Learning to Love the Blob

Author: Jodie T. Allen

Published: May 24, 2004

It's the blob that ate the tax code. A self-multiplying terror creeping across America, engulfing exemptions, deductions, shelters, preferences--even promised tax cuts--in its hideous maw. Already millions of tax filers have felt its oily embrace. Left unchecked, it could consume the taxable incomes of 10 times as many only six years hence. Code Purple! Where is the Department of Homeland Security when we need it?

The monster in question is the alternative minimum tax. The AMT infiltrated the tax code back in 1969 with the laudable aim of ensuring that the very wealthy, those with top tax consultants, could not dodge most or all tax liability by crawling through the loopholes that a caring Congress had embedded in the tax code. Fair enough. But the AMT has wandered far from its original goal. Failure to adjust its exemptions for inflation--and new tax benefits added by the Bush administration--have morphed the AMT into a pernicious blight. Next April 15, some 3 million taxpayers--triple the number in 1999--will find that their AMT liability exceeds what they owe under the regular tax code and have to pay the larger amount. By 2010, says the Urban-Brookings Tax Policy Center (TPC), that number will escalate to 29 million filers. Not only are such taxpayers denied many or all of the tax cuts promised by the White House, but they must also plow through two different sets of IRS forms (though if you use computerized tax software, it can usually figure out your AMT at the click of a button). And the AMT's complexities can also produce the strange result that families with incomes of about $ 100,000 may end up facing higher marginal tax rates than do multimillionaires--some of whom again pay no tax at all.

Of course, your Congress is not inattentive to the plight of the AMT-ridden. The House recently passed a fix-up that would arrest the growth of the AMT--for one year. Why not for all time if it's such a plague? Because repealing it outright would be hugely expensive--even the one-year fix costs $ 17 billion. A full repeal, says the Congressional Budget Office, would add nearly $ 550 billion to the deficit over the next 10 years. And if the Bush tax cuts are made permanent, the cost of abolishing the AMT would rise to $ 658 billion, since, if it were still on the books, it would reclaim much of the lost revenue.

What's more, as Robert Greenstein, head of the Center on Budget and Policy Priorities, points out, in the eyes of today's governing class the AMT has a secret virtue: It makes tax cuts look very cheap. Especially those aimed at the highest brackets. That's because the AMT no longer weighs heavily upon its original target, the truly rich. According to the TPC's Leonard Burman, six years hence a mere 24 percent of taxpayers with incomes exceeding $ 1 million will pay the AMT, compared with 92 percent of those with incomes between $ 100,000 and $ 200,000. Partly that's because some of the rich have gotten so rich that no practical amount of tax shelters can reduce their tax liability below the level where the AMT kicks in. But it's also because Congress has shielded certain preferences--notably the reduced rates on both dividends and capital gains--from the AMT's bite. And the capital-gains break, says the TPC's William Gale, is the "mother of all tax shelters" --the very things the AMT was supposed to wipe out. This makes it easier to offer further tax breaks to well-heeled constituents at bargain prices, since the AMT can be counted on to claw back much of the tax cuts promised to the not-so-wealthy.

Makeover. So, what to do? How about rather than trying to kill the AMT by degrees, we embrace and beautify it? Do a makeover on its bad features--index the exemptions, eliminate remaining preferences, and institute a modestly progressive tax schedule reaching to the very top. Even raise some revenue on the side. Then consign the current code with its still more hideous and perverse complications to the dustbin.

It won't work, warns Burman. "Politicians don't like to be explicit about how they're raising revenue." He suggests building the AMT's best features--the closing of many loopholes--into the regular tax code little by little. Gale is similarly dubious: "The income tax code is the messenger--it's where we stick all these things we want to do. If we had only an AMT, I am confident we would load it up with all the same stuff."

But couldn't we just try? Who knows? People might like it when filing their taxes is a breeze and they don't have to fret that others are skipping out on their fair share. Entrepreneurs and investors might find it refreshing--and ultimately more profitable--to make decisions based on economic realities rather than on the arcane incentives prescribed by the tax code writers. And think of all the money they could save on tax accountants.