Gotcha!

Published: April 4, 2004

Third of an occasional series of editorials on issues that ought to be "Hot Topics" in the 2004 presidential campaign.

Taxpayers, watch your backs. The government is about to hit you where it hurts the most.

Just when you thought it was safe to file that tax return, think again. Lurking just out of sight, a tax-hiking shakedown artist is chipping away at those tax cuts you've heard so much about, and growing greedier by the year. It's called the Alternative Minimum Tax, alias the AMT. Enacted to make sure that wealthy people pay at least a minimum amount of federal income tax, the AMT is now stalking Mr. and Mrs. Middle America.

Its turf is anyplace where people have comfortable incomes and pay high state and local taxes. It's favored prey? Taxpayers with children. In short, it will hammer taxpayers on Long Island and in New York City. Hard.

It doesn't matter if all the deductions and credits folks claim are perfectly legal. It doesn't matter that those deductions don't cancel out their obligation to pay the regular income tax. With the AMT, they'll pay more anyway. "It's going to be the largest tax increase on the middle class in history," said Rep. Steve Israel (D-Huntington).

Congress should rein in this rapacious monster, so that it serves its original purpose and nothing more. Recent temporary, year-by-year Band-Aids have slowed the AMT's encroachment. But that's no real solution for what Internal Revenue Service national taxpayer advocate, Nina Olson, identified in her annual report to Congress as one of the top two problems facing taxpayers. (The other is noncompliance by sole proprietors).

The numbers are startling.

In 2001, the AMT saddled 1.8 million taxpayers with higher taxes than they would have otherwise paid. This year it will be about 3 million.

By 2005, the AMT is projected to hit 65 percent of all married couples with two or more children and incomes between $75,000 and $100,000, up from 1 percent in 2003.

By 2010, the AMT is projected to pick the pockets of 32 million taxpayers, some with incomes of only $50,000 -- unless Congress does something to stop it.

Congress to the rescue?

Congress will stop it, right? A family consisting of Mom, Pop and two kids living on $75,000 or so a year is not exactly the caviar and champagne crowd that Congress had in mind when it enacted the AMT. Elected officials won't let this pernicious, creeping tax hike engulf that many middle-class voters, will they?

Well, maybe.

The problem is money. The AMT will raise a lot of it -- about $1 trillion over the next decade.

By 2008 it would cost less to repeal the regular income tax than to abolish the AMT, according to researchers at the joint Tax Policy Center of the Urban Institute and Brookings Institution.

So, if Congress closes the AMT spigot, it will have to do something to cover the loss of all that revenue. It could raise other taxes. Or it could end government as we know it, by cutting federal spending to the bone, and more. Or it could borrow more, which would undermine the economy by adding unconscionably to the nation's record deficits, just as baby boomer retirements are about to drive up the cost of Social Security and Medicare.

The AMT explained

So, what exactly is this AMT and how did it get so out of control?

It all started in 1966. That's when 155 taxpayers with incomes of over $200,000 (equivalent to about $1.15 million today) skillfully claimed enough legal deductions and tax credits to avoid paying any federal income tax at all.

The public was outraged. The answer from Congress was the AMT, a parallel system for calculating tax liability, enacted in 1969. The idea was to ensure that high-income earners paid at least a reasonable minimum in federal income tax.

Taxpayers who may be subject to the AMT are required to calculate their tax liability twice, first under regular income-tax rules and then again under AMT rules. Those rules provide one exemption -- currently $40,250 for single filers, $58,000 for joint returns -- but eliminate practically all the usual deductions and credits.

The unlucky souls trapped in that parallel universe must pay the greater of the two tax bills. If that's the AMT, the tax rate is 26 percent on the first $175,000 and 28 percent on income in excess of $175,000.

The AMT initially worked quite well. The problem is that it is not indexed for inflation, and the exemption has only been marginally adjusted. Had it been indexed, the $30,000 exemption set in 1969 would be worth $150,000 today. So as incomes rise with inflation and regular income taxes are cut, more and more people fall into the AMT's clutches.

How to fix it

Facing that prospect, Washington could repeal the AMT altogether. That would be a clean fix with the added benefit of simplifying the crushingly complex tax code. But the lost revenue would have to be made up somehow. And unless repeal was accompanied by major surgery on the regular tax code, the wealthy could once again eliminate their tax liability through skillful use of deductions and credits. We'd be right back where we started in 1966.

Or officials could continue to buy time. Congress increased the exemptions in 2001, and again in 2003, to $58,000 for married couples and $40,250 for most other taxpayers. That higher number is in place for 2004 and President George W. Bush has proposed continuing it in 2005. Unless Congress goes along, the exemptions will drop back in 2005 to $45,000 for married taxpayers and $33,750 for singles. But that's just kicking the can down the road. It postpones the day of reckoning; it doesn't prevent it.

There is a better idea. Reps. Steve Israel (D-Huntington) and Nita Lowey (D-Westchester) will soon introduce legislation to permanently raise the AMT exemption, for instance to $100,000 for married people, and index it to inflation. The cost? An estimated $400 billion over 10 years, to be offset by closing certain corporate tax loopholes.

Unintended consequences

It will be a tough sell, complicated by the politics of tax cuts and deficits roiling Washington in this presidential election year. Bush desperately wants to make permanent trillions of dollars in tax cuts enacted in 2001 and 2003. Unless Congress agrees, those cuts will be phased out by 2010. The biggest roadblock between Bush and his tax-cut objective is record deficits, currently in the neighborhood of $500 billion a year.

A permanent AMT fix would make the 5-to-10 year deficit picture even bleaker. Subtract the revenue that the AMT would generate over those years and projected deficits would explode, undermining the case for making permanent tax cuts that are already unaffordable.

Just as troubling are two other probable outcomes, should the tax cuts be made permanent and the AMT left unchanged.

First, even more middle-income taxpayers will be pushed over the AMT cliff -- a total of 44 million by 2014, according to the Tax Policy Center. That's because tax cuts that benefit the middle class -- elimination of the marriage penalty, for instance, and tax rate reductions -- will lower regular taxes for more families to the point where the AMT is triggered. Bush would, in effect, give with one hand and take away with the other.

Second, permanent tax cuts for the wealthy -- such as a lower top marginal rate and elimination of the estate tax -- and no AMT relief, could shift more of the burden for supporting the federal government onto the middle class.

Hard working middle America deserves better.