04.29.07
AMT: Who pays?
A recent rumor suggests the Democratic leadership has reached consensus on a plan to “reform” the Alternative Minimum Tax. While I’ve never met a tax that was broadly popular, the AMT has received more than its share of bad press in recent years. Why so much angst?
Originally created in 1969 to answer a couple dozen millionaires who had creatively used massive deductions to eliminate their tax liability, the AMT is a parallel tax system with a higher exemption ($62,550 for the 2006 tax year), fewer allowable deductions, and a lower top tax rate. Those who might potentially be eligible must calculate their tax bill under both systems, with their actual liability being the greater of the two. (In strict usage, the term “AMT” refers only to the amount owed that is above and beyond the regular income tax.)
So, who is affected? Consider the table below, prepared by the Congressional Budget Office in 2004. (All figures from 2004 and beyond are projections.) Because of the large AMT exemption, very few households with an AGI of less than $100,000 owe the AMT. Because the top rate under the AMT is 28%, less than the top regular tax bracket of 35%, most households making $500,000 and up are also missed. Yet the majority of households with incomes of $200,000 to $500,000 owe more under the AMT.
Taxpayers with AMT Liability, by Adjusted Gross Income in 2003 Dollars, Calendar Years 2001 to 2014
Looking forward from 2004, however, we see some dramatic changes in the AMT profile. Both political parties blame the opposition, however the most immediate cause of this dilemma was the 2001 Bush Tax Cut. Since AMT is owed any time the regular income tax is less than the AMT calculation, a reduction in the regular tax rates forces more people into the AMT.
While people “caught” by the AMT in this example still pay no more than they would have paid before the tax cuts, an expansion in the scope of the AMT is undesirable for several reasons:
- It doesn’t seem fair for some people to benefit from the tax cuts while others end up paying just as much as they did before — especially if you are one of those unlucky few who don’t benefit!
- Though the essential AMT calculation is simple enough, the rules reconciling it with the regular income tax get pretty arcane. Look up details on “AMT credit for tax paid in prior years” if you dare. The work required to file a return increases dramatically for those affected by the AMT.
- Tax incentives, such as the hybrid vehicle tax credit, only serve their purpose if they modify people’s behavior. If somebody is unsure which system will apply to their situation, then tax credits become far less useful for social engineering.
Adding to the confusion is the penchant our legislators have for “temporary” tax measures. For example, the Bush tax cuts are mostly subject to a “sunset” provision under which the tax system reverts to its previous state in 2011. Had this clause not been included, the long-term cost of the tax cuts would have been much greater (presumably sapping public support for the bill). Similarly, Congress has enacted one-year “patches” to the AMT exemption every year since 2001, temporarily increasing the exemption from current default of $45,000.
Our legislators could pass a permanently increased exemption, or even index the increase to inflation, but this would deal a severe blow to future budgets that depend on the AMT revenues. According to this article, “The Tax Policy Center estimates that repealing the AMT would cost $851 billion between now and 2017, assuming the president’s tax cuts are allowed to expire. If they’re extended, the projected cost over 10 years rises to $1.6 trillion.” Increasing the AMT exemption would reduce revenues less, but the numbers are still staggering! Perhaps it is understandable that Congress has thus far preferred to play “ostrich”, fixing the problem in the short term while pretending that the future revenues will still be available?
The current reform proposal is expected to:
- Exempt taxpayers with less than $250,000 of income.
- Phase in the AMT between $250,000 and $500,000 of income.
- Tax those with more than $500,000 of income at a 35% rate, substantially higher than the 28% marginal rate that presently applies.
The first line will obviously resolve concerns of the AMT spreading to affect middle-class families. The second line serves to avoid a “threshold” effect in which households with a $260,000 income pay dramatically more than those with a $240,000 income. I expect that most or all taxpayers in that range would be required to calculate the AMT (or hire an accountant to do it for them), however they would only pay a fraction of the additional tax. The third line is the kicker — by boosting the tax rate on the wealthiest families, it ensures that this proposal is revenue-neutral. Since the top marginal tax rate under the Bush tax cuts is the same 35%, it seems to imply that the AMT would apply to essentially all taxpayers in this category.
The AMT is a necessary evil to prevent the wealthy from manipulating the tax code to avoid paying their share of taxes. As the chart illustrates, the AMT is currently most significant for households with an AGI of $200,000 to $500,000. Under the new proposal, this profile would once again become a tax on the ultra-wealthy. Seems fair, perhaps? Unless, of course, you are making more than $500,000 and would prefer that somebody else pick up the check.
Pontifex said,
April 30, 2007 at 1:21 pm
1. It doesn’t seem fair for some people to benefit from the tax cuts while others end up paying just as much as they did before — especially if you are one of those unlucky few who don’t benefit!
– Fairness and Luck? Seriously? If things were “fair,” then I’d be paid a lot more for what I do considering the revenue I generate for my company. I guess then I’d be “unlucky” because I’d be taxed even more than I already am.
2. — No need to delve into the complexities of tax law. It’s a mess from any angle.
3. Tax incentives, such as the hybrid vehicle tax credit, only serve their purpose if they modify people’s behavior. If somebody is unsure which system will apply to their situation, then tax credits become far less useful for social engineering.
– How about a tax incentive that rewards hard work? And do you really think that social engineering is an aim of the tax code? Engineering towards what goal? Yours? Mine?
Let’s avoid redistribution of wealth. Do you want to hand over a percentage of the money you make to me, in cash *each and every week* even though I have no hand in what you do or how you make your living? How about from your hand to, say, my cousin’s. He’s a good guy, down on his luck. But he doesn’t make as much as you, so what do you say?