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April 09, 2007

One More Thought on the AMT

It's worth saying, too, that issues like the AMT and college tuition deductibility are inevitable and annoying focuses of the Democratic Party. They are, in effect, attempts at economic relief for the middle and upper middle classes. The middle class sort of controls electoral politics in this country, so such focuses are inevitable. What would be nice is if the Democrats had the spine or vision to parlay the need to reform the Alternative Minimum Tax into a push for a wholesale tax simplification, along the lines of what Ron Wyden has proposed. That would allow for much more progressive outcomes even as the public argument focused on the need to change a policy the middle class loathed.

April 9, 2007 | Permalink

Comments

While Bush might sign (not veto) an AMT adjustment, it seems very unlikely that he will sign a bill that raises any taxes.

Finding a way to get to a veto-proof majority in both houses on this issue will not be easy, and more likely impossible.

I hate that damn Presidential veto. Very un-democratic (lower case d)!!

Posted by: JimPortlandOR | Apr 9, 2007 1:10:35 PM

Let me add: i guess i don't hate the veto idea, i just hate the 2/3rds majority needed to overturn a veto. The majority should rule - at least on budget/financial matters - and maybe everything.

Posted by: JimPortlandOR | Apr 9, 2007 1:12:45 PM

Why don't Democrats talk about "merging" the AMT and the regular income tax into a single tax, instead of "ending" one income tax and "raising" the other. That would provide for fairer outcomes up and down the income ladder, while shielding Democrats from the inevitable "tax-and-spend" epithets as long as total tax revenues are steady.

Posted by: rosswords | Apr 9, 2007 2:14:43 PM

I fail to see how Wyden's proposal does much towards "simplification." The tax code is 62,000 pages long, and no one could possibly master it. This strikes me as fundamentally absurd.

And until I consider how much the Dems are beholden to special interests, too, I can not for the life of me understand why they don't outflank the GOP on tax policy from the "right," and talk about trashing the Code altogether, as everyone I talk to regardless of political persuasion agrees the whole thing is a mess, and suspects it is where the super-rich go to hide money. Which David Kay Johnston's "Perfectly Legal" makes an awfully good case for.

Posted by: John O | Apr 9, 2007 2:14:50 PM

This should not be complicated. Simply cap deductions at some arbitrary figure (say, four times poverty level for a family of four) that gets adjusted annually and automatically for inflation. No more need for AMT. Of course I also think the standard deduction should be povery level for a family of four (yes of course the tax brackets would need a little bit of adjusting). This would allow most people to get their taxes finished in less than an hour, greatly improving compliance and reducing the number of low and middle income audits.

Posted by: ShortWoman | Apr 9, 2007 3:37:30 PM

One of the reasons why Capital Gains has always been taxed differently than wages is that there is a risk involved with capital gains. Generally, you are selling a capital asset that you bought earlier. You took a risk in making that investment. Wages are hardly a risk. Another issue is that I didn't see anywhere there would be increased relief if the investment goes South, only that there would be more tax if a profit materialized.

Now, do you think that investments are so inelastic that doubling or tripling of the Capital Gains tax rate (less return to investor) for the same risk will not affect the rate of investment? Does anyone here believe that a lower rate of investment is anything but negative for the economy?
If you don't think this will change anything, is this the 'something for nothing' theory offered up to support the minimum wage increase? Make major economic changes, but it really won't change anything?

Posted by: Fred Jones | Apr 9, 2007 3:41:06 PM

Fred, I am with you in spirit, but it is the double taxation of capital gains that is the most important reason why it has a seemingly lower rate. Liberals/socialists/progressives (whatever) like to frame the issue in class envy terms: the "super-rich" are getting a sweetheart deal (no fair!) on their income even whilst sipping martinis. But they conveniently ignore the fact the corporate dividends, for example, have already been taxed at the full rate as corporate profits (say 33%). Dividend income is then taxed again at 15%, for a total of 48%.

There might be good reasons for taxing capital gains, but the premise that people who derive income from investments are getting a sweetheart deal at the expense of wage slaves isn't one of them.

