Defending the Alternative Minimum Tax.

Policy made plain.
Oct. 20 2007 7:05 AM

A Viable Alternative

Defending the tax the GOP wants to kill.

Sen. Chuck Grassley (R-IA). Click image to expand.
Sens. Max Baucus (left) and Chuck Grassley (right)

The Alternative Minimum Tax. It sounds horrible, doesn't it? And it gets very bad press. It was invented in 1969 as a way for the government to collect at least something from affluent people who had been a bit too successful at taking deductions and credits on the basic Form 1040. The AMT operates like an extra fence around a maximum-security prison. If they don't get you the first time, they'll get you the second.

Conceptually, this is all wrong. Tax deductions aren't (or aren't supposed to be) goodies distributed like candy on Halloween. Each one should have its own justification. And you are entitled to each one you qualify for. Giving the kids too much candy and then trying to take some of it back is a good way to become unpopular in the neighborhood. The AMT is getting more unpopular every year, as more and more taxpayers fail to make it over that second fence. The group that was fewer than 1 percent of taxpayers in 2000 will be 20 percent in 2010 unless something is done.

Having to calculate your taxes twice is annoying, too, although the Congressional Budget Office observed a few years ago that for most folks:

[T]he process is fairly simple. If they elect not to itemize their deductions, they just subtract the AMT exclusion—$58,000 for married taxpayers filing jointly and $40,250 for most other taxpayers in 2003 and 2004—from adjusted gross income (AGI) and apply the two-step tax rates of 26 percent on the first $175,000 and 28 percent on any excess. If that amount exceeds their pre-credit regular tax liability, they owe the excess as AMT.

What could be easier? For others, the CBO acknowledges, "the process is more complicated."

More people are getting caught in the AMT trap for two reasons. One is that inflation is pushing middle-class people into territory associated with the rich. The other is that George W. Bush's first-term tax cut lowered the regular income tax for affluent people so dramatically that many more people qualify for exactly what the AMT is supposed to do—make sure that nobody with a high income gets away with paying little or no income tax. Bush's tax cut was, in this sense, a fraud. He let people escape past the first fence, knowing that many would be caught by the second one. All the budgets of his presidency have assumed—and spent—the money raised by the AMT, even as he and every other Republican have inveighed against it.

In the Oct. 11 Wall Street Journal, Sen. Charles Grassley, R-Iowa, urged repeal of the AMT and expressed great frustration, contempt, and downright bewilderment about the so-called "pay as you go" or "paygo" rules of the Democratic Congress. Under these rules, you can't introduce a tax cut without saying where you propose to get the money to cover it. Can you imagine anything sillier? Grassley cannot. With an inflamed sense of indignation but a firm grasp of arithmetic, Grassley noted that if you try to eliminate the AMT under this rule, as the Democrats are trying to do, "vast numbers of people would see their taxes go up." That is absolutely true. Every dollar someone's taxes are lowered is a dollar that someone else's must be raised. Unless, of course, you forget about those ridiculous Democratic "paygo" rules—"a simple procedural step," as Grassley says blithely.

And what about the $840 billion that the AMT is supposed to bring in over the next 10 years? Grassley doesn't say what he would do about that. More to the point, Republicans urging repeal of the AMT without a compensating increase in top brackets of the regular income tax (the Democratic solution) never have said where they'll get the money. Oh well, said Robert Novak in his WashingtonPost column the same day as Grassley's piece in the Journal, if we kill the AMT, "[g]overnment would have to get leaner." Next problem?

In the six years ending last January, when they controlled both Congress and the White House, Republicans could have made government as lean as they wished, and no one could have stopped them. They didn't. It used to be that when they proposed irresponsible or fantasmagoric tax cuts, Republicans at least went through the motions of coming up with some theory about how it would all be paid for.

Supply-side economics—tax cuts would pay for themselves by generating new economic activity—often played this role. It made no sense, but it honored the tradition that you at least give the voters the material they need to fool themselves. It was the tribute that demagoguery pays to mathematics. Now, they don't even bother.

The problem with present arrangements isn't the AMT. It's Bush's tax cut for the affluent. For example, Citizens for Tax Justice (a left-wing group, but one whose analyses are rarely challenged by neutral experts) figures that the most startling element of that tax cut—the reduction of tax rates on both dividends and capital gains to a maximum of 15 percent—reduced tax revenues by $91 billion in one year (2005). Three-quarters of that benefit went to taxpayers—the top 0.6 percent—who reported incomes of more than $500,000. The AMT prevents the federal deficit from being even higher than it is. And although it no longer strikes only the very tippy-top incomes, it still is fairly progressive: Even in 2010, when the AMT will hit 20 percent of taxpayers if it isn't changed, more than half of AMT revenue will come from taxpayers reporting incomes higher than $200,000.

Actually, if you were designing the tax system from scratch, you might come up with something that looks a lot like the AMT. It resembles the "flat tax" of many reformers' dreams: a high basic exemption, so that low-income people don't pay it at all; very few deductions, credits, or exclusions; and (because of that) a much lower top rate than the current system: 26 percent compared with almost 40 percent. What makes it complicated is having to figure your taxes twice to see if it applies to you. Of the two parallel tax systems we now have—the regular income tax and the Altermantive Minimum Tax—it might make more sense to scrap the regular one and keep the AMT.

The tax code goes through generational cycles. The last big reform was 1986, when loopholes, deductions, and credits were eliminated and rates were cut dramatically. People remember this as a triumph of Ronald Reagan. But in fact, that reform emerged out of popular anger at the discovery that Reagan's earlier tax cuts had allowed many rich individuals and corporations to pay little or no tax. That is exactly the same anger that led to the creation of the AMT in 1969. And again today, many people, especially Republicans, say they want a simpler tax system with low rates and no loopholes. But one person's loophole is another person's important social policy—or, in fact, the same person's important social policy. As soon as we get that simpler system, people will start cluttering it up again: lower rates for capital gains, to encourage investment; the charitable deduction, to encourage private philanthropy; a bigger exemption for dependents, to encourage "family values" (you got a problem with this, buddy?). But all that's OK—in 20 years we can sweep out the clutter and start all over again.

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