WASHINGTON -- The tax "bubble," one of the more exquisitely convoluted provisions of the income tax code, has suddenly taken center stage in the budget debate.
Democrats and some Republicans seeking a budget compromise have proposed eliminating the bubble in exchange for a capital gains tax cut. For a while, it looked as though President Bush might go along with the idea.
Is the bubble, as some Democrats claim, a loophole benefiting the rich? Or as Sen. Bob Dole, R-Kan., says, are complaints about its lack of fairness "a bubble of hot air?"
Here is how "the bubble" works:
The bubble is a 5 percent surtax on higher-income taxpayers that looks like a step up and down in tax rates when displayed in a graph.
Those taxpayers who are "in the bubble" pay a 33 percent rate on the portion of their income that falls within a set range.
The 1986 tax reform established two basic income tax rates -- one at 15 percent, the other at 28 percent -- that one pays on income above a set level.
The bubble was designed to eliminate the benefit that wealthier taxpayers would get from paying the 15 percent rate on the first part of their income and to strip away the benefit of the personal exemption for those taxpayers.
In 1990, for example, the 15 percent rate applies to the first $19,450 of income for single filers and the first $32,450 for a married couple filing jointly.
After the benefit of the lower rate is "recaptured" by the bubble at the 33 percent rate, the rate drops back to 28 percent. The effect of the bubble is to tax all income of taxpayers in that bracket at 28 percent.
In 1990, a married couple filing jointly would enter the 33 percent bubble at $78,400 of income, according to the Internal Revenue Service. Their tax rate would drop back to 28 percent after $185,730.
Single filers would enter the bubble at $47,050 of income. Their rate would drop back to 28 percent after $109,100.
"Many people believe -- incorrectly -- that taxpayers [now] sub-ject to the 33 percent rate are being treated unfairly compared to higher-income taxpayers whose top marginal rate is 28 percent," said Sen. Bill Bradley, D-N.J., who helped write the bubble into law.
"In fact," he added, "the bubble does not reward the rich. It enhances the tax system's progressivity."
Democratic proposals to eliminate the bubble would extend the 33 percent rate beyond the point where it now drops back to 28 percent. That would increase taxes paid by the nation's 600,000 richest taxpayers.
Since the budget summit agreement included hefty excise tax increases that hit the lower and middle classes disproportionately hard, Democrats argue that it is only fair to raise income taxes on the rich.
Said Mr. Dole: "The bubble may be the first major tax provision ever repealed because people don't understand it."