For Some, the Tax Cut on Investment Income Is Not as Sweet as Advertised

Author: David Cay Johnston

Published: July 19, 2005

Millions of investors who bought dividend-paying stocks after President Bush persuaded Congress to lower the taxes on investments to 15 percent are paying a lot more, in some cases almost 50 percent more, two new analyses show.

The cause is the alternative minimum tax, a parallel income tax that was originally aimed at the richest taxpayers but is affecting an increasing number of Americans and denying them at least part of the Bush administration's tax cuts.

Until 2003, dividends were taxed at the same rates as wages, as high as 35 percent for some taxpayers. But the alternative minimum tax can subject taxpayers who make less than $382,000 (roughly the threshold for the top 1 percent income class) to an effective tax rate on dividends and capital gains of 22 percent. The higher rate can affect some taxpayers making as little as $75,000.

John Buckley, the chief tax lawyer for Democrats on the House Ways and Means Committee, argued in an article published yesterday in Tax Notes, a weekly nonprofit journal of tax policy, that this denial of promised tax relief was not a mistake, but part of a calculated Republican strategy dating back to at least 1996. The article is also posted at www .taxanalysts.com . "The use of the A.M.T. to reduce the cost of recent tax cuts clearly is the most consequential of the many budget gimmicks we have seen in recent years," Mr. Buckley, who opposes most of Mr. Bush's tax policies, wrote.

"The 1997, 2001 and 2003 tax cuts are remarkably similar in one respect," he wrote. "They used the A.M.T. to limit the benefits provided to middle-income and moderately wealthy taxpayers to provide the greatest benefits to the very wealthy."

The Treasury Department, speaking for the White House, issued a statement on Friday calling Mr. Buckley's analysis "absurd."

Taxpayers affected by the alternative minimum tax can lose tax deductions for state and local taxes, exemptions for themselves and dependents and even the standard deduction. In place of those deductions, the tax law approved in 2003 allowed taxpayers who are married and filing jointly to exempt the first $58,000 of income and smaller amounts for heads of households and single taxpayers. (Those exemptions are to fall to $45,000 for married taxpayers and $33,750 for single ones this year unless Congress acts.)

But the exemption is subject to income limits, then begins to phase out at a rate of 25 cents for each dollar. The phaseout begins when married taxpayers filing jointly make more than $150,000, when taxpayers who are single make more than $112,500 and when a spouse filing separately makes $75,000. Once taxpayers who are married and filing jointly make $382,000, they lose their entire exemption. Single taxpayers lose their exemption at $273,500.

Once the married taxpayers make more than $150,000, any additional income, including dividends, reduces their exemption by 25 percent, leading to the higher effective tax rate on their investments.

Married taxpayers who make more than $382,000 get the promised 15 percent rate. Mr. Buckley's finding was confirmed by the Institute for Research on the Economics of Taxation, a nonprofit group in Washington allied with the White House in seeking to eliminate taxes on dividends, capital gains and other income that is not from wages.

Stephen J. Entin, the institute's president, ordered his own analysis in response to questions. He concluded that many investors lose 7 percent to 38 percent of their promised tax relief to the alternative minimum tax. Mr. Entin said that denial of the full tax relief promised to investors "poisons the tax cut."

By 2010, several estimates show, the alternative tax will bring in so much money that repealing it would cost more than repealing the regular income tax. Families with two or more children are 30 times more likely than single people to lose part of the Bush tax cuts to the alternative tax, according to studies by the Tax Policy Center, a nonprofit research organization in Washington. Homeowners are far more likely to be affected than renters.

Mr. Buckley said the rapidly growing reach of the alternative minimum tax was not a result of inflation, as official government reports and many politicians have stated.

"In materials submitted to the President's Advisory Panel on Tax Reform, the Treasury Department suggested that the increase in the number of A.M.T. taxpayers is due to the lack of inflation adjustments in the A.M.T. and, to a lesser extent, real growth in income," Mr. Buckley wrote. "The Treasury Department made no mention of the contribution that the recent tax cuts have played."

He wrote that "the Tax Foundation (a conservative group that has been a consistent supporter of lower taxes) is far more objective in its analysis." He quoted its finding: "A far more important factor causing the A.M.T.'s recent expansion is the effect of the 2001 and 2003 tax cuts. Ironically, by reducing regular income tax liabilities without substantially changing the A.M.T., the Bush tax cuts would be responsible for most of the expansion of the A..M.T. through 2011."

The Congressional Joint Committee on Taxation found that "approximately 60 percent of the A.M.T. liabilities in the future are due to the 2001 tax cut," Mr. Buckley wrote.

He added that "a substantial portion" of the remaining alternative tax effect was related to the 1997 Tax Act. Sponsored by Republicans and signed by Bill Clinton, it lowered capital gains taxes and created a child credit for many middle-class parents, but denied it to millions more.

Mr. Buckley also wrote that the marriage penalty relief in the 2001 Bush tax cuts was illusory, saying that "it merely changed the name of the tax imposing the penalty" from the regular income tax to the alternative.

"The current broad reach of the A.M.T. is not accidental as some suggest," he wrote. "The fine print of the A.M.T. has been consistently and deliberately used to reduce the budgetary costs of the tax reductions promised in the much advertised big print of recent tax legislation."

In his 2001 tax cut, Mr. Bush made no provision for alternative tax relief, which was inserted at the insistence of Congress. The president has yet to propose any form of permanent alternative tax relief or repeal, but has instead said that it should be done as part of wholesale overhaul of the tax system.

Taylor Griffin, a Treasury spokesman, said: "The president's tax cuts were designed to provide tax relief to all Americans and to stimulate economic growth. That's exactly what they did and continue to do."

He added that Mr. Buckley's assertion that the alternative levy was a sleight-of-hand to focus tax cuts on the highest-income Americans "is absurd," and said that "the administration is as concerned as anyone about the growth of the A.M.T. and its effect on taxpayers."