Social Studies March 2006

A Bad Tax With Good Timing

The alternative minimum tax could turn out to be a politically tolerable tax increase at a time when the country needs all the fiscal help it can get.
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In 1969, Treasury Secretary Joseph W. Barr announced that 155 taxpayers with incomes over $200,000 had paid no income tax. "The news created a political firestorm," write Leonard E. Burman, William G. Gale, and Jeffrey Rohaly of the Tax Policy Center, a joint project of the Brookings Institution and the Urban Institute. "In 1969, members of Congress received more constituent letters about the 155 taxpayers than about the Vietnam War." Thus was born the alternative minimum tax, more widely known as the AMT—the single most reviled initialism in the tax lexicon, which is saying something.

Michael J. Graetz, a tax expert at Yale Law School, writes that the AMT is "the train wreck coming down the tracks." Other commentators make him sound gentle. Announcing the introduction of a repeal bill last May, Sen. Max Baucus, D-Mont., called the AMT "Darth Vader lurking in our tax code." Senate Finance Committee Chairman Charles Grassley, R-Iowa, another sponsor of repeal, called it "a mess, and we need to clean it up for good."

Well, any policy so uniformly reviled in Washington can't be all bad. The AMT is a dog, no doubt about that.

But every dog has its day.

The AMT is a separate tax code that operates parallel to the regular income tax. It allows fewer deductions than does the income tax, and it has only two rates, 26 percent and 28 percent. If they earn enough money to be subject to the AMT, taxpayers figure their tax liability both ways and then pay whichever is greater. This weird doppelganger has reduced the number of tax escapees, but that is the only respect in which it has worked as planned.

Because of its 28 percent top rate, it goes easier on the super-rich than does the regular income tax, which tops out at 35 percent. The wealthiest generally pay the income tax, not the AMT. The group that the AMT hits hardest is in the $200,000 to $500,000 range. Moreover, most of the tax breaks that the AMT disallows aren't plutocratic tax shelters at all; they are ordinary deductions that benefit the middle class. The AMT also arbitrarily cancels out many provisions of the regular tax code, which are themselves often pretty arbitrary; if the regular income tax is nonsense, piling the AMT on top of it is nonsense on stilts.

Most important, Congress never got around to indexing the AMT for inflation, as it did the income tax in the early 1980s. The result is that as nominal (not real) incomes increase with inflation, more and more taxpayers fall into the AMT's clutches. Already, in 2006, about 20 million taxpayers qualify to pay the AMT, and the number will rise to 30 million or so by 2010. The number of AMT payers will approach 60 million in 10 years, according to the Treasury Department. For the upper-middle class, the AMT will gradually become the de facto tax system. "It's like kudzu," says Gale, a Brookings Institution economist. "Eventually it just takes over."

As it sweeps in more taxpayers each year, the AMT becomes a revenue machine. In 2007, according to Treasury, it will increase individual taxes by $48 billion; in 2016, by $261 billion. Without reform, the result is an exorable middle-class tax increase. This is not nice. It is especially not nice for married couples and families with children, because the AMT raises their taxes.

Granted, this is no one's first choice. But is it a train wreck? Darth Vader?

In the real world, the alternative to the AMT is not some clean, rational, fair tax code. The alternative is the income tax, which Graetz is not alone in describing as "a horrible mess." The code contains more than 1.4 million words, he writes, "four times larger than War and Peace and considerably harder to parse." Tax regulations run to an additional 8 million words. Treasury figures compliance costs at roughly $125 billion per year. In his 2005 State of the Union speech, President Bush called the tax code archaic and incoherent. No one was heard to disagree.

The AMT is no less complex than the income tax, and running both systems in tandem is complexity squared. On the other hand, it is not clear that the AMT is a worse tax code than the income tax, and the AMT does have one considerable advantage: It collects more money.

What tax codes are supposed to do, after all, is pay the bills. The current income tax is not doing that. It could pay the bills, of course, if Congress raised taxes, but Congress is more interested in cutting taxes. The bills would be lower if Congress cut spending, but dream on.

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Jonathan Rauch is a contributing editor of The Atlantic and National Journal and a senior fellow at the Brookings Institution.

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