According to the New York Times, “House Democratic leaders, in an effort to upstage Republicans on the issue of tax cuts, are preparing legislation that would permanently shield all but the very richest taxpayers from the alternative minimum tax, which is likely to affect tens of millions of families as early as next year if it is left unchanged.”
Unfortunately, the simplest solution — repealing the AMT — doesn’t seem to be on the table, nor is the almost-as-simple solution of indexing the AMT to inflation. So we’re left with a needlessly complex situation created by past tinkering with the tax code and current attitudes.
The AMT was created in 1969 to make sure millionaires could not use “loopholes” and deductions — all carefully created by Congress in response to special interests — to avoid paying any federal income tax at all. Taxpayers with certain levels of income are required to do a second tax calculation without claiming popular deductions such as those for state and local taxes. In practice it works similarly to a flat tax of 26 percent to 28 percent.
But the income levels at which the AMT kicks in are not adjusted for inflation. It can now hit people with incomes of around $50,000. Congress has been doing one-year fixes on the AMT so it won’t hit most of those who would otherwise be eligible; last year about 3.4 million households had to pay AMT, but if there’s no legislative fix this year, about 23 million households would have to pay at the AMT rate.
Interestingly, Democrats may have a political incentive for proposing a tax cut — that’s what a permanent change in AMT would represent — which seems uncharacteristic. The AMT has a disproportionate impact in states with higher incomes, higher property values and higher state and local taxes. States with such characteristics — New York, California, Connecticut, Massachusetts — tend to lean Democratic.
There are two potential problems with a permanent change. One is that the government has become addicted to the money the AMT brings in — about $50 billion this year, according to Cato Institute tax policy analyst Chris Edwards.
President Bush’s latest budget proposal contains a one-year fix of the AMT but not in ensuing years — and his hope of a balanced budget by 2012 rests on increasing money from the AMT.
The other is that the Democrats passed what they call “pay-go” legislation, meaning that proposed tax cuts or spending increases must be paid for in the current budget. Eliminating or reducing a tax would at least theoretically require increasing taxes elsewhere or cutting spending. Not easy for politicians.
Indexing the AMT for inflation would be a relatively simple fix in terms of protecting middle-class taxpayers from a provision originally intended to target millionaires, but doing so would reduce the government’s take in future years.
In an ideal world, the AMT would simply be repealed, because cutting taxes almost always leads to increased tax revenue — though not always enough to replace the revenue “lost.” And the tax “loopholes” that benefit only the wealthiest would also be scrutinized and many scrapped.
Edwards thinks all these complications and political calculations will keep congressional Democrats from a permanent fix of the AMT — and if a fix involves even higher marginal tax rates on people earning $250,000 or more a year, one of the proposals on the table, failure might not be bad. If they can’t simply repeal the AMT, however, we hope they come up with a long-term approach that doesn’t make the tax code even more needlessly complex than it already is.