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Tuesday, December 25, 2007

The AMT: A Study in Opportunism, Cynicism, and Incompetence

Last week the Congress agreed to a one year moratorium on the alternative minimum tax...

Congress on Wednesday gave final approval to a plan that will spare millions of middle-class taxpayers higher tax bills for 2007. The White House welcomed the development and said President Bush would sign the bill.

The tax reprieve postpones for one year only an expansion of the alternative minimum tax, a parallel tax system enacted in 1969 to prevent very wealthy investors from using deductions and tax shelters to avoid paying income tax altogether. The alternative tax has ensnared a growing number of middle-class Americans in recent years because the 1969 law was not indexed to inflation.

Without the fix by Congress, some 25 million filers would have had to pay the tax on their 2007 income, up from four million who paid it on 2006 income, according to the White House.

Like with many things, the politicians didn't necessarily solve anything for the long term but rather punted responsibility for a year. While they may have created a one year moratorium, they haven't dealt with the fundamental difference in the two party's approach in confronting the AMT. Until that is dealt with, there is no long term solution to the AMT.

The AMT should be studied not only in accounting classes everywhere but also in political science classes because it is a case study in opportunism, cynicism and incompetence gone wild. This tax started merely as a means of closing a loophole so that 155 fat cats paid their fair share of taxes.

The AMT was introduced by the Tax Reform Act of 1969,[1] and became operative in 1970. It was intended to target 155 high-income households that had been eligible for so many tax benefits that they owed little or no income tax under the tax code of the time.[2]

The AMT is imposed under 26 U.S.C. § 55 and disallows many deductions and exemptions allowable in computing "regular" tax liability. (Regular tax liability is defined in 26 U.S.C. § 55(c)(1), with reference to 26 U.S.C. § 26(b), and does not include AMT and various other categories of taxes imposed under Chapter 1 of Subtitle A of the Internal Revenue Code.) The AMT sets a minimum tax rate of either 26% or 28% (depending on the amount of the taxpayer's "alternative minimum taxable income," as adjusted) on some taxpayers so that they cannot use certain types of deductions to lower their tax. By contrast, the rate for a corporation is 20%. Affected taxpayers are those who have what are known as "tax preference items". These include long-term capital gains, accelerated depreciation, certain medical expenses, percentage depletion, certain tax-exempt income, certain credits, personal exemptions, and the standard deduction.

The problem was that in their thirst to stick it to the wealthy Congress didn't dot every I and cross every T so to speak. What the AMT failed to do was account for inflation and soon these loopholes started to affect a lot more people than the really wealthy.

The AMT's lack of an indexation is widely conceded as a flaw across the political spectrum. In 2005, the Urban-Brookings Tax Policy Center and the Treasury Department estimated that around 15% of households with incomes between $75,000 and $100,000 must pay the AMT, up from only 2-3% in 2000, with the percentage increasing at high incomes.[citation needed] That percentage is set to increase quickly over the coming years if no change is made such as indexing for inflation. Currently, households with incomes below $75,000 are subject to the AMT only very rarely (and thus most tax advisors do not recommend computing AMT for such households). That is set to change in only a few years, however, if the AMT remains unindexed.

Of course, this isn't a problem that just came about in the last year. In fact, it has been looming for years. In 1999, it already affected one million people and the problem was exacerbated by the tax cuts of 2001.

...up from 1 million in 1999. This would make the AMT almost as common as the mortgage interest deduction is today. The AMT will be the de facto tax system for households with income between $100,000 and $500,000, 93 percent of whom will face the tax. It will encroach dramatically on the middle class, affecting 37 percent of households with income between $50,000 and $75,000 and 73 percent of households with income between $75,000 and $100,000 (compared to less than 3 percent for each group in 2002).

The expansion occurs because the AMT is not indexed for inflation and because of the 2001 tax cut. Because it is not adjusted for inflation, AMT liability tends to increase every year, even if real income does not change.

The problems with eliminating a tax almost everyone, including politicians, hates, is layered. First, despite never being meant as a tax for the masses, the Congress has become reliant on the AMT a serious source of revenue.

