The looming Alternative Minimum Tax catastrophe, and why the Democrats shouldn't try to prevent it.

The looming Alternative Minimum Tax catastrophe, and why the Democrats shouldn't try to prevent it.

The looming Alternative Minimum Tax catastrophe, and why the Democrats shouldn't try to prevent it.

Moneybox
Commentary about business and finance.
April 10 2007 10:22 AM

Fix the AMT (But Not Yet)

The looming Alternative Minimum Tax catastrophe, and why the Democrats shouldn't try to prevent it.

Tax Form 6251.

It's the middle of April, which means it's time to wring our hands about the Alternative Minimum Tax. This parallel tax system, first created to make sure really rich people couldn't avoid paying taxes by notching huge deductions, has slowly expanded its reach. (Here's a Congressional Budget Office backgrounder about the tax.) If you live in a state where incomes, property taxes, and state income taxes are comparatively high—i.e., the coasts—you're in greater danger of paying the AMT. That's why I've dubbed it a secret tax on Democrats, and that's also why the AMT could become a powerful political weapon for Democratic candidates in 2008.

An estimated 3.4 million people wound up owing the AMT in 2006. But since the AMT threshold isn't indexed for inflation, projections in any given tax year generally call for the number of AMT payers to rise enormously in the following year. In recent years, Congress has adopted a series of temporary fixes to prevent the AMT from exploding. Next year, Edmund L. Andrews * wrote in the New York Times Sunday, the AMT "if left unchecked is expected to affect 23 million households during the 2007 tax year."

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Andrews'* article lays out the Democrats' plan to make the annual AMT panic a thing of the past by fixing it permanently. Democrats propose to exempt from the AMT the 97 percent of Americans making less than $200,000 a year. In fact, the best political and fiscal strategy for the Democrats might be to do the opposite: let the AMT hit all the 23 million taxpayers vulnerable next year and see what happens.

Unlike drunken-sailor-spending Bush Republicans, Democrats still have a vestige of 1990s-era fiscal responsibility remaining. Democrats believe that revenues lost by tax cuts should be offset by spending cuts or other tax increases. But to fix the AMT satisfactorily, Andrews * writes, Democrats would have to either jack up tax rates on high earners or eliminate popular deductions, which would effectively raise taxes on many taxpayers.

In either case, Republicans would have a carnival, attacking the Democrats as tax-lovers. The Republicans' main argument against Democrats is that they'll raise taxes by letting the Bush tax cuts expire in 2010. Fix the AMT now and it will simply allow Republicans to argue that the Democrats are raising taxes in 2007 and 2008, too. What's more, fixing the AMT permanently provides all the drawbacks of responsible tax cutting with none of the benefits. The point of fixing the AMT is to shield millions of Americans from future tax increases. But Americans, who are instant-gratification addicts, would sooner vote for somebody who cuts taxes by $1,000 today than for someone who spares them a tax hike of $2,000 tomorrow. The last time Democrats with a narrow majority in Congress raised taxes on high earners to improve the nation's fiscal picture was 1993. The following year, they were unceremoniously booted into the wilderness, whence they wandered for a dozen years.

The alternative is to let the long-dreaded AMT explosion take place next year. Sit back and wait for President Bush to propose a solution. (He won't.) Or propose a permanent fix but make it conditional on proposals that would be anathema to Bush—like restoring the estate tax.

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A year from now, 20 million additional people, including me and probably most of my colleagues, co-workers, co-commuters, and neighbors, will find themselves suddenly hit by the AMT.

Letting a crisis develop would be irresponsible. But it would help clarify issues and force action. Policy wonks on the left, center, and right all know that simply patching the AMT year after year forestalls a larger debate about tax rates, deductions, and entitlements.

Would Democrats suffer political backlash? Probably not. The AMT's victims will be concentrated in states in which Republicans are not likely to be all that competitive in 2008. In the home of Bushenfreude, middle-class and well-off voters already tend to blame Bush and his Republican associates for everything that has gone wrong. And well they should, given the GOP's shocking fiscal irresponsibility under Bush. It would be easy to fault them for the AMT crisis, too.

When the crisis peaks, Democrats can offer their alternative: fix the AMT, which would then be hitting millions of middle-class voters by rolling back the Bush tax cuts on the very rich. That's a political argument they will win. What they shouldn't do is try to repair the AMT problem too soon, before the catastrophe next April. Fixing it before taxpayers feel the sting would be better fiscal policy—but lousy politics.

*Correction, April 10, 2007: This article originally misidentified the author of a New York Times story about the AMT. It was Edmund L. Andrews, not Robert Pear. Click here to return to the corrected sentences.