Looming issues with the so-called Alternative Minimum Tax (AMT) have been discussed aplenty in econblog land, but today's New York Times article on the subject is perhaps timely in light of the heightened (but legitimate) hand wringing about how the U.S. economy might find its way back to long-run equilibrium. (Kash is the latest, I think.)
First, the set up:
The alternative minimum tax is similar in some ways to a flat tax that blocks people from using most of the big deductions that reduce their taxable income under the normal rules. A married couple with a gross income of $100,000, for example, must first calculate its tax bill the traditional way, then again under the A.M.T. In the alternative calculation, the couple gets to exclude $58,000 from taxation, but it must also strip out all the personal exemptions and most itemized deductions.
The prohibited deductions include those for state and local taxes, medical expenses, employee business expenses and interest on home-equity loans. The A.M.T. would then apply a flat tax of 26 percent (28 percent for couples who earn more than $175,000). The couple must pay whichever is higher, the tax calculated under the traditional method or the one under the A.M.T.
The huge looming tax increase is caused by two things. The first is that the exclusion level for the alternative minimum tax is not adjusted for inflation, so the tax affects more people each year as nominal incomes go up. The second, paradoxically, stems from Mr. Bush's tax cuts of 2001 and 2003.
Those cuts reduced regular tax rates at all income levels but did not change the alternative minimum tax. At the same time, some of the cuts came in the form of expanded deductions - the child tax credit, child care tax credits and bigger exemptions for married couples - that are not allowed under the alternative formula.
The "payoff"?
... If current law remains unchanged, the alternative minimum tax is expected to wring an extra $33.9 billion from 18 million households in 2006. In 2010, it will rake in an additional $100 billion, and by 2015 an extra $200 billion...
The effect of making Mr. Bush's ordinary income tax cuts permanent would be significant. Mr. [Leonard E.] Burman, at the Urban Institute, estimated that the alternative minimum tax would generate about $69.2 billion in extra tax revenue in 2015 if the president's income tax cuts expired on schedule. But if the White House persuaded Congress to make the cuts permanent, the alternative minimum tax would raise a staggering $200.8 billion in that one year.
OK, I can hear you already: This is no way to run a railroad. Fair enough. But, as people have rightly argued in the social security debate, sustainability is a necessary condition, but it is not the same thing as good policy.
Several years back -- in early 2000, to be precise -- I argued against getting too carried away with spending projected surpluses. I based my argument, in part, on how difficult it was to foresee those surpluses arising in the first place. Today, I have about the same level of confidence in the view that the fiscal apocalypse is upon us. (As do capital markets apparently, as long as you entertain the possibility that not everywhere who accumulates Treasury debt is insane.)
The Times article goes on:
President Bush has promised to fix the alternative minimum tax as part a fundamental overhaul of the tax code, and he has ordered a bipartisan advisory panel to come up with recommendations by the end of July.
But in giving the panel its marching orders, White House officials made it clear that they are counting on the extra money regardless of what happens to the alternative tax. Under the president's instructions, the panel's recommendations on addressing the alternative minimum tax are supposed to be "revenue neutral," neither raising nor lowering taxes, and to assume that his income-tax cuts will be made permanent rather than expire in 2010, as required under current law...
Jeffrey F. Kupfer, executive director of the tax panel and a former Treasury official, confirmed that interpretation. "Our mandate is to be revenue-neutral, and we are interpreting that with respect to the president's policy baseline, which does not include a permanent fix to the A.M.T.," he said in an interview last week.
A tall order, that one. But this is what I truly believe: Fundamental tax reform is orders of magnitude more important for the future of the U.S. economy than what the deficit is at any point in time, let alone what it is projected to be in some very murky future. Let's get on with that discussion.
Note: The Congressional Budget Office describes the effects of the AMT on revenue projections here -- see Box 4.2, in particular.