Posted by: FoolsMate | Apr 9, 2007 8:10:21 PM

One tricky issue with capital gains is what's called the bunching of income problem. That is: someone builds a business over 20, 30, or 40 years and then sells it for, say, $5 or $10 million. It's unfair to tax the entire gain as though it were all earned in one year. High risk venture capital would also be adversely impacted by significantly higher rates. When the capital gains tax was very high during the Carter Administration and inflation was raging, the venture capital industry was virtually non-existent.

The Tax Reform Act of 1986 taxed capital gains, interest, dividends and wages all at the same rate, but the maximum federal rate was 28%. Numerous states now have top marginal income tax rates of 8%-12% which get added to the federal rate. I think it would be fine to go back to the 1986-1988 approach, but a 35% top federal rate on capital gains is too high, in my view.

A simpler way to fix the AMT, I think, is to add capital gains and dividends to the income base that would be subject to the AMT. So, if you're a middle class taxpayer that has modest capital gains and dividend income, you will still benefit from the 15% rate (assuming the exemption amount is also raised and then indexed to inflation going forward). If you're a mogul that just sold your company for $1 billion, you will pay 28% (plus state income taxes if applicable) on the capital gain instead of the current 15% federal rate.

Posted by: BC | Apr 9, 2007 8:15:23 PM

BC: The simplest way, duh, to fix the AMT is to raise the threshold to account for inflation, so it will impact only the high-income earners (and not middle-class) as it was intended. Why all the extra contortions?

Posted by: FoolsMate | Apr 9, 2007 8:32:24 PM

Why all the extra contortions?

Raising the exemption loses revenue that has to be made up under PAYGO rules. Either other taxes unrelated to the AMT must be raised or the AMT income base has to be broadened or some combination of the two. If all that was required was to index the exemption to inflation, it would have been done years ago.

Posted by: BC | Apr 9, 2007 8:40:49 PM

That is the problem. No one is willing to have the government take the cut. Oh, yeah, we can lower this tax or that tax as long as the government doesn't have to tighten it's belt.

Why are spending cuts off the table?

Posted by: Fred Jones | Apr 9, 2007 9:02:59 PM

There is nothing sacred about the paygo rules and nothing HAS to follow it. They are an artificial construct designed to preserve the AMT by preventing tax cuts from offsetting it. These are key strategic goals of the Democratic party--they intend to use the AMT as leverage against the middle/upper-middle classes. Relief from the AMT will only come at the price of tax increases for the "wealthy".

Posted by: FoolsMate | Apr 9, 2007 10:00:05 PM

But they conveniently ignore the fact the corporate dividends, for example, have already been taxed at the full rate as corporate profits (say 33%).

Wages and dividends all come from the same funds. Corporations are free to pay dividends whether they make a profit or not, and they choose to pay to attract investors. It's not the same as profits. Why treat wages and dividends differently?

It's unfair to tax the entire gain as though it were all earned in one year.

How should it be taxed? I'm not clear on how this matters.

A simpler way to fix the AMT, I think, is to add capital gains and dividends to the income base that would be subject to the AMT.

This makes sense to me (if I understand it right). The threshhold needs to be raised too, though, right?

Why are spending cuts off the table?

Because government is the most efficient means to do so many things we want to do.

Posted by: Sanpete | Apr 9, 2007 10:07:51 PM

It's unfair to tax the entire gain as though it were all earned in one year.

How should it be taxed? I'm not clear on how this matters.

A simpler way to fix the AMT, I think, is to add capital gains and dividends to the income base that would be subject to the AMT.

This makes sense to me (if I understand it right). The threshold needs to be raised too, though, right?

The tax rate matters if the tax structure is highly progressive, and the gain was built over an extended period of time. Sensible alternative taxing approaches include 10 year averaging or an Alternative Maximum Tax. Ten year averaging would figure the tax due on one-tenth of the gain and multiply that by ten to arrive at the total tax. The Alternative Maximum Tax would apply some reasonable rate (like 25%-30% at most) to the entire gain as an alternative to the regular tax. The taxpayer would pay the lower of the two alternatives.

