Advisory panel takes on tax monster

Author: Dave Beal

Published: October 30, 2005

When the Advisory Panel on Federal Tax Reform issues its recommendations Tuesday, here's a prediction: Most commentators will say the chances that the panel's advice will be taken up are slim to none.

That may very well turn out to be true.

Yet if this group does nothing else, it has already performed a great public service. That's because the panel, appointed by President Bush 10 months ago, has made an absolutely golden recommendation: dump the federal "Alternative Minimum Tax" on individuals and find alternative ways to raise enough money to replace the tax revenue from the AMT.

Last week, the panel members disclosed that they will suggest that Bush and Congress go with one of two plans. The plans differ, but both recommend that the federal AMT on individual taxpayers be eliminated.

"I think that's a good idea," says Tom Stinson, Minnesota's state economist. "It no longer serves the purpose it was designed for. It's a stealth tax."

The Minnesota Society of CPAs, the state's primary professional organization for accountants, agrees. The society has been trying for two years to expose the shortcomings of this tax to Minnesota legislators, journalists and the general public.

Another AMT opponent is Barry Melancon, CEO of the American Institute of Certified Public Accountants,interviewed here last week.

Melancon says the AMT is so bad that if you gathered 100 taxpayers hit by it into a single room, only five would understand it.

Bob Ebel, a fellow at the Tax Policy Center in Washington, led a commission to study Minnesota's tax system in the mid-1980s. He worked on broad reform of the nation's tax system in 1986 during the Reagan administration.

"They were very bold when they had to be," Ebel says of the panelists' position on the AMT. "The AMT is such an awful thing."

To understand how this levy is metastasizing into the Frankenstein monster of all taxes, it's necessary to go back to the late 1960s.

When Treasury Secretary Joseph Barr in 1969 said that 155 wealthy taxpayers had paid no federal taxes in 1966, the American public was outraged. Leonard Burman, co-director of the Tax Policy Center, says that in 1969, members of Congress received more letters from constituents about this than about the Vietnam War. The center, a nonprofit think tank, is a joint venture of the Brookings Institution and the Urban Institute that focuses on tax, budget and social policy issues.

Congress reacted by passing a minimum income tax designed to prevent wealthy individuals from worming out of their federal tax liability. Later, the AMT replaced the original minimum tax.

Taxpayers in danger of being subjected to this levy must figure their income tax twice: first under regular income tax rules, then under AMT rules.

If the process determines that the AMT applies, various preferences and deferrals of income will be disallowed. The result is that they must pay a higher tax.

But the AMT exemptions and tax brackets, unlike those governing liability under the regular tax, are not indexed to inflation. Thus year after year, the AMT is harpooning more taxpayers.

And politicians, busily soliciting cheers from U.S. taxpayers for giving them tax cuts with one hand, are quietly taking them away with the other hand.

So far, the effects have been concentrated among upper-income taxpayers.

In 2003, the latest year for which state-by-state data are available, 2.5 percent of Minnesota's tax filers were hit by the federal AMT. That same year, 1.8 percent of all of the nation's filers paid this tax.

But now the numbers are heading up, in a stunning example of how the Law of Unintended Consequences is making an already seriously troubled tax system much worse.

The share of U.S. taxpayers who face the AMT this year is estimated at 3 percent. From here on out, projections show this ratio mushrooming.

A fact sheet issued by the U.S. Department of the Treasury last March projects that the number of federal taxpayers subject to the AMT will increase from 3.8 million this year to 20.5 million next year and 51.3 million by 2015.

These projections assume that Bush's temporary tax cuts, passed in 2001 and 2003, will be made permanent.

One reason for the big jump in projected AMT filers next year is that provisions protecting taxpayers from this tax are scheduled to expire or be sharply curbed at the end of 2005.

The bipartisan tax panel has nine members, including former Minnesota Republican congressman Bill Frenzel.

It has not spelled out critical details of its two proposals, which are designed to provide a general framework for Congress next year.

One is called the "streamlined income tax" plan. It creates four tax brackets, replaces the mortgage interest deduction with a lower-valued tax credit, eliminates the deduction for state and local taxes, reduces the capital gains tax and simplifies various provisions.

The other, more of a departure, is described as the "progressive consumption tax." It contains most of the provisions of the first plan but shifts the system toward taxing spending to encourage more savings and investment.

Why do so many people believe the tax reform panel's ideas won't get past first base anytime soon?

For one thing, 2006 is an election year - not the best time to be tinkering with the tax deductions and exemptions that affect the pocketbooks of millions of taxpayers.

For another, the panel's admirable suggestions for replacing the tax revenue lost by killing the AMT are virtually certain to lead those who see themselves adversely affected to "go ballistic."

The very idea of reducing the benefits for mortgage interest paid already has the housing industry up in arms. So does the plan to eliminate the deduction for state and local taxes. Both moves would hurt many Minnesota taxpayers.

Also, Bush is far weaker politically now than was President Ronald Reagan in 1986. The true tax reform Reagan achieved that year, with help from congressional leaders, was a crowning achievement of his presidency. And there was more money available to pay for tax cuts approved then than there is now.

But here's the rub. Something must be done soon about the AMT. It flunks miserably on all three major measures of good tax policy: fairness, simplicity and efficiency. Left untouched, it will become a monster.

Laura Kalambokidis, an economist at the University of Minnesota,puts it this way: "I wouldn't call it tax reform if they don't do something about the AMT."