "refundable tax credits."

"Obama's basic ethos that he ran on was that he wanted to spread the wealth, to take money from people that he perceived to have too much money and give it to people he perceived did not have enough money," said Ryan Ellis, tax policy director at Americans for Tax Reform, which pushes for lower taxes. "He's very consciously using refundable credits a lot in order to give money to people that aren't taxpayers, which is a big deal."

The difference between a tax credit and a refundable tax credit is that a normal tax credit reduces liability down to zero. For example, if the refundable credit is $500 and a taxpayer owes $300, the taxpayer receives a $200 check from the government.

Mr. Obama "wants to take existing credits in the code, bulk them up, and them make them refundable," Mr. Ellis said. "This is the way he's spreading the wealth, doing his social engineering."

• David M. Dickson contributed to this report.