If capital gains and dividends were added to the income base to figure the Alternative Minimum Tax, the exemption amount would, indeed, need to be raised which is the proper way to fix the problem for the middle class. Ideally, it would be raised to the level that would have applied if the original exemption were indexed to inflation in the first place.

Posted by: BC | Apr 10, 2007 9:04:24 AM

Because government is the most efficient means to do so many things we want to do.

Ummmmm...yeah, for national defense, fire and police protection, but this blanket statement is the stupidest thing you've said to date. Citizens Against Government Waste estimates that reforms could save 1.27 TRILLION over the next 5 years.

Posted by: Fred Jones | Apr 10, 2007 11:04:08 AM

Many here talk of AMT and really don't understand that it's a secondary, stand-alone tax system. Income must be figured under the regular income tax system and also under the AMT system. The AMT system has fewer deductions and lower tax rates. Anytime a taxpayer's AMT tax amount is higher than his regular tax amount, the difference is added to his regular tax. It was a patch to catch those who didn't pay hardly anything by playing by the rules at that time.

As a tax accountant, I shouldn't bitch as it keeps me working and able to buy more rentals. That being said, I would chuck it all in a heartbeat for a national sales tax even though it would not be in my personal economic interest.

Posted by: Fred Jones | Apr 10, 2007 11:11:25 AM

Great post, Ezra.

I'm helping build Senator Wyden's new website, and while I don't speak for him or his campaign, I thought I'd summarize the plan briefly for y'all:

Basically, Senator Wyden has proposed a "fair, flat tax". It retains a very progressive rate structure, but the flat-ness comes from the elimination of most of the tax loopholes, as well as from an equalization of the tax rate between work and investment. Because of that, it becomes possible to take on the tax-prep industry and dramatically simplify tax preparation for regular folks.

There's lots more info about Senator Wyden's tax reform plan here.

Posted by: Kari Chisholm | Apr 10, 2007 1:50:27 PM

I don't speak for him or his campaign

Ack, I don't speak for him or his staff.

Posted by: Kari Chisholm | Apr 10, 2007 1:52:51 PM

The big problem with this kind of tweak is that it will not stay that way for long. All it will take is a future congress to want to favor a group and there will be changes...

Posted by: Fred Jones | Apr 10, 2007 5:33:32 PM

I would like to see a consumption tax instead of an income tax.

1)The hundreds of billions of unreported income from crime, sports gambling, drugs, etc. will be taxed when it's spent.
2)A consumption tax encourages savings and investment.
3)A consumption tax is inexpensive to administer and the infrastructure is already in place.
4)A consumption tax is transparent. Everyone will know it if Congress hikes their taxes everytime they go to shop.

Posted by: Fred Jones | Apr 10, 2007 5:38:58 PM

Fred,

I like consumption taxes also for the same reasons you do – especially the ability to tax economic activity that would otherwise go untaxed and transparency. The problems are that (1) the rate would have to be quite high to completely eliminate the income tax and it would shift the tax burden from the wealthy to the middle class.

On the AMT, for the millions of us that now use TurboTax and other tax software, it is no extra effort to deal with the AMT because the software computes the tax liability both ways for you and lets you know which one applies. I can't imagine that very many people who prepare their own taxes don't use tax software, and all professional preparers probably do.

My own preference would be to pass a Value Added Tax in the range of 6%-8% that could probably raise 2.5%-3.5% of GDP as compared to the 10% of GDP that the current income tax brings in. We could scrap the regular income tax and keep the AMT. With an exemption of $100K for joint filers ($50K single) and indexed for inflation, the income tax would disappear for most of the population. Typical wage earners would pay FICA taxes and the VAT while higher income and wealthy people would also pay the income tax but at a rate no higher than 28% on all income regardless of its source except for tax exempt bonds which, in effect, are already taxed in the form of the lower interest rate that investors accept when they buy them vs what they could have earned from a taxable bond.

Posted by: BC | Apr 10, 2007 6:31:45 PM

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Posted by: judy | Sep 28, 2007 5:25:49 AM

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