Repealing the AMT in 2005 would reduce revenues by $660 billion through 2014 if the 2001 tax cut expires as scheduled in 2010, and about $1,090 billion if the tax cut is extended. By 2008, it would cost more to repeal the AMT than to zero out the regular income tax. More than 75 percent of the benefits of repeal would go to households with income above $100,000 in 2010.

Thus, merely eliminating isn't as simple as it may seem. Neither side has stepped up with any reasonable solution. According to the activist web site, Reform AMT, there are roughly twenty different bills currently in one stage or another to deal with the alternative minimum tax. The Democrats version of fiscal responsibility is eliminating this insidious tax and replacing it with other taxes that are also meant only to target the rich. This is highlighted with a plan lead by Charlie Rangel. In his plan, Rangel goes after the wealthy demon du jour, private equity firms, as his main target.

Well, we haven't really concluded exactly how we're going to do it. There's some discussion as to, if there are people that are operating equitable funds and they do a good job, why should one group get taxed at a rate of 15 percent as capital gains when they've made no investment and another firm get paid at ordinary income?

Another thing that we're looking at is that we have the ability to have people who get large sums of money for pension funds to have this taken to tax havens overseas, and there's no tax consequence of it for them. Billions of dollars are lost with all of these tax schemes.

It is both surreal and absurd to watch a politician eliminate one tax that was originally meant to target only the wealthy with a series of others that they now again claim will only target the wealthy. Remember, the AMT was originally meant to close another loophole so that other fat cats couldn't take advantage of other supposed tax havens. The exact same language that Rangel is using now was used back then to sell the AMT on the public. Here is the language LBJ used when selling the AMT in its original format.

to embrace a conception of tax reform consisting in closing revenue leaks and erosion of the tax base concomitant to the many preferences that had crept into the tax code

Despite the obvious failings of the AMT, Rangel is now using much the same language to the target many of the same type of new taxes in order to eliminate the AMT.

The Republicans, on the other hand, see fiscal responsibility as the elimination of the AMT, and its hundreds of billions of dollars worth of revenues, and increasing spending at the same time. The Republican's plan is highlighted by a propsoal by Paul Ryan.

But the proposal also underscored why it will be so challenging for lawmakers to reach common ground on a permanent solution to this particular tax and budget dilemma.

The Ryan plan pointedly provides nothing to replace the estimated $840 billion in tax revenue that would be lost over 10 years with the abolition of the AMT, as it's known.

Meanwhile, neither side dares to decrease spending which would actually be the fiscally responsible thing to do when such a huge source of revenue is eliminated. The latest omnibus spending bill has 9170 earmarks.

Yet, the 2008 omnibus spending bill contains 9,170 earmarks in the 2008 omnibus spending bill. This total, in addition to the 2,161 earmarks in the 2008 defense spending bill (none of which were requested by the Pentagon), bring this year's earmark total to 11,331 earmarks for 2008, a mere 16 percent reduction compared to OMB's baseline of 13,492 earmarks in 2005. (Note: all earmark estimates exclude earmarks requested by the White House.) See Sen. Coburn's site for more details...

with such notable spending items as: Rodent control in Alaska ($113,000)Olive fruit fly research in France ($213,000)Hunting and Fishing Museum in Pennsylvania ($200,000)Louis Armstrong Museum in New York ($150,000)A bike trail in Minnesota ($700,000)A river walk in Massachusetts ($1,000,000)A post office museum in downtown Las Vegas ($200,000); andThe Lincoln Park Zoo in Illinois ($37,000).

The problem here is also more complicated than one would think. The sort of spending cuts necessary to be fiscally responsible in dealing with the elimination of such a huge source of income are impossible in this climate, in my opinion. That's because I believe that spending has become a tool of horse trading among legislators, and most of the spending has been promised as payback for support on some measure or another. I can't see Congress tightening its belt properly to deal with the reduction in revenue from the AMT because that would mean eliminating spending promised for votes.

Thus, here we are. The Congress has kicked the can on the AMT for one more year. A tax that was originally meant only for 155 people has now become so vital that it can't merely be eliminated. One side wants to eliminate and replace it with several other new taxes eerily similar to the AMT itself, and the other side wants to eliminate and spend some more. Thus, a tax that was created in an opportunistic, cynical and incompetent manner is being dealt with just the same.

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